Southern European economies have diverged – POLITICO


Carla Subirana Artús is an economist and has as Policy Analyst for the Bank of England and Europe Research Analyst for Economist Intelligence.

If the Eurozone were a school, Portugal, Italy, Greece and Spain would be the slackers of the class. The four countries branded with the ugly acronym PIGS talk loud, enjoy the slow life under the sun, and are over-indebted and in need of reform – so the cliche goes.

But if you look more closely, you’ll find that some of these once recalcitrant students have now become unlikely model students.

Although Italy and Greece remain economic laggards, Spain and Portugal’s growth trajectory has become more resilient and compelling since the 2012 sovereign debt crisis – a shift that has become apparent as an era of super-loose monetary policy has ended. And much of the credit for this split between the Iberian peninsula and Italy and Greece goes to the structural reforms introduced by Spain and Portugal over the past decade. Nevertheless, the euro zone is not crisis-proof.

A recent example of the divergence between southern Europe’s economies and their respective approach to reform was the European Central Bank’s (ECB) pledge to end its asset purchase program in June. While 10-year government bond yields in Italy and Greece soared, borrowing costs for Portugal and Spain remained closer to those of the Netherlands – seen by European Union officials as a model student.

Over the past decade, Italy’s labor reforms have been hesitant and the country has only partially addressed its bank defaults, while Spain has tackled these problems much more decisively. As a result, Spain’s GDP per capita in purchasing power overtook Italy’s in 2017, supported by a rise in total factor productivity – or the efficiency with which an economy uses its productive inputs.

The country has since grown into one of Europe’s largest car manufacturers, and its exports have diversified beyond tourism into chemicals, pharmaceuticals, machinery and professional services.

Investors are now looking at the country in a different light, resulting in lower borrowing costs for households and businesses. While the country’s credit default swap spreads – which are insurance-like derivatives that pay out in the event of a default – were identical to those of Italy until 2014, they have since been closer to those of France.

Portugal also has a promising decade behind it. Since 2014, the Greek economy has grown on average three times faster than Greece’s, where production is almost a quarter below 2007 levels. By spurring growth while implementing onerous reforms and meeting tough budget targets demanded by EU officials, António Costa, Portugal’s socialist prime minister since 2015, has become Brussels’ favorite student.

In contrast, Syriza, the Greek left-wing party that governed the country from 2015 to 2019, was the class rebel. The government postponed reforms as public debt remained the highest in the eurozone, banks’ bad loans were piling up and tax revenues remained on too narrow a basis, requiring high interest rates that discouraged hiring.

Despite his progress, however, any jubilation over the Iberian Peninsula’s success was yet to be dampened.

Portugal’s fiscal caution, for example, comes at a price. Public investment was the lowest in the EU in 2020 and 2021, and the country’s public debt – the highest in the eurozone after Greece and Italy – puts the broader economy at risk of being hit by higher government borrowing costs. In addition, salaries are low by Western European standards, which sends many Portuguese to work abroad.

Across the border, the Spanish government, made up of the Socialists and far-left group Unidas Podemos (Together We Can), has also failed to offer creative solutions since 2019 to fix the country’s unsustainable pension system and sky-high youth unemployment. And in the face of an ugly election in which neither party is likely to win a majority, the moderates are now eyeing Vox – a relatively new far-right organization which has worryingly strong support in the polls – with suspicion.

Meanwhile, Greece has been busy doing its homework to join the club of successful turnaround stories in the eurozone periphery. The government of Kyriakos Mitsotakis, Greece’s centre-right prime minister since 2019, has managed to boost its image among tourists and investors, attracting record levels of foreign investment over the past year.

However, Italian growth will most likely continue to disappoint as the rare stability Prime Minister Mario Draghi brought to his politics has now come to an end.

Political stability is important – not only for Italian families. ECB officials fear that the monetary union would falter if the infamous “doom loop,” which ties banks’ solvency to that of their host countries, hits Italy and threatens to trigger a debt crisis.

And while most European banks have reduced their exposure to their home country since the 2012 sovereign debt crisis, Italian banks are as exposed to sovereign debt as they were a decade ago, with the bank-sovereign linkage being particularly strong.

So if political unrest in Italy intensifies and investors start demanding higher yields on holding Italian debt, the country’s banks will inevitably suffer. There are already signs Italian banks are headed for trouble: the country’s largest lender’s annual yield — a measure of investment performance — has fallen 24 percent since February.

And now, plagued by sluggish investment, meager reforms and renewed political instability, Italy will remain the eurozone’s problem student for the foreseeable future.


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