Skip to main content
economy

ABBAS MOMANI

The yawning productivity gap between the more prosperous northern economies of the euro zone and their less efficient neighbours in the Olive Belt played a little-heralded role in the debt crisis that did so much to undermine the currency and exposed deep fissures in the monetary union itself.

Thanks to their embrace of the euro, cash-poor Greece, Portugal and a handful of other countries gained access to the lower-cost capital they needed to address endemic structural problems within their economies, including a chronic lack of productivity growth. Improving this record was one of the selling points of joining the monetary union.

The idea was that the shared currency and cheaper costs of financing, combined with more efficient access to larger markets and greater labour mobility, would enable the poorer countries to eventually catch up. They did plenty of spending, driving up public debt to unsustainable heights; but it had little to do with making their economies more competitive. And with the traditional weapon of currency devaluation removed from their arsenal, the chasm remained. Portugal's labour productivity, for example, has remained consistently below two-thirds of the European Union average for most of its euro decade.

"I don't think the gap can be narrowed any time soon," said Tyler Cowen, an economics professor at George Mason University in Arlington, Va. "Institutions cannot be changed overnight and usually cannot even be changed with a 20-year time span."





Investor Education: Productivity





Prof. Cowen singles out eastern Germany, whose productivity still trails that of west Germany two decades after the former Communist regime collapsed. "Unification has gone so well only because so many East Germans have moved to the west."

When economists talk of competitiveness problems in southern Europe, they are typically referring to wages and prices in euros that are too high in relation to economic output. Before the advent of the euro, these weaker countries could - and occasionally did - devalue their currencies to help maintain their competitive footing. Once they adopted the common currency, this avenue to higher productivity was no longer open. But the countries did not alter their behaviour.

"They had sort of a creep in price and wage increases. They were used to prices moving up fairly regularly and they haven't changed their habits," said Amy Verdun, co-author of a new book on the euro zone, Ruling Europe: The Politics of the Stability and Growth Pact, and chairwoman of political science at the University of Victoria.

It's not only the Club Med countries that have been afflicted with this chronic illness. The list has also included Ireland and even the Netherlands. But in the latter, strong growth and low unemployment before the recent slump reined in upward pressure on wages and prices.

In a handful of other small European economies, including Denmark, Austria and Belgium, inflation expectations were not an issue, and they have been more competitive as a result.

Greece "has an economy which is not competitive at the prevailing exchange rate and which lacks the structural flexibility to become competitive," Roland Nash, head of research with Renaissance Capital in Moscow, said in a note to investors.

Now, a weaker euro is boosting productivity throughout the region. But more efficient producers like the Germans are reaping the biggest benefits.

Greece ranked a sorry 109th last year on the World Bank's annual index measuring the ease of doing business. Spain came in 62nd and Portugal 48th. By comparison, Canada ranked eighth.



Cat:e528746c-3414-401a-b14b-50247e3bdf01Forum:2d13dc33-9921-4d4a-815f-e809277631e4



Without a devaluation option, the weaker euro members could still boost labour productivity through improved infrastructure, higher investment and a great deal more mobility. But they lack the capital for better infrastructure or increased business investment; and the European promise of greater movement of workers remains largely unfulfilled.

"I don't see the Greeks moving where nobody wants them [in northern Europe]" said Cornell University economics professor Eswar Prasad, a former IMF official. With the standard means of improving productivity closed off, the only other solution, he said, is for Germany to pump increasing amounts of transfers to the south.

"And that's clearly not politically tenable. So it's not easy to see how they can resolve these tensions. In the best-case scenario, the problem doesn't get worse. A more realistic scenario is that it will get worse over time, because Germany will continue having rapid productivity growth and they [the weaker euro members]won't."

Interact with The Globe