Two Speed European Economy

The idea of a two speed Europe is nothing new. Roughly the strong dynamic north(Germany in particular), the weaker more sluggish south (Italy, Spain, Portugal, Greece) . At one point it was often used to refer to those who had joined the Euro and those who had risked being marginalised on the outside.

Recent figures on economic growth highlight this two speed Eurozone economy. Germany has posted the fastest growth for many years + 2.2% in the last quarter, giving annualised growth of 8%.

Ireland on the other hand has posted negative growth. Greece has provisionally shown a deep recession with GDP figures showing growth of -1.5%. Other club med countries such as Spain and Portugal barely posted positive figures. The UK's last quarter showed growth of 1.1%. (link FT)

But, these figures have to be treated with care, all countries have a significant output gap, so you would usually be expecting strong growth at this stage in the economic cycle. But, many factors make these economic recoveries look increasingly fragile. I fear that Spain and Portugal are heading for a double dip recession.

The German economy has benefitted from the weaker Euro, enabling its strong export industries to increase sales to China and other countries. Certainly a strong German economy is a boon to the Eurozone. Higher growth will help to reduce the German budget deficit and make Germany feel more confident in helping out its profligate neighbours.

However, the recent Sovereign debt crisis has sparked a deep change in thinking. There is a realisation, that you can't rely on Germany to bail out its profligate neighbours. Unless the peripheral countries regain a sense of competitiveness, productivity and long term budgetary focus, there will be continued problems which threaten the whole Eurozone project.

The worrying signs are that those countries faced with large budget deficit's are stuck in a vicious cycle. High deficits leading to harsh austerity measures. Austerity measures (spending cuts, tax rises) reducing confidence economic growth. In turn this negative growth leading to a fall in tax revenues, higher unemployment and therefore a bigger deficit.

This vicious cycle is difficult to break because in the Eurozone, member countries are being faced with the twin problem of disinflation (close to deflation) and lack of independent exchange rate policy. Even strong economic growth in Germany may be insufficient to break this cycle of slow growth.

Related

• European Fiscal crisis
• Germany and the Euro