It is useful to compare the trend of per capita real GDP in the US and in the eurozone (figure 1). The graph shows a decline in real average incomes since 2007-08 in both areas. The impact of the crisis on the US is larger, the decrease in per capita income is of minus $2,459 at constant prices (minus 6%), compared a fall of minus 1,200 euro (minus 4.7%) in the eurozone. However, in 2012, the average US income has recovered to pre-crisis levels, whilst Europes is still 2.5 points below.
In order to understand why, it is useful to look at the state-level data. Figure 1 shows two bands for the US and the eurozone, respectively, whose upper and lower limits describe the per capita income in the richest and poorest state: the District of Columbia and Mississippi in the US; Luxembourg and Estonia in the eurozone. From the graph it is clear that internal differences are much greater in the eurozone than in the US. Between 2000 and 2012, real per capita income of the richest US state is five times that of the poorest state. In the eurozone this ratio is 8.6 to 1.
The data on unemployment confirms this patternboth countries experience a sharp rise during the crisis years; however, aggregate unemployment rate in the US has been declining since 2010, whilst it is still increasing in Europe. In 2012 the gap between the lowest (4.3% in Austria) and the highest (25% in Spain) rate skyrocketed.
A closer look at convergence/divergence
According to the standard model of economic growth, poor countries should grow faster than rich ones. This is because in such countries capital, compared to labour, is relatively scarce, and thus more productive. Consequently, one would expect poorer countries to save and invest more, as return on capital is higher. This process of convergence has occurred in Europe between 2000 and 2007; however, the speed of convergence has halved in recent years.
On the supply side, countries which before 2008 had lower (incentives for) productivity growth, are those that are suffering more as a result of the crisis. Figure 2 shows the relationship between cumulative growth of total factor productivity in Europe in the pre-crisis period, 2000-08, and the subsequent change in real GDP per capita, 2008-12. Countries whose productivity had risen less before the crisis are those where average per capita GDP falls more (or increases less) during the crisis.
There are, of course, exceptions. Greece, in the lower part of the graph, suffers a meltdown of GDP per capita during the crisis (minus 17%), despite having experienced a modest rise in productivity (plus 1.5%). Slovakia, the point towards the right in the chart, experiences a decline in per capita income (minus 2.8%) despite a spectacular cumulative growth in productivity between 2000-08 (plus 31%). The case of Greece is clearly due to the sovereign default and the harsh austerity measures; that of Slovakia is largely due to the sharp contraction in exports. Both cases highlight the role of aggregate demand factors in addition to supply rigidities.
The explanation of the heterogeneous impact of the crisis on eurozones economies cannot abstract from the impact of fiscal consolidations on aggregate demand. Figure 3 shows the relationship between the severity of fiscal tightening in the period 2009-12, measured by the improvement in the budget balance in percentage of GDP (x-axis) and the growth of GDP per capita in the same period (y-axis). On average, a reduction of one percentage point in the deficit/GDP ratio is associated with a fall of 0.84 points of GDP per capita.
The figure also shows a strong heterogeneity in the response of European countries to the budgetary tightening, which suggests that fiscal austerity alone is not enough to explain the differential impact of the crisis. The most significant cases are Greece and Irelandtwo small economies that have lost access to international capital markets, have suffered the consequences of a credit crunch, and have resorted to conditional loans from the Troika. In Greece, on the bottom right of the graph, GDP per capita fell by nearly 20 percentage points during the period, whilst the budget improved by about 5,6 points of GDP. In contrast, in Ireland, to the right in the graph, per capita income has remained largely unchanged despite a tightening of over 6% of GDP.
Redistribution in Europe, US
The lack of an adequate EU federal budget does not only prevent the eurozone countries from sharing a macroeconomic policy to contrast aggregate shocks, such as the global recession; it also precludes the implementation of an effective insurance system based on inter-state transfers, in order to address country-specific shocks, such as the banking crisis in Ireland or Spain. Italy, the largest net contributor relative to its GDP, pays to the EU budget 0.38% of its GDP per year; Hungary, the country that most benefits from the EU budget, receives transfers equivalent to 4.67% of its GDP. The size of the transfer scheme in the US is of a much larger magnitude. The poorest states, such as West Virginia, Mississippi, and New Mexico in the decade 1990-2009 have received transfers between 244 and 261% of their GDP in 2009, while rich states, such as New Jersey, Delaware, and Minnesota have given contributions that in total amount to 150-206% of their 2009 income.
The crisis has slowed down the process of convergence between European economies. This happened because the effects of demand shocks were amplified by pre-existing supply-side structural problems in the markets for goods, labour, and credit. The crisis has also highlighted the inadequacy of European institutions, and has exposed the faults in their design.
Unlike the US, the integrity of the eurozone ultimately depends on the political will of each member state; this makes the eurozone intrinsically vulnerable to speculative attacks. The way to shed the eurozone from the risk of disintegration is long, and fraught with political obstacles. It requires each country to jumpstart the path of structural reforms, and it requires Europe to gradually establish a federal budget, an inter-state insurance scheme, and enforce a no-bailout commitment. Last but not least, the eurozone needs to move away from centralised system of ineffective and invasive rules. This is a path worth pursuing, since the alternativethe disintegration of the eurozoneis quite dire. The benefits of free movement of goods, persons and investmentsthe factors that make the US economy strongcould be at stake.
Isabella Rota Baldini & Paolo Manasse