Despite these more favourable factors, no recovery is expected in 2014 and 2015 but only a mild rebound in activity. Public and private debt reduction is a key requirement to expect the end of the crisis. A genuine recovery – one that starts to close the output gap that has opened up and bring down unemploy-ment – supposes a reasonable strategy combining return to growth, a low level of sovereign interest rates and a credible path for fiscal consolidation which would not overwhelm growth. This strategy needs to define a realistic timeframe, a sustained process and a coordination of economic policies between countries and agents.
A key issue for implementing such a strategy is to evaluate the extent to which the economy could rebound, i.e. the extent of the output gap, on which the breakdown of public balance into cyclical and structural deficits depends: the higher the output gap, i.e. the gap between current and potential, non-infla-tionary output, the higher the cyclical component of the deficit and therefore the smaller the structural effort required to reduce public deficit. Then, the question arises regarding the impact on potential output of the biggest slump in Europe since the Great Depression. Estimating potential output is not an easy task, espe-cially when economies have been depressed for six years. Should we consider a permanent downward shock to the level of potential output or only a slowdown in the potential growth rate? Are the losses of potential output definitive as suggested by the Spring estimates of the EC? If they are, the output gap in the euro area is small and the capacity of rebound would be limited (Figure 8).
Another possibility would be to consider that only the growth rate of potential output has been negatively affected. In that case, a higher rebound could be in view, involving less structural effort to address the excessive deficit problem. An even more favourable pattern would leave the potential output fully intact with no consequence of the Great Recession on both its level and its growth rate (2.2%). If so, the size of the current output gap would be much higher, around 15%, which would imply a huge cyclical component of deficits in the euro area.
The main problem regarding potential output is that evaluations depend on the current state of affairs, as suggested by the huge difference between the Spring 2013 estimate of the EC when compared with that in Autumn 2007. As a conse-quence, austerity may be a self-sustaining process. Given high multipliers, it could lead not only to depressed current activity but also to downward revisions of potential output and consequently upward revisions of the structural component of deficits, which in turn would imply the need for an additional fiscal effort.
There is no consensus regarding the measure of the level of potential output or the potential growth. Some indications may be given by survey data on the utilization of production capacity in the industry sector. The average utilization
Economic perspectives for the euro area and euro area countries in 2013, 2014 and 2015 21
rate in the euro area is currently not far from the 1993 recession low level (Figure 9). It is still significantly below the long-term average, suggesting a high level of production factor hoarding and the potential for a substantial rebound.
Furthermore, in the light of the low level of inflation reached in the euro area, 0.7% y-o-y in October 2013, the existence of a very substantial negative output gap should be undoubtedly considered.
Figure 8. Evaluations of potential output by the EC for the euro area and different patterns
Constant 2005 million euros
Sources: EC, calculation OFCE-IMK-ECLM forecasts.
Figure 9. Capacity utilization rate in the euro area In %
Source: DGECFIN, EC.
7000 7500 8000 8500 9000 9500 10000
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Potential output without downward shock
Actual GDP Potential output estimated in Autumn 2007
(extended beyond 2009)
Potential output estimated in Spring 2013
65 70 75 80 85 90
85 87 89 91 93 95 97 99 01 03 05 07 09 11 13
Long term average
gh the late recognition of the existence of both high multipliers and strong negative impacts of fiscal consolidation on activity led the Commission to ease the consolidation path, austerity will still be a driving force of economic developments in 2014 and 2015. Multipliers should not be lower during the next two years, given the still high level of unemployment. However, fiscal consolidation will not drag activity down as much as in the recent years because more countries will reach, or will get closer to the 3% threshold in 2014, like the Netherlands, Belgium, and even Greece, in addition to Germany, Finland Austria and Italy, for which the objective has already achieved in 2013 (Table 3).
Intermediate objectives for total deficits are still settled, but the EC has said that attention would also be given to the structural effort to reduce deficit. This could be seen as an open possibility to avoid additional measures during the coming calendar year if the objective for government lending is not reached.
Conversely, Spain, in 2012, had to implement three successive consolidation plans. In any case, the upturn in the growth rate will not be strong enough in 2014 and 2015 to close the output gap if we assume a less deteriorated potential path of GDP than currently estimated by the EC.
Growth in 2014 and 2015 would benefit not only from a less drastic consoli-dation scheme but also from a better outlook regarding firm's investment. The shortfall in private investment since 2008 should start a surge in capital spending with a view to upgrade plants after six years of slump. In addition, an accelerator effect could be initiated in some countries from the South of the euro area where gains in competitiveness are stimulated by wage deflation, i.e. mainly in Portugal, Spain, and Greece. But it should be stressed that the increase in the external contribution to growth mirrors the slump of internal demand and the negative impact of the decrease in wages on private consumption. The recovery in investment will be constrained by still shaky financing conditions. External financing, regarding both bank lending and market-based funding, remains hard
Table 3. Fiscal balance and GDP growth rate in the euro area
Fiscal balance in % of GDP GDP growth in %
2013 2014 2015 2013 2014 2015
DEU -0.1 0.0 0.0 0.4 1.2 1.6
FRA -4.1 -3.5 -3.0 0.1 1.1 1.5
ITA -2.9 -2.5 -1.5 -1.8 0.3 1.0
ESP -6.8 -6.2 -5.3 -1.4 0.7 1.4
NLD -4.0 -3.0 -1.9 -1.1 1.0 1.6
BEL -3.4 -2.9 -1.5 0.0 1.2 1.6
PRT -5.8 -3.8 -2.4 -1.8 0.9 1.4
IRL -6.6 -5.2 -3.0 -0.5 1.4 1.9
GRC -7.8 -3.3 -2.1 -4.1 -0.4 2.4
FIN -1.8 -1.2 -0.5 -0.9 1.7 1.9
AUT -2.0 -1.3 -0.5 0.4 1.0 1.3
EA -2.9 -2.4 -2.0 -0.3 1.0 1.5
Sources: Eurostat,OFCE-IMK-ECLM forecasts.
Economic perspectives for the euro area and euro area countries in 2013, 2014 and 2015 23
for firms. Despite the highly expansionary stance of monetary policy, banks' conservative lending behavior weighs on firms' financing conditions. As Figure 10 shows, no signs for a recovery in financing flows are discernible: even from the very low levels reached again some quarters ago, they were still declining in the second quarter of 2013.
As a consequence, investment should come primarily from internal financing resources. The mild rebound foreseen in 2013 and 2014 will be an opportunity for firms to narrow the cyclical productivity gap and thus to improve their margins and the self-financing ratios, which drastically suffered from the downturn in activity, especially in France and Germany. The main drawback of such a dynamic is that the slow growth will not be enough to close the productivity gap. Mean-while the expected rebound will take place with few job creations on average in the euro area which will dampen households' disposable incomes. While unem-ployment will remain at a high level, dragging down wage rates, the incentives for a strong recovery in private consumption will be close to zero. Fortunately, activity will benefit from a mild acceleration in foreign demand and from market share gains on markets outside the euro area especially by Spain, Portugal and Greece experiencing a wage deflation.
The economic outlook has improved, but euro area countries are diverging.
The source of growth will be heterogeneous across countries and the process of reducing the external imbalances will give rise to new divergence in the standards of living. The gap between country members divided in “North” and “South” has widened since the beginning of the crisis1. The GDP per head developments since the beginning of the crisis show a widening fracture between North, where GDP per head has returned close to pre-crisis levels, and South where output per capita is 8 percent below (Figure 11). This divergence can be seen in all macroeconomic
Figure 10. Financial liabilities flows Millions euro, 4-quarter aggregate
Source: ECB.
-200 0 200 400 600 800 1000 1200 1400
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Shares
Securities
Loans
aspects of the euro area, except current balances for which a convergence process has started as deficits in the South countries have narrowed.
Public debt and deficit levels in southern countries suffered far more than those in the North. While all member countries had roughly balanced budgets in 2007, the gap between North and South reached over 2 GDP points in 2012, although the share of the South's fiscal consolidation in the whole fiscal stance of the euro area ranged between 60 and 90 percent in 2011/2013. However, austerity in the South has not been effective in lowering deficits because of high multipliers, which widened the cyclical components of deficits through a strong negative impact of fiscal plans on activity. As a consequence, the increase in public debt ratios has been higher in the South than in the North. Unemployment reached exceptionally high levels in some southern countries, doubling within a five-year period in Italy, Spain, Portugal, Ireland and Greece. Such a social and financial fragmentation between countries may make more difficult the emer-gence of true solidarity inside the euro area, especially in the pooling of public debts. Sure enough, to avoid the end of the euro area, the better-off countries, headed by Germany, agreed to make concessions, but with the counterpart of drastic austerity in the South. This has had very large consequences for youth employment, long term unemployment, the poverty rate and social cohesion.
1. North is defined as Germany, Belgium, Netherlands, Austria, Finland and Ireland. South is defined as France, Italy, Spain, Portugal and Greece.This geographical breakdown is highly debatable and is not based on a rational analysis. The issue on the most realistic partition of the euro area goes beyond the scope of this report. Yet, this figure highlights the ongoing divergence between euro area member states.
Figure 11. GDP per capita in euro area In euro, constant prices
Source: Eurostat.
24000 25000 26000 27000 28000 29000
19000 20000 21000 22000 23000 24000
2000 2011 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 North (rhs)
South (lhs)
Economic perspectives for the euro area and euro area countries in 2013, 2014 and 2015 25