Europe’s Great Depression: a tale of (at least) two economies

The European periphery is replaying the Great Depression in slow motion. This means that eventually the Euro may fall apart, despite the recent loosening by the ECB.

The ECB is just about to embark on a course of quantitative easing, in response to low inflation and signs that it may be entering its third recession.

The Eurozone as a whole is performing as badly as those countries during the Great Depression that stuck to gold (the worst bunch), argued the Wonkblog. At least as far as relative GDP level is concerned at this point of the recovery, compared to the pre-crisis peak. Here is their chart:

Source: Wonkblog

This is all the worse because it seems that European growth is stalling again, and we may be entering the third recession in as many years (Italy has already had two quarters of negative growth). The abysmal performance of the Eurozone prompted talk of a “Greater Depression” and policy blunders and calls for the ECB to loosen policy.

It is at least as interesting to look at how employment is behaving. Here is a good chart showing that in many cases, employment in financial crises dropped by more than 10%, and took 10 years or more to get back to the pre-crisis level. The US as a whole just reached its previous peak employment recently, and 35 of its states and territories have not done so yet – so even there it is the worst post-WW2 recession in terms of employment recovery.

Source: Oregoneconomicanalysis

But if you look at the experience of some of the peripheral countries in Europe, their employment record is even worse than that of the US during the Great Depression. Indeed it seems like they are re-running the Great Depression in slow motion. There is little sign of a lasting recovery apart from Ireland, and the current slowdown may make things even worse everywhere. And this is after 6 long years since the peak of employment (we have Eurostat data only for Q1 of 2014)…

Source: Eurostat, our calculations and seasonal adjustment

Some smaller Eurozone countries like Slovenia and Cyprus also are doing badly in terms of employment, as is Bulgaria, which is outside but has a fixed exchange rate regime.

Earlier we wrote about the different labor adjustment of the US state Nevada and Spain to similar macro shocks (a collapse of a credit-driven housing bubble). It is worth to update the 2 key charts from that post there, which shows the relative employment performance of the two:

Source: Eurostat, BLS, own calculations and seasonal adjustment

 The message is the same as before: Spain’s labor market is not functioning well – the initial jump in the unemployment rate was far bigger there (despite a smaller initial drop in employment), and people did not move to parts of the Eurozone that are more dynamic, at least not in large numbers. True, Spain had additional shocks later in the form of its fiscal adjustment, which contributed to pushing up unemployment further, but that just reinforces the message that Spains’s economy is very bad at dealing with asymmetric shocks, which are inevitable if you are in a currency union but your banking system and budget are not integrated.

Indeed the scale of the employment collapse in Spain and Greece raises the question if the official employment and unemployment numbers fully reflect reality. Certainly, the employment situation is dire, and social security systems mean that the same level of unemployment leads to less social tension than say during the Great Depression. But even then, unemployment rates at around 25% in both countries (and above 50% youth unemployment) may be an overstatement, reflecting an increase of the grey/black economy. Spain and Greece never had an unemployment rate much below 8%, not even during the greatest boom times. So at least part of the problem is structural, and no amount of demand stimulus could cure that.

This question is important because it has implications on overall Eurozone monetary policy and especially regarding how much monetary stimulus (quantitative easing by the ECB) will help. Note that apart from Greece and Spain, the employment performance of the rest of the Eurozone is not that bad, compared to the US: It had a faster growth than the US before the crisis, a smaller decline during the crisis, and now is at a very similar level to the US one relative to its peak (see chart below).

Source: Eurostat, BLS, own calculations and seasonal adjustment

Of course some of the woes of Spain and Greece are obviously demand driven, but without structural reforms, demand increase would eventually push them in the same boom and bust cycle as before – or into a stagnation followed by a shallower bust, as it happened in Italy. So probably the right remedy is somewhat looser policies (after all, the overall Eurozone inflation rate is also below the target), even if that may not help much. But also a heavy emphasis on structural and especially labor market reform is necessary in peripheral countries. This latter is sorely missing, which means that the long term viability of the Eurozone is still questionable. If the periphery is incapable of reforming itself, it cannot be a member of the Eurozone, whatever the monetary policy there is.

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Tags: economics, Eurozone, unemployment