The coronavirus shock is threatening the eurozone on several fronts, not only from a purely economic perspective. And while there will be a further integration, the outbreak’s diverse impacts and the uneven eurozone fiscal response will result in further divergences this year, erasing the marginal improvements in GDP per capita convergence that occurred during the 2014-2019 recovery. Over the medium term, however, a very gradual level of convergence will resume.
The lack of convergence won’t be an issue for the functioning of the monetary union because economic cycles in the eurozone have become much more synchronized since 2015. Going forward, the southern block will perform as well as the northern one, but only if we exclude Italy, which remains in a league of its own. Italy’s perennially subdued growth could risk fuelling populist political forces and sovereign stress.
Convergence stopped in the mid-2000s
Convergence, as measured in the standard deviation of GDP per capita in PPP terms with respect to the eurozone average, stopped in the mid-2000s and worsened during the GFC and eurozone debt crisis, before a period of marginal improvements in the 2014-2019 recovery.
Since the euro launched, Germany has been the bloc’s only large country that managed to increase its relative GDP per capita by a significant amount (Figure 1 and 2). In per capita and PPP terms, Germany was 13 ppts richer in 2019 than the bloc average, a 5 ppts improvement since 1999. Italy, on the other hand, has performed abysmally. Having entered the euro in a relative stronger position – in per capita terms, Italian GDP was stronger than France’s and Spain’s – Italians are now more than 10% poorer than the bloc average. And as we’ve argued in several other reports, we don’t see this trend reverting. Greece was the other country to show a drop in relative terms, with its GDP per capita now 36 ppts lower than eurozone average.
Figure 1 Germany, Italy, and Greece have seen sizeable changes in their relative per capita GDP
Other large countries, such as France, Spain, Netherlands, and Belgium have broadly maintained their GDP per capita in relative terms. Central and Eastern European countries, such as Latvia, Slovakia, Estonia, and Lithuania (Figure 2) have massively improved their livings standards. But this is more a reflection of the transition to market economies rather than a direct effect of joining the euro.
Figure 2 Catch-up only happened for the CEE economies
EZ country dispersion is better than in the US
Another way to look at the lack of convergence is to focus on the gap between the average GDP per capita of the five richest countries vs. the five poorest. This gap has widened since 2007, and in 2019 it was 10ppts higher than in 2017. However, if we want to understand if a catch-up from the poor countries happened, the difference between the poorest countries and the bloc’s average is more telling. Again, if we exclude Luxembourg and Ireland and the CEE countries, in 2019 the average per capita GDP of the five poorest countries was around 20% less than the eurozone average, lower than in 1999 and in 2007.
Figure 3 US dispersion is higher than that of the eurozone
While far from optimal, this is still better than in the US. In fact, excluding Washington, DC, and a commodity-dependent state such as Alaska, the five poorest US states have per capita GDP around 30% below the national average (Figure 3). Admittedly, this analysis isn’t complete because it doesn’t consider other factors, such as the different degree of fiscal integration within the different areas and the fact that the number of US states is much larger than the number of eurozone countries. Nevertheless, it’s another point that puts the limits of Eurozone integration into perspective.
For monetary policy, what matters is the cycle
While the lack of convergence in GDP per capita is far from optimal, it’s not a threat per se to the functioning of monetary policy. The eurozone remains an incomplete project with substantial flaws in its infrastructure. But what matters for monetary policy is the convergence in economic cycles rather than discrepancy in level. And in this respect, the eurozone has made strong improvements. The standard deviations of GDP growth (Figure 4) in 2018 and 2019 were at the lowest since 1995, having constantly decreased from the 2012 peak.
Figure 4 Convergence in GDP growth did happen
Moreover, while the North-South divide is still an issue, the picture is much more nuanced than a few years ago. True, since 1999 the southern countries have underperformed the northern ones (Figure 5), but this story hides another one. In fact, excluding Italy from the southern countries, the picture changes radically.
Figure 5 The north-south divide is still an issue
Figure 6 shows that without Italy, the southern block has maintained a very similar growth rate as the northern block since the euro’s introduction. And after the overperformance of the southern countries in the early 2000s, which reversed in the crisis years, the dynamics of the two areas have been very similar since 2015 – a trend we see continuing over the next few years.
Figure 6 Italian underperformance is driving the North-South divide
Italy continues to be the main risk
This means the eurozone faces mainly one threat: Italy’s perennial growth underperformance (Figure 7). In short, the fact that nominal growth rates for Italy will remain subdued over the medium term and in line with the interest rates it’s paying on its debt, means maintaining a primary surplus is crucial for debt sustainability. This isn’t a risk in the short term because the ECB has been providing a shield with its enlarged Pandemic Emergency Purchase Program and Italy’s payments on its public debt remain low (3.5% of GDP in 2019). But we see this as the main threat to the eurozone in the medium term. Unfortunately, Italy doesn’t have the political appetite to introduce policies it needs to kickstart growth, so we expect this to remain a persistent threat in years to come.
Figure 7 Italy will continue to underperform the eurozone
A simultaneous drop and recovery
Finally, as opposed to the 2011-2013 debt crisis, this recession is simultaneous across countries despite being asymmetric in depth (Figure 8). All the eurozone countries will face a massive recession this year, but we expect them to rebound in 2021. Moreover, a majority of countries that will see the biggest drop should then experience the strongest rebounds. The outlook in the medium term is less clear-cut and will also depend on how the Eurozone’s architecture evolves. In the short term, the ECB will continue to provide targeted support. Over the longer term, the EU’s proposed Recovery fund is a step in the right direction of a common fiscal union. And while not a booster for growth, it will formalize the principle of targeted supports. But in order to become the basis of a much more efficient fiscal union that could reduce the asymmetry of future shocks, the Recovery fund would have to be significantly expanded with further resources and converted into a permanent scheme.
Figure 8 2020 recession will be followed by a strong recovery in all eurozone countries
 When not specified, we consider the eurozone countries that entered the euro in early 2000. We exclude Luxembourg and Ireland from our sample because they have distorted national accounts statistics.