The most acute phase of the Global Crisis appears to be over in the Eurozone. Prospects for growth are still moderate but no recession is foreseen in the short-run and sovereign debt markets seem to be getting out of the turbulences. The prevailing view is that the countries that have been under the Economic Adjustment Programmes (EAP) have drastically improved their conditions with the recovery extending to large, non-EAP but ‘vulnerable’ member states like Spain, Italy, and France. The latest IMF’ vision on Spain, which since 2010 has been intermittently considered as a possible trigger of the Eurozone implosion, is that the country “has turned the corner” (IMF 2014).
The merit in this stabilisation process is credited to a policy mix that includes financial sector reform, budget discipline, internal devaluations, and ‘structural reforms’. On the monetary policy side, a series of incremental expansions of the ECB objective function have finally led the institution to provide a liquidity backstop. Apparently, it is this very specific ECB move what best explains the decline in sovereign spreads since 2012 in the peripheral countries (De Grauwe 2014) and, one could confidently argue, what paved the way for the Eurozone recovery.
Although it is common knowledge that many roadblocks still need to be removed (the crux of the matter being how to engineer a job-rich recovery), the improvement in several headline indicators has led to a sort of policy complacency in certain circles. Perhaps the most notorious case is the improvement in the current-account balances, which is often interpreted as a sign of increasing competitiveness and, furthermore, considered not to be short-lived but rather of a more fundamental nature (Auer 2014).
In this column, we disagree with this complacent account by pointing at some structural limitations that the three largest southern Eurozone countries (France, Italy, and Spain) face both from a macro and micro perspective. This is based on a recent working paper (Xifré 2014) with data being updated whenever possible and combined with other work in progress. The main policy implication is that it might be the case that the toughest tasks have not yet been done:
These three countries still need structural reforms that facilitate the reallocation of resources (human and financial) to tradable sectors and to those firms better prepared to grow and compete.
The macroeconomic conditions in these three countries have improved since 2008 but two important assertions need to be made.
- Firstly, in pure quantitative terms, progress is much shorter than in the rest of the Eurozone.
- Secondly, in a more fundamental way, the sources of value added creation in these three economies appear to be moving away from the tradable sector while the public administration is becoming increasingly important. This twofold pattern clearly contrasts with the situation in Germany, which is usually taken as an EU benchmark.
As Figure 1 shows, the current-account balance adjustment in the three countries is well below the EA average correction. To start with, France was in deficit in 2013 and it will most likely remain so in 2014 according to the IMF estimates; indeed, the current-account trajectory of this country is deteriorating over time. Spain reached a record current-account deficit of 10% of the GDP in 2007, then quickly recovered and entered the surplus zone in 2013, just when Italy also did. However, the current-account balance corrections in these two countries are not only below the EA average but, perhaps more tellingly, also below the average correction of the three countries under the EAP. Greece, Portugal, and Ireland are running an (non-weighted) average current-account surplus of more than 2.5 % of the GDP since 2013, which nearly triples the current-account surplus of Italy and Spain.
Figure 1. Current-account balances as % of GDP
Notes: Estimates after 2012 for Ireland, Italy, and Portugal and after 2013 for France, Greece, and Spain. For Greece, Portugal, and Ireland, the non-weighted average is represented.
Figures 2 and 3 report -- for the three southern EA countries and Germany -- the shares of the total value added generated by the tradable sectors and the public administration, respectively. While the definition of public administration activities is sufficiently clear, the determination of tradable sectors is a somewhat more open issue. Here, we follow a relatively restrictive definition that covers agriculture, industry, and manufacturing (see European Commission 2013 for a similar approach and the notes to figures 2 and 3 for further details).
Figure 2. Tradable sectors’ share in the total value added
Figure 3. Public administration’s share in the total value added
Note: Tradable Sectors: NACE Rev. 2 sectors A - E (agriculture, industry and manufacturing, except construction). Public Administration: NACE Rev. 2 sectors O - Q (Public administration, defence, education, human health, and social work activities)
Figure 2 shows that the tradable sector’s value added share has been falling steadily in Italy and France, while in Spain the downturn stopped in 2009 and since then there has been a very mild recovery. The trajectories in these three countries are in sharp contrast with the performance of Germany, where the tradable sector of the economy has consistently contributed with more than 40 % of the total, nearly twice as large as the French share. In the case of the public administration’s share, the story is just the contrary. As illustrated in figure 3, in the last 14 years the participation of the public administration in economic activity has grown by nearly 3 percentage points in France and Spain, by more than 1.5 points in Italy, while it has remained essentially stable in Germany.
From a micro perspective, the three southern EA countries suffer from the combination of two facts of their business demography: benchmarking with Germany, the proportion of small firms is larger, and smaller firms are particularly less productive.
Figure 4 represents the size in value added of an average industrial firm in Germany, France, Italy, and Spain in relative terms to the EU average in 2011. The countries where the point is above the 45-degree line are those with larger firms than the EU average and vice-versa. The average industrial French firm is slightly larger than the EU average firm, while a typical German firm is nearly three times as large as an EU typical firm. The difference is still larger between German and Spanish firms, which are on average almost twice as small as the EU average. As a result, firms based in Germany generate approximately 6 times the value added of their Spanish counterparts. The typical Italian industrial firm is approximately two-thirds of the EU average firm size.
Figure 4. Number of firms and firms’ value added, as a share of EU totals, industrial sector, 2011.
In terms of information about firms’ productivity, the availability of comparable databases across EU countries is still very limited. National databases are typically representative but not comparable, while the contrary tends to happen with multi-nation datasets. In this respect, the EFIGE project has provided very interesting insights and so is the ECB-created Competitiveness Research Network (CompNet). The messages that emerge from the exploitation of both datasets are consonant – firms’ main characteristics – such as size – tend to determine individual firm performance more strongly than the country of origin (Barba Navaretti et al. 2010 and Békés et al. 2012). In addition to this, a recent analysis based on the CompNet database finds that firms’ productivity distributions are very different across EA countries. Spain and Italy are characterised by more concentrated distributions around relatively low productivity levels while the distribution in Germany has a higher mean and a much greater density in large productivity tails (di Mauro and Pappadà 2014).
In this context, the current debate on resource reallocation between firms within a country is very relevant. The conceptual basis for this debate is the influential paper by Melitz (2003) which has allowed subsequent research to establish firms’ heterogeneous productivity as a high-powered explanation factor for a very large set of economic relevant aspects. For instance, we know that productivity distributions that are flatter and have higher means tend to correspond to countries that have adopted business environment policies that facilitate factor reallocation (Bartelsman et al. 2009).
This perspective is useful to design and implement optimal policies that help countries, including the three southern EA ones, to overcome the crisis by improving their total factor productivity and not only their apparent productivity. Two policy prescriptions seem particularly appropriate to facilitate resource reallocation in France, Italy, and Spain:
- A new generation of industrial policy that goes beyond the classical tension between vertical and horizontal measures and acknowledges that the industrial sector is mutating. Some of the most successful ‘industrial’ firms are so because they are expanding their activities to cover industry-related and high-value added services.
- A specific policy programme that targets and supports the minority of companies most likely to experience high growth, irrespective of their activity and sector. The evidence from the UK suggests that 6% of business with the highest growth rates generated half of the new jobs between 2002 and 2008 (NESTA 2009).
Auer, R (2014), “The increasing competitiveness of the southern Eurozone”, VoxEU.org, 11 April.
Barba Navaretti, G, M Bugamelli, G Ottaviano and F Schivardi (2010), “The Global Operations of European Firms”, Bruegel Policy Brief 2010/06.
Bartelsman E, J Haltiwanger and S Scarpetta (2009), “Measuring and analyzing cross-country differences in firm dynamics”, in T. Dunne, J. B. Jensen, and M. J. Roberts (ed.), Producer Dynamics: New Evidence from Micro Data, NBER Studies in Income and Wealth.
Békés G, L Halpern, B Muraközy and M Koren (2012), “Still standing: Global crisis and European firms”, VoxEU.org, 18 May.
De Grauwe, P (2014), “Revisiting the pain in Spain”, VoxEU.org, 7 July.
Di Mauro, F and F Pappadà (2014), “Eurozone external adjustment and real exchange rate movements: The role of firm productivity distribution”, VoxEU.org, 2 June.
IMF (2014), “Spain Article IV Consultation - Staff Report”
European Commission (2013), “Firms’ investments decisions in vulnerable Member States”, Quarterly Report of the Eurozone, vol. 12, no. 4.
Melitz, M (2003), “The impact of trade on intra-industry reallocations and aggregate industry productivity”, Econometrica 71 (6), 1695-1725.
Xifré, R (2014), “The Competitiveness of the Spanish Economy. A bird’s-eye view of the four largest Eurozone economies”, IESE WP-1088-E.