28 July 2011

Hey Europe, What Is Going On? (Part 2)

In Part 1 of this series we introduced the more in-depth analysis of the situation in Europe, especially in the euro area, and put thing into perspective. We promised to continue with the discussion of polarizations within the zone. Well, “polarization” sounds intriguing; yet it has to be kept in mind that while we are specifically focusing to the countries’ different economic and financial realities, there are actually even more similarities. The reason for our focus is that these are not similarities that threaten the monetary union, but differences.

We have chosen four basic indicators to figure out differences between countries and identify imbalances within eurozone. The analysed period covered ten years, 2001-2010, and involved economic growth forecasts for 2011 and 2012. Let’s first take a quick look to the selected indicators.

Balance of the Government Budget. The governments of some countries appeared to have permanent deficit problems while the others have balanced their revenues and expenditures reasonably well. Reasons for choosing the indicator: firstly, permanent budget deficit means accumulating government debt (which is currently in focus), and secondly (perhaps even more importantly), it says something about the cost culture of the ruling elite.

Current account deficit/surplus. ChinAmerica is a textbook example of a pair of countries where one “partner” earns and the other spends. The relationships and dynamics within Europe are more complicated and not that clear; at the same time we can still easily differentiate between countries that year after year import more than they export, and countries the current accounts of which have been positive for long time. If a country cannot print money (as it cannot do in a monetary union like eurozone), it can only finance deficits by a) getting financial aid, donations or something similar, b) borrowing money, and/or c) selling assets. In each case, a permanent “minus” refers to the inefficient use of money, and thus clearly points to mounting economic & financial problems.

Net International Investment Position (NIIP), the difference between a country's external financial assets and its liabilities (also referred to as external debt). Within Europe and more narrowly within eurozone we can clearly distinguish a few countries that “live on the expense of the others,” i.e. that have large positive NIIP and hence can profit from their external assets. In the other end there are countries with large negative NIIP, i.e. those that have sold their assets and now work for the others. A sidenote: strangely (or perhaps not that strangely) this indicator is often forgotten or skipped by mainstream analysts.

Economic growth. Has the country’s GDP started to grow after the Great Recession in 2008-2009? This indicator helps to translate the above indicators into the pace of economic recovery.

The summary overview of the above described indicators for each of the eurozone countries as well as for some other selected European countries is presented in Figure 1. I believe that the information provided is self-explanatory. It explains why PIIGS countries are under fire. It also explains why Germany and Nordic countries have been referred to as the drivers of Europe’s recovery. The one large country that catches the eye within eurozone is actually France. Despite of its AAA rating, its economic indicators increasingly look rather those of a “loser”. Also the position of another large AAA-rated European country, the United Kingdom, appears to be shaky.

Thus, within Europe we can draw various lines:
* A historic line between East and West
* A hotly debated line between North and South
* A line that is not dared to be spelled out, the line between Germany and France, or Germany and the other large European economies

For an illustration of the latest “line” take a look to Figures 2.1-2.3 below where you can see a comparison of Germany’s and France’s a) Government Budget balances, b) current account balances, and c) Net International Investment Positions (NIIP) over the years 2001-2010. Most importantly, improving current account and NIIP for Germany, and worsening current account and NIIP for France attract the attention.

To conclude Part 2: Germany clearly shines in this kind of comparisons. We shall see if its shine is “real” or not. France and UK on the other hand need closer exploration.

Up next in this series: a refreshing look to the European banking sector

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