Monday, July 25, 2011

25/07/2011: Comprative analysis of Euro Area and Euro Big 4

There’s a lively debate going on in parts of Europe about the longer-term fall out from last week’s ‘Deal for Greece +”. Most notably – in Germany (see here). In light of this, it is worth looking into some facts about economic performance of the Euro area Big 4 economies: is Germany right about protecting its fiscal conservativism from collectivization of risks envisioned by the ‘Deal’?

Let us plough through some data and IMF forecasts for the following set of countries & country-groups: France, Germany, Italy and Spain (the Big 4) against the Euro area as a whole, plus Advanced Economies and Major Advanced Economies (G7). Please note that the IMF forecasts are not exactly in agreement with my view of where some of these economies are heading, but for the reasons of comparative simplicity and transparency, I will rely on IMF data here.

In the end, what I am after here is some (crude – so be warned) metric of risks – disaggregated across countries and groups.

Starting from the top: chart below shows annual growth rates in GDP expressed in constant prices.

Economies, 2000-2007 growth rates averaged 2.61%, while the crisis years growth fell on average 0.06% annually. The projected growth for post-crisis period 2011-2016 IMF forecasts growth of 2.46%. In all of these periods, Advanced Economies group leads the league table of our sample countries/regions.

Area managed to achieve average annual growth of 2.16% in pre-crisis period, but suffered 0.63% annual average contraction during the crisis. Post-crisis, Euro area economies are expected to grow 1.76% which is the third slowest rate of growth in our sample.

G7 economies grew 2.27% on average annually in pre-crisis period and faced a relatively mild average crisis-period contraction of output of 0.36%. These economies are expected to grow at 2.29% per annum on average in 2011-2016.

France recorded average annual growth of 2.12% in 2000-2007 and subsequently posted relatively mild contraction of 0.32% (annual average) in 2008-2010. The country is expected to grow its economy at an average annual rate of 1.94%.

German economy grew on average at an annual rate of 1.58% during the pre-crisis years – posting second slowest growth in the sample. During the crisis, the economy contracted 0.15% per annum on average (second best performance in the sample), while it is expected to grow at 1.84% average rate in 2011-2016 – not a blistering growth forecast, but above Euro area as a whole.

Italy posted slowest average annual growth in the sample during the pre-crisis period (1.46%), the deepest average annual contraction in the sample during the crisis (-1.75%) and is expected to continue slowest growth performance with 1.32% average annual growth rate in 2011-2016.

Spain recorded the fastest real growth in the sample for the pre-crisis period (3.62% average annual rate), followed by the second magnitude of contraction (-1.0% per annum on average) in the crisis period. Spanish economy is expected to grow at 1.62% on average in 2011-2016 – second slowest in the sample.

In terms of GDP per capita (chart below):

Germany was the first in our sample to reach pre-crisis peak level of GDP per capita between 2009 and 2010, followed by the Advanced Economies and the Euro area. G7 group of countries recovered from the crisis in terms of GDP per capita by the end of 2010, while France’s recovery will take it into 2011. Spain is expected to recover from the declines in GDP per capita around 2011-2012, while Italy will take the longest to reach pre-crisis peak – some time between 2012 and 2013.

In terms of investment as a share of GDP (chart below):

Advanced economies investment averaged 21.05% in the period prior to the crisis, falling to 19.08% during the crisis before recovering somewhat to 20.08% in the period 2011-2016. No data is available for the Euro area and G7 countries.

France invested 20.2% of its GDP on average during 2000-2007 period, recording a marginal decline to 20.11% in the crisis years and is expected to recover to 20.60% of GDP in 2011-2016.

Germany was the weakest country in the sample in terms of investment with investment ratio to GDP of 18.24% in the pre-crisis years, followed by 17.50% during the crisis and by expected 17.81% in the post-crisis period.

Italian economy investment as a share of GDP was 21.01% in pre-2008 period, followed by 20.11% during the crisis. IMF expects Italian investment to rise to 20.54% of GDP in the post-crisis period.

Spain’s investment to GDP ratio was 28.30% in 2000-2007 period, followed by 25.5% in 2008-2010 and 22.98% projected for 2011-2016.

So in terms of investment as a share of GDP, Germany is clearly a laggard here, which is of course explained by two core factors: (1) aging population and (2) already extensive stock of capital.

Unemployment rates are shown in the chart below:

During pre-crisis period, Spain psoted the highest rate of unemployment, averaging 10.54%, followed by Germany (8.93%) and France (same as Germany). Euro area as a whole averaged 8.45% unemployment rate during the pre-crisis period, followed by Italy at 8.11%. This poor performance by European part of out sample is contrasted by the pre-crisis unemployment of 6.11% for the group of Advanced Economies and 6.05% for G7 group.

During the crisis, Spanish unemployment rose to 16.47%, followed by France (9.02%) and Euro area (9.0%). G7 economies posted 7.35% average rate of unemployment while Advanced economies came in at 7.34%. Germany shows the best unemployment rate for the period at 7.22%.

Post-crisis, IMF forecasts for Spain to remain worst performing country in our sample with 16.91% average unemployment rate, followed by Euro area at 9.03% and France at 8.57%. In contrast, Italy’s unemployment is projected to settle at 7.87% average, with Advanced economies coming in at 6.77% and G7 economies at 6.54%.

So what about employment – in other words, jobs creation:

The chart clearly shows that Germany, G7 group and France are the weaker performers in the sample in terms of longer-term trends in jobs creation. Now, see the following chart on population changes. Of course the problem here is that while German population is shrinking (so jobs creation is not exactly high on their agenda, especially with low unemployment), for France (with expanding population) slow jobs creation is a major draw back (hence high unemployment as well).

By 2015, based on IMF projections, German population will shrink by 1.284 million relative to 2000, while Italian population will grow by 4.638 million, French by 5.352 million and Spanish population will expand by 6.304 million.

In terms of fiscal performance, consider the following two charts plotting general government revenue as % of GDP and the general government expenditure as % of GDP:

The following chart shows general government deficits:

Based on three charts above, consider the fiscal adjustments required to deliver on the deficit targets to 2016:

Of all countries in the sample, France represents the steepest required fiscal adjustment in terms of deficit reductions, totaling 4.475% of GDP between 2011 and 2016, followed by the G7 group of countries with 4.063% and Advanced economies at 3.567%. Euro area projected adjustments are 2.519%, while German projected adjustment is 2.326%. The weakest – fiscally – performing countries – Italy and Spain – have the lowest fiscal adjustments planned at 1.439% and 1.679% respectively.

Mapping these adjustments alongside the absolute measure of fiscal performance (Gross Debt) and taking into account the economies growth potential, chart below shows two groups of countries. The first group (no shading) is the group of economies facing the moderate adjustment on deficits side, against stronger targets on debt reductions. This group includes Germany, Italy and Euro area. The second group of countries represents a group facing steeper adjustments on fiscal deficits side and/or significant deterioration in debt positions. This group covers Spain, Advanced economies, G7 and France. It is worth noting that this group of countries faces stronger growth prospects, but Spain and France represent two weaker economies in this group.

Chart below provides an illustration of the debt challenges faced by the sample economies. General Government debt rose 48% in Spain form an average of 47.62% of GDP in 2000-2007 to 70.5% of GDP projected average for 2011-2016. In France, the same increase was 43.6% from 61.83% of GDP pre-crisis to 88.76% average in post-crisis period. At the same time in Germany, gross government debt to GDP ratio rose from 63.64% of GDP pre-crisis to 76.48% of GDP in post-crisis period – the second slowest rate of increase in the sample after Italy.

Overall, for the period of 2011-2016, average gross government debt levels are expected to range from 121.93% of GDP for the G7 economies, to 119.32% of GDP for Italy, 105.33% of GDP for Advanced economies, 88.76% of GDP in France, 87.55% of GDP for the Euro area, 76.48% of GDP in Germany and 70.49% of GDP in Spain.

Lastly, let’s take a look at the current account positions.

As chart above shows, cumulative 2011-2016 expected current account positions as the share of GDP are: Germany +25.9% of GDP, Euro area +0.67% of GDP, Advanced Economies -1.92% of GDP, G7 economies -7.13% of GDP, France -14.6% of GDP, Italy -17.4% and Spain -24.5% of GDP.


Now, let us pool the information contained in the above data to derive the overall riskiness of each economy/group in the sample. To do this, I assign to each country/group a score out of 1-14 based on their performance relative to the top performing economy. So top performer in each category of score below gets 14, the with the next performer getting 12 or less, with distribution of scores within each category/heading following the underlying data. The higher raw scores reflect stronger economic performance and / or lower risk. So the final risk scores are based on inverting the raw scores. Summing these up across categories/criteria produces the total risk score reported in the penultimate column of the table. These are ranked in the last column with 1=highest risk country.


The results are consistent with statistical distribution and are robust to several checks, namely:
1) Removal of the GDP per capita recovery statistics
2) Removal of the Employment index
3) Removal of the Government Expenditure metric

The core results are:
  1. Germany clearly represents the most sustainable country in the sample of all Big 4. In fact, its fiscal and macroeconomic position would be significantly undermined if it were to move to Euro area harmonized position
  2. Spain and Italy are the two weakest economies in the sample with very high risk rating
  3. France is statistically closer to Spain and Italy than to Euro area harmonized economy and is clearly the least sustainable economy in the sample after Spain and Italy.

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