Wednesday, June 22, 2011

Little evidence of convergence across the Euro area 12 after adopting the euro

Eurostat released measures of annual per-capita GDP expressed in Purchasing Power Standards for the European Union. Purchasing power standards corrects for price differentials in nominal income and is useful for cross-country comparison (Eurostat data).

Given the economic dispersion across Europe (a recent article highlighting this using Q1 GDP growth), I wanted to investigate 'convergence' among the Euro area 12 countries. Specifically, are the lower income countries benefiting from the single currency policy more so than the higher income countries and thereby 'catching-up' to the average?

The chart below illustrates the per-capita income bases across the Euro area 12 - those countries that adopted the single currency in 1999 plus Greece (they adopted in 2001).

The chart illustrates 2001 per-capita GDP measured in PPP euros across the Euro area 12 (now called average income). Luxembourg, Netherlands, and Ireland had the highest average incomes, while Spain, Portugal, and Greece had the lowest. If income disparities among the Euro area (12) countries were to converge over the following decade, then the lower income countries should grow more quickly than the higher income countries, and average income differentials should fall.

The chart below illustrates the average catch-up rates for the Euro area 12 (excluding Finland which averages 234% from 2001-2008, so distorts the chart) both before adopting the euro (1996-1999) and after (2001-2008). They are calculated as in Péter Halmai1 and Viktória Vásáry, Real convergence in the new Member States of the European Union (Shorter and longer term prospects).
Note: I did not include the years 2009 and 2010 to avoid distortions created by fiscal austerity in key countries. Furthermore, the year 2000 is omitted since Greece didn’t adopt the euro until 2001.

The catch-up rate is essentially the average annual rate of change of the difference between country average income and that of the Euro area (12). A positive number represents an average increase in this differential, while a negative number indicates a decline in the differential. For convergence, you would expect for these rates to be negative among the lower income countries and some of the higher income countries as well.

The discrete shift in convergence is quite striking. Basically, the Euro area went from generally converging before the formation of the Euro area, as illustrated by 6/11 shown negative catch-up rates spanning 1996-1999, to generally diverging, as illustrated by just 3/11 shown negative catch-up rates spanning the 2001-2008 post Euro area formation. Only Belgium and Spain demonstrate convergence across both time periods.

Following adopting the euro, the income differentials grew markedly in France, Italy, Germany, and Ireland, and often not for the better (i.e., the income differential widened). In Italy’s case, the income differential went from positive PPP700 in 1995 to –PPP2,400 in 2010 (not illustrated in chart); this differential turned for the worse in 2002.

According to this measure, there's little evidence of convergence. Here's a thought exercise: I'm one of the countries that are set to adopt the euro (see light blue countries here) - why would it be in my best interest to do so if history tells me that adopting the euro leads to rising income differentials?

Rebecca Wilder

1 comment:

  1. [I'm one of the countries that are set to adopt the euro ...- why would it be in my best interest to do so if history tells me that adopting the euro leads to rising income differentials?]

    Rather than look at the ostensible losers (Belgium is an odd fit, politics/ethnics must play a large role)...Denmark and Sweden make interesting cases. Last time I was following this, the Riksbank was putting out feelers (notice really) of imminent euro adoption.

    I thought it odd, Sweden has handled the recent downturn better than almost all in the EU, and independent monetary policy takes a huge amount of credit, pun not intended.

    Could the sub-text be that when the PIGS go to the trading floor, Sweden and Denmark can be assured that new standards are in play?

    I'm amazed that there's been little press on the matter. It may *benefit* the euro(zone) in the long run. Finland's position is exquisite as per vote on bailout, etc, but are the other Nordics playing wait-and see? They be idiots not to. Norway and Switzerland too to varying degrees. Norway has a lot to lose if things don't get better.


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