The Eurozone: Whatever Happened to Convergence?
article examines the relative performance of Eurozone countries since the start
of the single currency. This extends a previous study Gough (2012) which gave a
snapshot of relative performance for only one year, 2011. In Section 2 we analyse
the concept of “convergence” necessary for the formation of the currency union
and how it might be measured in practice. Section 3 examines the pattern of
convergence for three main economic indicators – inflation, GDP growth and
government debt – as well as a brief summary of patterns for each nation.
Recent problems in the Eurozone have centred on the size of government deficits
in certain countries, and these are examined in detail in Section 4. A wider
view of convergence looking at GDP/head and unemployment is presented in Section
5, while a summary and conclusion is given in Section 6.
euro was brought in on January 1 1999 in eleven countries, in order that
governments and businesses could use it as a means of payment and a unit of
account. Three years later, in the months following January 1 2002 the national
currencies were replaced by the euro and the new currency came into full
operation. As James and Gough (2004) observed “the introduction of the euro was
a bold, ambitious but potentially risky monetary experiment”. A single currency
area of such scale and diversity of nations had never been attempted before, aiming
at forming a monetary union without having a fiscal union. It was also part of
a wider political ambition to build a more unified Europe.
the new currency to work effectively it was thought essential that the
economies in the constituent countries should be performing similarly. This
involved a series of tests that were intended to encourage applicant nations to
adopt suitable policies to bring convergence of economic performance. There
were five tests:
Inflation – a
country should be within 1.5% of the average of the best 3 countries
deficit – this should not be more than 3% of GDP
government gross debt - this should not be more than 60% of GDP
rates – these should be within 2% of the average of the best 3
rates – these should remain within the normal Exchange Rate
Mechanism (ERM) banks for the previous 12 months.
five tests centre on what is called “nominal convergence” concerned mainly with
monetary issues. In contrast, so called “real convergence” (Gough (1997)) takes
a wider view of performance including economic growth, unemployment rates, and
the business cycle.
five nominal tests were set both for entry and for continual monitoring
post-entry to ensure convergence was maintained. Of these original five tests
two are now redundant – a common interest rate is set by the ECB across all
member nations, while exchange rates, by definition, have disappeared with the
focus is therefore now on inflation, government borrowing and total debt. A wider
view of real convergence would include GDP growth and unemployment.
should we measure the convergence or divergence between nations over time? The
conventional way of assessing the variability of any series is to compute its
standard deviation. However, the standard deviation is measured in absolute
units and can only be interpreted in relation to the value of the arithmetic
mean. As a result we use an alternative relative measure – the coefficient of
variation, see Yeomans (1968). The coefficient is defined as the standard
deviation expressed as a % of the mean. It can be used to track the variability
over time for one series - if it is falling over time the series is converging,
if it is rising the series is diverging. The coefficient may also be used to
compare different series - e.g. if one series has a coefficient of just 10%
then it is more converged than another series with a coefficient of say 50%. We
can then use this measure to track what has happened to convergence since the
start of the euro, and identify how and when convergence was lost. Full
convergence is achieved when the coefficient of variation is less than about 25%
order to undertake the task of comparison we need reliable data. There are now
17 members in the Eurozone, each with their own government departments for
assembling economic data. The European Union has established its own
statistical organisation, Eurostat, which compiles data for the EU and Eurozone.
It provides guidelines and definitions for member nations, and collates them on
a broadly comparable basis. The reliability of the aggregated data is, of
course, still dependent on the standards for providing source data in each
country. Eurostat publishes its data on-line on its own website. We now examine
the trend and variance in three important economic series – inflation, growth
in GDP and total public sector debt.
pattern for Eurozone inflation for the period 1999 to 2011 is shown in the following
in the Eurozone is measured through the Harmonized Consumer Prices Index
(HICP). This is designed to enable international comparison of consumer price
inflation. It is use by the European Central Bank (ECB) for the monitoring of
inflation in the European Union or for the assessment of inflation convergence
as required under Article 121 of the Treaty of Amsterdam. The HICP uses a
geometric mean for its calculation, rather than the more familiar arithmetic
mean The HICP has a limitation in that excludes expenditure on housing, which
is one of the most important elements of consumer expenditure.
ECB sets itself a target of achieving an inflation rate in the range 0 to 2%.
The graph above shows that inflation started very low at 1.1% in the first year
of the single currency. It then rose to 2.1% in 2000 and remained remarkable
steady at marginally above the target range right up to 2007. There was then a
period of instability as inflation spiked up to 3.3% in 2008, and was followed
by a dramatic fall back to 0.3% in 2009. Inflation got back to its normal level
in 2010, only to rise sharply again to 2.7% in 2011.
second graph shows the coefficient of variation for inflation within the 17
countries. This fell from 63% in 1999 to 29% in 2007 showing a process of
convergence for almost a decade. However with the global financial crisis in
2007 and 2008, this stability was lost with some nations still remaining with
positive inflation while others plunged into deflation. A move back towards
greater stability was achieved in 2010 and 2011.
Domestic Product (GDP) is a measure of the economic activity of a nation. It is
defined as the value of goods and services produced less the value of any goods
and services used in their creation. It is therefore the sum of value added in the
output of all industries. Alternatively, it may be measured by the sum of
factor incomes - wages & salaries, rent, interest and profit. Finally, it
may be measured by the sum of final expenditure – consumers’ expenditure,
investment, government expenditure and net exports. The output measure is
usually available first, and tends to be used by nations to interpret changes
in GDP. The data for the other two methods comes after a longer time lag, but are
used to check and possibly adjust the output based data. In terms of economic
theory all three methods should give exactly the same answer, although errors
and omissions in data will always result in differences.
calculation of the annual growth rate of GDP volume is intended to allow
comparisons of economic development both over time and between different
nations. It is derived by taking GDP volume at current prices and valuing it at
the prices in the previous year. The computed volume changes are then imposed
on the reference year to generate a chain-linked series. Accordingly price
movements will not influence the growth rate, so growth is measured in real
(inflation adjusted) terms.
trend and variance of Eurozone GDP growth is shown in the following two graphs
average growth of the Eurozone was quite high in the first two years of the
single currency. It then fell in 2003 and 2004 as many of the main countries in
the Eurozone battled with recession. Growth rates picked up markedly up to
2007, but were then hit by the global financial crisis with recession in 2008
and 2009. Positive growth re-emerged in 2010, but weakened again in 2011.
of variation between nations was high and varied over time. There was a lack of
convergence in the early 2000s as the low growth in some major nations as the
centre of the Eurozone (Germany, France and Italy) contrasted with high growth of
some on the fringe (e.g. Greece, Spain and Ireland). A more even performance
between nations followed up to 2007, but was then hit by the financial crisis
which saw the coefficient of variation rise dramatically in 2008, fall back
temporarily in 2009, only to rise again in 2010 and 2011.
Government Gross Debt.
is defined in the Maastricht Treat as the value of consolidated general
government gross debt at nominal value outstanding at the end of the year.
Categories of debt included general liabilities (as defined in European System
of Accounts (ESA) 95), currency and deposits, securities other than shares,
excluding financial derivatives and loans. The sectors of government include
central government, state government, local government and social security
trend in the ratio of General Government Gross Debt to GDP is shown below,
together with the coefficient of variation between nations.
ratio of gross debt to GDP was fairly steady between 1999 and 2008 at about 70%
- well above the 60% threshold for entry. However, increasing budget deficits
from 2009 to 2011 sent the ratio up to 87.2% by 2011.
variability between nations, as shown by the coefficient of variation, was high
but did not change markedly over the whole period. So while the debt levels
increased alarmingly between 2009 and 2011 the relative variability between
nations did not correspondingly increase.
analysed the trends at the Eurozone level, it is of interest to look at the
patterns over time in each of the 17 countries. These are briefly summarised below.
Each of the original 11 nations which entered in 1999 is compared with the Eurozone
average of inflation of 2.0%, GDP growth of 1.5% and total government debt/GDP
ratio of 72.6% over the whole period 1999-2011.
on inflation was generally slightly better than the Eurozone average at 1.9%,
but there were inflationary spikes in both 2008 (3.2%) and 2011 (3.6%). GDP
growth was well above the Eurozone average at 2.0%. The total debt ratio
averaged 66.2%, significantly better than the Eurozone average. The debt ratio fell
slightly up to 2008 but increased sharply from 2009 to reach 72.9% in 2011
averaged 2.2% over the complete period, slightly higher than the Eurozone
average. There was a marked spike in inflation to 4.5% in 2008. GDP growth over
the period was 1.8%, slightly higher than the Eurozone as a whole. The total
debt ratio was 97.3% over the whole period, this being the third worst
performance in the Eurozone. Belgium was admitted to the Eurozone in 1999 with a
debt ratio of 113.6% compared to the requirement that debt should not exceed
60% of GDP. Considerable leniency was therefore shown to Belgium in this
respect. The debt ratio fell fairly consistently to 84.1% in 2008 but then rose
sharply to end 2011 at 98.0%
inflation over the period averaged 1.9%, slightly better than the Eurozone
average. As with many countries there was a spike in 2008, of 3.9%. GDP growth
averaged 2.3%, well above the Eurozone average, and the fourth best of any country.
Total debt ratio averaged only 42.6%, the second lowest of any of the original
11 countries which started the Eurozone in 1999. The debt ratio was steady up
to 2004 at about 44%, fell to 33.9% by 2008, and then gradually increased to
48.6% in 2011.
in France at an average of 1.8% was slightly better than the Eurozone as a
whole. GDP growth averaged 1.5%, equal to the Eurozone average. The total debt
ratio averaged 67.0%, somewhat better than the Eurozone, although the ratio had
risen to 85.3% by 2011.
in Germany was the best of any of the original 11 entrants, with an average of
1.6% over the period. GDP growth over the period, rather surprisingly, averaged
only 1.4%, slightly below the Eurozone as a whole. The slow growth of GDP in
the period 2001-5 contrasted with rapid growth in 2006-7 and in 2011. Total
debt averaged 67.6% over the whole period, somewhat better than the Eurozone
average. The ratio was very steady at about 60% up to 2002, rose gently to 66.7%
in 2008, and rose rapidly to 83.0% in 2010, before easing back to 81.2% in
2011. This is a worryingly high debt ratio for the country which is likely to
take the main burden in bailing out other nations with severe debt problems.
averaged 2.5% over the whole period, well above the Eurozone average. The
variability of inflation over the period was the greatest of any of the 11
original entrants. Inflation was above 4% in 2000-2003, and 2-3% between
2004-7; this was followed by two years of deflation in 2009 and 2010, before
returning to moderate inflation in 2011. GDP growth averaged 3.9% over the
period, this being the fastest growth rate of any of the original entrants. But
again the pattern was very volatile – growth in excess of 10% in 1999 and 2000,
about 5% up to 2007, followed by a fall of 2.1% in 2008, 5.5% in 2009 and 0.8%
in 2010. Positive growth of 1.4% returned in 2011. Somewhat surprisingly total
government debt ratio averaged only 45.7% over the whole period, but the
pattern was again highly volatile. The ratio fell from 46.6% in 1999 to only
24.9% in 2007.There then followed a rapid deterioration as large budget
deficits pushed the ratio up to 65.1% in 2009, 92.5% in 2010 and 108.2% in
was remarkably steady in Italy, with an average of 2.3% slightly higher than
the Eurozone average. GDP growth averaged only 0.7%, the lowest of any of the
original 11 entrants; there was a deep recession in 2008-9. The total debt
ratio averaged 109.0% for the whole period and was the worst of any of the
original entrants. Like Belgium, Italy was allowed to enter the Eurozone with a
debt ratio far in excess of the threshold of 60% - in fact it had a ratio of
115.0% in 1999. Extreme leniency was afforded to this key country in Europe. Debt
fell only modestly to 103.1% in 2007, and then rose again to 120.1% by 2011.
in the small nation of Luxembourg at an average of 2.7% was the second highest
of the original entrants to the Eurozone. Meanwhile, GDP growth at an average
of 3.6% was the second highest of the original entrants. Debt levels were
exceptionally low throughout the period, averaging only 9.5%, this being the
lowest of any nation in the Eurozone. However, there was an upward trend at the
end of the period from 6.7% in 2007 to 18.2% in 2011.
averaged 2.2% and GDP growth averaged 1.8%, both slightly above the Eurozone as
a whole. Total debt averaged only 54.7%, well below the Eurozone as a whole.
The ratio fell from 61.1% in 1999 to only 45.3% in 2007 but then rose to 65.2%
was the second highest of the original entrants with an average of 2.6%, while
GDP growth was the second lowest at 1.0%. The country was in recession in 2011
when most other countries were in recovery. The total debt ratio averaged 68.8%
for the whole period, slightly better than the Eurozone as a whole. However, the
debt position deteriorated through the period, starting with only 51.4% in 1999
rising to 68.3% in 2007 and ending the period at 107.9% in 2011.
in Spain averaged 2.8%, the highest of any of the original entrants. The growth
in GDP averaged 2.4%, the third highest of the original eleven. However, there
was a marked contrast between the high growth rates of the early years, with
low growth and periods of recession in the latter years. The total debt ratio
averaged only 51.6% for the complete period, well below the Eurozone average.
The debt ratio on entry in 1999 was 62.4% and fell markedly to only 39.7% in
2006; it then rose to end the period at 68.5% in 2011. While there has been
much attention given to Spain’s economic problems, its debt ratio is not nearly
high as other countries.
was one of the original applicants for entry in 1999 but was refused entry, on
the grounds that it did not meet the five tests. Given the leniency afforded to
some other countries, Greece felt aggrieved at this decision. It was allowed to
enter two years later in January 2001. Inflation averaged 3.4% over the period
2001-11, higher than any of the original entrants. Growth in GDP averaged 1.4%,
near the Eurozone average, but was highly variable. High growth rates were
achieved in most years up to 2007, but this was followed by four years of
recession as the country struggled with its financial crisis. The total debt
ratio averaged 115.3%, the highest of any Eurozone country. On entry in 2001 it
had a ratio of 103.7%, slightly better than Belgium and Italy which had been
allowed entry two years earlier. The ratio then fell slightly to reach 98.8% in
2004, before climbing again to reach as much as 165.3% in 2011. This debt
level, combined with recession and high budget deficits ended up threatening
its continued membership of the Eurozone.
country entered in January 2007. Since then it has experienced inflation of
2.8% considerably higher than the 2.0% for the Eurozone as a whole. GDP growth
has averaged 1.0%, well above the Eurozone average of 0.3% for the same period.
Total debt ratio has averaged only 33.4% compared to the Eurozone average of
77.8% over the same period. There was a very low ratio of only 23.1% on entry
in 2007 but this rose rapidly to 47.8% by the end of the period.
island economy entered in January 2008. It experienced inflation averaging 2.7%
over the period 2008-11, somewhat above the average of 2.0% for the Eurozone.
Growth in GDP averaged 0.8% over the period compared to a slight decline of
0.1% in the Eurozone as a whole. Total debt ratio averaged 58.9% well below the
Eurozone’s 80.7% over the same period. However, debt grew from 48.9% in 2008 to
71.6% by 2011.
island of Malta also entered in January 2008. Inflation averaged 2.8%, well
above the Eurozone average of 2.0% over the same period. Growth in GDP averaged
1.7% over the period 2008-11, well above the Eurozone’s decline of 0.1%. The
total debt ratio averaged 68.0% over the period, well below the Eurozone’s
80.7% over the same period. There was a slow gradual rise in debt from 62.3% in
2008 to 72.0% by 2011.
entered the Eurozone in January 2009. Inflation in the three years 2009-11
averaged 1.9% well above the Eurozone average of 1.5% over the same period.
Meanwhile GDP growth averaged 0.9%, well above the decline of 0.3% in the Eurozone.
The total debt ratio averaged 40.0%, well below the Eurozone average of 84.1%
over the same period. The ratio gradually rose from 35.6% in 2008 to 43.3% in
entered the Eurozone in January 2011 and so we can only compare performance in
that year with the Eurozone average in that year. Inflation was much higher at
5.1% compared the Eurozone’s 2.7%, while GDP growth was very high at 8.3%
compared to 1.4% in the Eurozone. The total debt ratio was a mere 6.0% compared
to the Eurozone average of 87.2%.
is clear from the above that each country has its own story and experiences,
and it is very difficult to find common patterns of inflation, growth and
government debt. Instead there seem to be sub-groups of countries with similar
economic performances. Germany, Austria, France and the Netherlands at the
centre have broadly similar patterns of experience. Italy and Belgium stand out
for their high government debt, while Luxembourg’s high growth and inflation but
very low debt is exceptional. Spain, Portugal and Ireland had similar
experiences of high initial growth followed by a period of rapidly increasing
debt and recession. Greece is exceptional in that its initial progress was
dramatically wiped out by the more recent experience of spiralling government
debt and deep recession. In marked contrast, Finland exhibits very good overall
performance, and is the only country of the original 11 that would still pass
all tests for entry. Finally, the recent newcomers of Slovenia, Cyprus, Malta,
Slovakia and Estonia generally show dynamic growth and low debt levels, but
coupled with rather high inflation.
the previous section we noted that the ratio of total government debt to GDP
rose dramatically from 2007. The reason has been the sharp increase in budget
deficits in nearly all Eurozone countries since that date. Data for the four
years from 2008 to 2011 is shown in the table below.
government deficit (-) (or surplus (+)) is the net borrowing (or lending) of
the whole general government sector and is calculated according to the national
accounts concepts (ESA 95). It shows the difference between what the government
sector spends in a year and what is obtains from taxation and other sources of
revenue. The deficit (or surplus) is then expressed as a % of GDP in that
year. Data on government deficits are constantly being revised by member
nations as new information becomes available. The above table is taken from a
press release by Eurostat (2012).
data shows why government deficits have given rise to such a crisis in the Eurozone.
Only three countries (Luxembourg, Finland and Germany) in the Eurozone had
average budget deficits of less than 3% of GDP in the period 2008-2011. The
average for the Eurozone as a whole was 4.7% over these four years, suggesting
that the monetary union was simply unable to meet one of its key targets for
convergence. The spread of nations around the average is shown by the
coefficient of variation. This was very high throughout but particularly so in
2008 and 2010.
end with a wider look at real convergence by examining the unemployment rates
and GDP/head data for Eurozone countries in 2011.
is expressed per head of the population, in the form of an index relative to
the Eurozone = 100. Data is expressed in Purchasing Power Standards (PPS) which
allows for differing price levels in the various countries. GDP per head is
often used as a measure of prosperity in a country. It can be seen that the
tiny country of Luxembourg stands out from the rest in terms of its
exceptionally high prosperity.
is followed by the Netherlands, Austria and then, somewhat surprisingly, Ireland
comes ahead of Germany. At the other end of the table, the least prosperous
country is Estonia, followed by Slovakia, Portugal and Greece.
unemployment rate is the number of unemployed persons as a percentage of the
workforce, based on the International Labour Force (ILO) definition. The labour
force is the total number of people employed and unemployed. The unemployed are
persons aged 15-74 who are out of work in a particular week, available to start
work within two weeks and have been actively seeking work in the past 4 weeks
or already found a job and are due to start work in the next 3 months The
lowest rates in December 2011 were all about 5% in the Netherlands, Luxembourg
and Germany, while rates in excess of 20% were found in Greece and Spain.
terms of the variability of the data, the two measures of prosperity showed
similar characteristics. GDP/head among countries of the Eurozone showed a high
coefficient of variation of 47.6%, while the unemployment rate showed a
coefficient of 48.7%.
whatever happened to convergence in the Eurozone? The limited degree of
convergence that existed in 1999 was largely lost eight years later, when in
2007-8 the twin shocks of the global recession and financial crisis exposed the
Eurozone’s fault lines.
was broadly subdued and stable between countries up to 2007, at a rate just
above the upper limit of the 0-2% set by the ECB as its target for price
stability. From 2008 onwards all convergence was lost, with the Eurozone
swinging first into an inflation spike and then almost into deflation. There also
was increasing diversity between nations, with some suffering significant
government debt as a % GDP, was fairly stable in the period up to 2007, but at
a level some 10% above the 60% threshold required for entry. Yet it would be
incorrect to describe this situation as converged, as three countries Belgium,
Italy and Greece has debt ratios over 100% for most of this period. From 2008
onwards, the average debt ratio for the Eurozone rose dramatically in response
to huge budget deficits in several countries.
deficits were supposed to be contained by the Stability and Growth Pact of
1997, limiting deficits to no more than 3% of GDP. However, any country could
plead “exceptional circumstances” and leniency was the rule in practice. Hence
the Pact failed to impose discipline and deficits grew alarmingly in 2009 and
2010. This led to a gradual loss of confidence in the working of the Eurozone,
and particular to severe problems for high debt nations in financing their
deficits. Greece was, and still is, in the eye of the storm, although Spain,
Portugal and even Italy are threatened by contagion. Over the last four years
the coefficient of variation has lurched one way and then another, as each
country tried to react to its own problems. Only Finland and Luxembourg seem to
have the position firmly under control.
growth between nations has never shown any real convergence. There was generally
a triple split between the mature industrial nations at the heart of Europe, the
nations bordering the Mediterranean and new nations in Eastern Europe. All were
hit by the global recession and financial crisis in 2007 and 2008, but to
varying degrees. Finally, prosperity as measured by the unemployment rate and
GDP/head shows a very wide variability between the rich and poor in this huge
are becoming increasingly pessimistic about the euro’s future and are already
discussing how a country in severe difficulties may be allowed to leave in a
managed way, rather than forced out by default. Roger Bootle (2012), who won
the Wolfson Prize for a plan for such an eventually, has described the history
of the euro as
failure of the greatest monetary experiment in history. The financial crisis
made it worse but did not cause it. This failed experiment is condemning the Eurozone,
which accounts for about a sixth of world GDP, to depression”
leaders continue to meet in summit conference after summit conference,
nervously contemplating fiscal union as a solution to the budget and debt
problems. But it is not politicians, nor even economists, who will determine
the Eurozone’s fate. If the financial markets perceive there is no long term
solution to be found, they will finally turn against holding government debt
from Eurozone nations, and the euro as a reserve currency. The verdict of the
markets could then be quick and brutal.
R. (2012) “The Daily Telegraph” – business section Monday Oct 15, 2012
(2012) News Release Euro-indicators 62/2012 April 23 2012 “Provision of
deficit and debt data for 2011”
J. (2012) “The relative economic performance of Eurozone nations” The
Business Economist Vol 43 No. 2 p 6 – 16
J (1997) “Are the European economies really converging?” The Business
Economist Vol 28 No. 2 p 10-13
S. & Gough J. (2004) “The Economics and Politics of EMU” in Political
issues of the twenty first century (ed. Morland D & Cowling M)
Ashgate p 161-192
K.A. (1968) “Introducing Statistics” (Penguin) p 112-3
deviation is the square root of the average of the summed squared deviations
of each observation from the arithmetic mean.
the standard deviation
an individual observation of series x
the mean value of the x series
the number of observations in the series
the coefficient of variation (CV) is the standard deviation expressed as
a percentage of the mean
CV = 100s/x’
may now consider what value of the coefficient of variation is associated with
a converged series. For this we need to make some assumptions about the
tolerated variability of observations around the mean value. These are set out
in the following table.
is set to converge on 2% which is the top of the ECB target range. Assume we
allow a standard deviation of 0.5% around this central value of 2%. This would
equate to a coefficient of variation of 25%
the same logic to the budget deficit we allow a standard deviation of 0.5%
around the mean maximum value of 3% of GDP, defined in the original convergence
conditions. This would equate to a coefficient of variation of 16.6%
total government debt the average value is set as 60% of GDP, as the maximum in
the original convergence conditions. If we set a standard deviation of 5%
around this central value this implies a coefficient of variation of 8.3%
growth in GDP we assume a long term trend growth of 2% for the Eurozone, with a
standard deviation of 0.5% around this central value. This would equate to a
coefficient of variation of 25%
employment is likely to be associated with an unemployment rate of about 5%,
and we assume a standard deviation of 1% around this central value. This would
imply a coefficient of variation of 20%
is recognised that the above assumptions are open to debate, but they do give
us a guide to the values of the coefficient of variation which are associated
with convergence around the central values. The value of 25% or less in the
above table gives us a benchmark to judge the actual results of Eurozone
nations over the last twelve years.
fact none of the calculated coefficients get as low as 25%, and only in the
inflation data do they get near that level. In most other series the value of the
CV exceeds 40%, and in many cases considerably higher than this, sometimes well
in excess of 100%. The overall picture is one of lack of convergence right
across the Eurozone for nearly all of the relevant series, with the exception
of inflation up to the global recession and financial crisis in 2007.