Economic Divergence in Europe

The common currency has not led to common outcomes.

After almost a decade of preparations starting in the early 1990s, the euro saw the light of day in January 1999. The idea was that a common currency union would increase economic convergence among member states. Twenty-five years later, these expectations have not been met. Europe’s economic performance has been anything but homogenous.

Countries like Spain and Austria have expanded at a rapid rate, benefitting from a common market and currency. Others, like Italy, didn’t gain much from joining the bloc. The Italian economy has expanded by a little over ten percent in 24 years, showcasing the stark divergence among the member states.

Over the years, economic differences have persisted due to differing models of growth embraced by individual governments. Nations like Germany, the Netherlands and Austria have pursued an export-oriented growth model. They are also among the frugal states with low public debt and deficit levels. On the other hand, southern states have had a history of spending beyond their means, leaving them on a shaky pile of debt. Periodic devaluation of domestic currencies was the main instrument for countries like Italy, Portugal and Greece to maintain their competitiveness prior to 1999. Joining the monetary union meant giving up an important economic policy tool.

The economic gap between countries has become more apparent in the post-COVID era. While output declines were uniformly large across the currency union in the initial phase of the pandemic, the recovery has been uneven. The largest eurozone economy, Germany, is fighting to avoid a recession. Italy is barely growing. Spain and France have performed well in the first two quarters of 2023. Purchasing Managers’ Indexes are pointing to continued divergence into the third quarter.

After COVID put all economies on shaky ground, the energy shock related to the Ukraine War contributed to the current uneven recovery. Germany, being an industrialized economy, was the most impacted by the energy crunch. The crises forced the otherwise frugal northern state to spend large sums of money to shield households and firms. Berlin’s fiscal support to combat the energy shock was among the largest in Europe, amounting to 7.5% of gross domestic product.