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Economic Commentary
QNB Economics
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May
Eurozone’s Fragile Recovery Depends on Continued Adjustment
The Eurozone’s recovery is slowly underway.
Data for the first quarter of 2014 published last
week confirmed that real GDP growth is on an
upward trend in Germany and Spain while
France and Italy continue to lag behind. This
two-speed growth performance is mainly
driven by the extent to which each Eurozone
country has managed to gain competitiveness
in the last few years by reducing its unit labor
costs relative to Germany. Unless this internal
adjustment process continues, the growth
performance in the single currency area will
diverge further, with important implications
for the stability of the Eurozone.
Data for the first quarter of 2014 indicate a
two-speed Eurozone recovery. While Germany
grew faster than expected (0.8% quarter-on-
quarter), other countries lagged behind.
Spain’s growth ( . %) continued to accelerate
on a positive trend for the third consecutive
quarter. Growth in Ireland has not yet been
released, but the consensus estimate is for a
similar growth rate (0.5%). On the other hand,
France (0.0%) and Italy (-0.1%) continue to lag
behind, while growth in Greece (-1.1%) and
Portugal (- . %) remains depressed by the
fiscal austerity measures contained in the
ongoing IMF-supported adjustment programs.
Overall, this two-speed economic recovery has
resulted in a worse-than-expected Eurozone
expansion in the first quarter of 2014 of only
. %.
What explains this two-speed expansion in the
Eurozone? The answer is competitiveness
measured by unit labor costs – the cost of labor
for one unit of production. What drives growth
is the ability of businesses to compete in the
global economy, which largely depends on
their labor costs, particularly in advanced
economies. As unit labor costs rise without a
corresponding rise in labor productivity,
businesses lose competitiveness. A
sufficiently large loss of competitiveness can
force businesses to reduce their activities or
even shut down. At an economy-wide level, a
loss of competitiveness means lower growth
and higher unemployment as both external
and domestic demand for the country’s goods
and services weaken. This is even more
evident in countries with a common currency
like the Eurozone where the option to regain
competitiveness by weakening the currency is
unavailable.
Unit Labor Costs
(Index, 2000 Q1 = 100)
Sources: Eurostat and IMF estimates and projections
for Greece after 2011Q1
The economic story of the Eurozone for the
last 15 years is very much one driven by unit
labor costs. Starting in early 2003, Germany
implemented a series of labor market reforms
aimed at reducing unit labor costs in order to
increase the competitiveness of German
businesses and reduce unemployment. These
reforms— named after Peter Hartz, the head of
90
100
110
120
130
140
150
160
2000Q1 2002Q4 2005Q3 2008Q2 2011Q1 2013Q4
Ireland
Germany
Greece
Italy
France
Portugal
Spain

2. Page of
Economic Commentary
QNB Economics
economics@qnb.com.qa
May
the commission that recommended them—
have managed to keep unit labor costs well
below the Eurozone average for the last 12
years, resulting in higher German economic
growth and one of the lowest unemployment
rates in Europe.
Other countries in the Eurozone did not follow
the German example right away. As unit labor
costs rose rapidly during the last decade in the
Eurozone periphery (Greece, Ireland, Portugal
and Spain), their economies became
uncompetitive and turned inwards to domestic
sectors (e.g., the real estate sector) to maintain
the growth momentum. Eventually, the rising
gap in unit labor costs between Germany and
the Eurozone periphery became so large that it
forced an abrupt outflow of capital as the
economy could no longer generate the required
returns, thus unleashing the Eurozone crisis.
Since then, it has been a painful road for
Greece, Ireland, Portugal and Spain to adjust
unit labor costs down by reducing government
spending and thus repressing domestic
demand in order to regain competitiveness.
The first dividends of this painful adjustment
are starting to pay off in Ireland and Spain,
while more is still needed in Greece and
Portugal.
Unit labor costs, however, continue to rise in
France and Italy. Notwithstanding the painful
lessons of the Eurozone crisis, the second and
third largest economy in the Eurozone have
not yet mustered the political will to
implement the necessary reforms and thus
unit labor costs are now the highest in the
Eurozone. As a result, France and Italy
continued to lag behind the Eurozone recovery
in the first quarter of 2014 and registered
record-high unemployment rates.
Overall, the Eurozone recovery remains fragile
and predicated on continued adjustment in
unit labor costs. What is worrisome is the
continued divergence in growth performance
between Germany and Spain on the one hand
and France and Italy on the other, reflecting
the necessary adjustment in unit labor costs
still needed in the latter two economies.
Without such adjustment, the economic
recovery could unravel, calling into question
the stability of Eurozone once again.
Contacts
Joannes Mongardini
Head of Economics
Tel. (+974) 4453-
Rory Fyfe
Senior Economist
Tel. ( ) -
Ehsan Khoman
Economist
Tel. (+974) 4453-
Hamda Al-Thani
Economist
Tel. (+974) 4453-
Ziad Daoud
Economist
Tel. (+974) 4453-
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