Italy and Spain - Club Med economies face meltdown with euro zone
SPAIN and Italy are on a collision course with the rest of the euro zone because of their soaring current account deficits and excessive wage growth, a top consultancy will warn on Monday. The two “Club Med” economies have been crippled by the euro zone’s one-size-fits-all exchange rate and are facing meltdown, Lombard Street Research’s upcoming report will say.
The surging debt and artificially low euro interest rates that have kept Italy and Spain afloat are likely to come to an end, threatening to force Italy to quit the euro and prompting a house price crash in Spain. Charles Dumas, an economist at Lombard Street, says: “Their uninhibited run-ups of debt have obscured the blight from labour cost inflation, cumulatively 15% for Spain and 10% for Italy above the euro zone average over the eight years of the euro’s operation.” The Club Med countries’ willingness and ability to borrow more have helped prop up the euro zone over the last few years, inflating its growth and jobs performance. Spain, which makes up 11% of the euro zone’s economy, has accounted for 32% of its gross domestic product (GDP) growth between 2002 and 2005, and 39% of extra domestic demand. While this kept the European economy growing, it has come at a disastrous cost for Spain, which is saddled with a current account deficit of 7.5% of GDP.
In Italy, labour productivity is stagnant and total factor productivity negative. Reforms by Romano Prodi’s government will have to be more aggressive if surging labour costs are not to force Italy out of the euro or into a permanent slump, Lombard warns. Dumas says: “Lack of productivity growth seems to have gone hand in hand with Italy’s failure to adapt, and adopt higher value product lines. The Italian supply side failure looks both broad and deep-seated.”
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