ECONOMICS:Track records of EU states may show which can avert debt disaster

GREECE LOOKS done for. The risk of sovereign default in the rest of the heavily indebted European periphery – Ireland, along with Italy, Portugal and Spain – is real and rising. Economic history may provide the best guide to whether the peripherals can avoid that fate.

Looking at growth and debt trends over decades, the single biggest fact is a positive one – Europe made unprecedented material progress over the course of just one lifetime from the middle of the 20th century.

Three lost decades in the first half of the century, as a result of wars and depression, meant that the economy of western Europe in 1945 was not much bigger than it was in 1914. If the 30 years to 1945 were a nightmare, though, the next 30 were miraculous. As the chart depicting per capita incomes shows, all of western Europe enjoyed an almost uninterrupted period of high growth, heralding the first ever era of mass prosperity.

A second but much less positive trend has been the rise of public indebtedness. In most European countries in the first three decades of the post-war era, public debt was low and/or falling. The peripherals were no different.

However the 1970s brought change. Fiscal discipline went out of fashion and most governments began deficit financing. By the 1990s, public debt in many countries was high and/or rising. The peripherals were the worst offenders. The second chart shows their descent into debt over four decades.

Growth is the best way to deal with debt. What does history say about the peripherals’ growth prospects?

As the chart also shows, four of the five peripherals who are in trouble now were also Europe’s laggards in the post-war era.

Italy, the exception, and by far the biggest of the grouping, was different from the others in that it had industrialised more and earlier. By the eve of the second World War, Italians were richer than their peripheral cousins, if still poorer than their northern ones.

In the post-war period, Italy also differed from the other peripherals in that it opened up to trade. A broader industrial base and openness are the most likely explanation for the Italian economy’s surge in the post-war era, when it expanded more rapidly than any of the other large European countries. By the 1980s, it achieved its surpasso (overtaking) of Britain to become Europe’s third largest economy after France and Germany.

However, almost as soon as the surpasso had taken place, Italy began to flag. Its medium- tech industries – food, textiles and car parts – faced stiffer competition and higher-tech sectors were slow to develop. In the decade to 2010, the Italian economy recorded the second slowest growth in the euro zone.

A decelerating rate of economic growth over two decades does not augur well for the country’s chances of dealing with the third highest public debt/GDP ratio in the world.

Ireland and the Iberians not only started out as the poorest west Europeans in the pre-war period, they spurned the opportunity to liberalise trade in the immediate post-war period. This caused them to fall further behind the open economies.

When all three abandoned protectionism in the early 1960s, the dividend came quickly. The 1960s were marked by an acceleration in economic growth and some convergence on income levels in the north.

But none of the four smaller peripherals rose to the new policy-making challenges of the Great Inflation of the 1970s-80s, as the much less smooth developments in per capita GDP, illustrated in the chart, show. They again fell further behind the richer north until the mid-1990s. Then, having kept each other company at the back of the European growth pack for decades, Spain pulled away and Ireland burst into an explosive sprint.

Portugal continued to plod. It has been the slowest-growing of the euro area economies in the period since the currency was launched. Its economic fundamentals are very weak and both its public and household sectors are heavily indebted. Apart from Greece, its prospects look bleakest.

Spain’s look best. It boomed from the mid- 1990s. Although it never enjoyed the stratospheric rates of growth enjoyed at the height of the Celtic Tiger period, in the second half of the 1990s, per capita GDP had almost reached the European average by 2008.

Like Ireland, though, a good proportion of its catch-up growth was based on an unsustainable property and construction boom. That is gone, causing a massive employment shock (the jobless rate is 21 per cent). However, with public debt lower than Germany’s, it should avoid default if markets calm.

And Ireland? In 1945 it was the richest of the poor. By 1974 it was the poorest of the poor, according to Angus Maddisson’s figures used in the accompanying chart. Bad policy choices led to most of the 1980s being grim, before take-off in the 1990s. The chart shows the miracle that took place in this economy from mid-decade. Quite simply, no already developed economy has ever experienced a growth explosion of this kind.

Although nobody expects such tigerish rates of growth to return, the Irish economy has shown that, under the right conditions, it has the potential to expand quickly. Whether such conditions pertain will determine its fate.