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Mind the gap: Southern European economies have diverged

Carla Subirana Artús is an economist who has worked as a policy analyst for the Bank of England and Europe research analyst for Economist Intelligence.

If the eurozone were a school, Portugal, Italy, Greece and Spain would be the slackers of the class. The four countries, branded with the ugly acronym PIGS, talk loudly, enjoy slow living under the sun and are over-indebted and in need of reform — or so the cliché goes.  

Yet, look closer, and you’ll see that some of those previously unruly students have since become unlikely star pupils. 

Though Italy and Greece remain economic laggards, Spain and Portugal’s growth trajectory has become more robust and convincing since the sovereign debt crises of 2012 — a shift that has become conspicuous with the end of an era of super-lax monetary policy. And much of the credit for this split between the Iberian Peninsula and Italy and Greece goes to the structural reforms Spain and Portugal have introduced in the last decade. But still, the eurozone is not crisis-proof. 

A recent example of the divergence between Europe’s southern economies and their respective approach to reform was seen when the European Central Bank (ECB) promised to end its bond-buying program in June. Whereas Italy and Greece’s 10-year sovereign bonds yields soared, the borrowing costs for Portugal and Spain remained closer to that of the Netherlands — considered a model student by European Union officials. 

Over the last decade, Italy’s labor reforms have been tentative, and the country has only partly tackled its banks’ bad debts, whereas Spain has addressed these issues much more decisively. As a result, Spain’s GDP per person in terms of purchasing power, bolstered by a rise in total factor productivity — or the efficiency with which an economy uses its productive inputs — overtook that of Italy in 2017.

The country has since become one of Europe’s biggest car producers, and its exports have been diversified beyond tourism into chemicals, pharmaceuticals, machinery and professional services.

Investors now look at the country in a different light, leading to lower borrowing costs for households and businesses. Whereas the spreads on the country’s credit-default swaps — which are insurance-like derivatives that pay out in the event of a default — were identical to Italy’s until 2014, they have since been closer to those of France. 

Portugal, meanwhile, has had a promising decade too. Since 2014, its economy has grown, on average, three times faster than Greece’s, where output remains nearly a quarter below its level in 2007. And by lifting growth, all while implementing onerous reforms and meeting stiff fiscal targets demanded by EU officials, António Costa, Portugal’s Socialist prime minister since 2015, became Brussels’ favorite student. 

By contrast, Syriza, the Greek leftist party that ran the country from 2015 to 2019, was the class rebel. The government slid back on reforms as national debt remained the largest in the eurozone, banks’ bad loans piled up, and tax revenues continued to rely on too narrow a base, requiring high rates that deterred hiring. 

Despite its progress, however, any crowing over the Iberian Peninsula’s success should still be tempered. 

For instance, Portugal’s fiscal prudence has come at a cost. Public investment was the lowest in the EU in 2020 and 2021, and the country’s public debt — the highest in the eurozone after Greece and Italy — places the wider economy at risk of being hit by higher government borrowing costs. Moreover, salaries are low by Western European standards, sending many Portuguese abroad to work.  

Across the border, Spain’s government, made up of the Socialists and the far-left Unidas Podemos (United We Can) grouping, has offered no creative solutions to fix the country’s unsustainable pension system and sky-high youth unemployment rate since 2019 either. And with an ugly election in which no party is likely to win a majority looming, moderates are now warily eyeing Vox — a relatively new hard-right outfit, attracting worryingly strong support in the polls. 

Meanwhile, Greece has been busy doing its homework in order to join the club of successful “turnaround” stories in the eurozone’s periphery. The government of Kyriakos Mitsotakis, Greece’s center-right prime minister since 2019, has managed to polish its image with tourists and investors, attracting record foreign investment last year. 

Italian growth, however, will most likely continue to disappoint, as the rare stability brought to its politics by Prime Minister Mario Draghi has now come to an end. 

Political stability matters — and not just to Italian families. ECB officials worry that if the notorious “doom loop,” which ties the solvency of banks to that of their host countries, were to hit Italy and threaten to trigger a debt crisis, the currency union would start to look shaky.  

And while most European banks have reduced their exposures to their home country since the sovereign debt crisis of 2012, Italian banks remain just as exposed to their government’s debt as they were a decade ago, the link between banks and sovereigns holding particularly strong.  

So, as Italy’s political turmoil intensifies, and investors begin to demand higher yields to hold Italian debt, the country’s banks will inevitably suffer. Signs are already emerging that Italian banks are heading for trouble: The year-to-date returns of the country’s biggest lender — a measure of investment performance — have fallen by 24 percent since February. 

And now, racked by sluggish investment, meager reforms and political instability once again, Italy is set to remain the eurozone’s troubled student for the foreseeable future.

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