The New Great Divergence

This article was originally posted at PanamPost: panampost.com/editor/2020/09/23/the-new-great-divergence/

Walking around Madrid is quite sad nowadays. A day before moving to Cambridge, I went for a walk around Madrid’s city center. The atmosphere was depressing. Shops were closed or preparing to close in the next few weeks or months. And some others didn’t even reopen after the Great Lockdown. That same day, I received a call from a friend who had recently traveled to Switzerland and Germany for work and was notoriously happy with what he had seen and felt, especially in Germany. He told me that COVID-19 restrictions were much more relaxed there than in Spain, and restaurants, cafés, and shops in the city center were crowded most of the time. People were happy, going out again. Unemployment levels were controlled, and the health situation was mostly stable, which allowed more economic activities to develop and less harsh restrictions to be imposed. Being aware that visual analysis is not the best empirical analytic tool for economic research, I decided to search for the most recent data on the economic situation of both countries, translating the observed reality into numbers, trying to analyze how this new Great Divergence is already a reality, that will -sadly- accelerate its pace soon. 

The pandemic has changed it all. Before COVID-19 erupted in the West, Spain was growing at an annual rate above the average of the EU-27, while its counterpart for this analysis, Germany, was entering a technical recession due to a severe slowdown in global trade, while Spain’s tourism sector was expanding at astonishing rates. According to official data from Eurostat, after the pandemic froze the Spanish economy, the registered second-quarter growth was a negative 22% compared to the second quarter in 2019. Meanwhile, the same statistic for Germany is negative 12%, a much more positive result in a very pessimistic economic environment.

Spain’s own economic structure has been one of the main causes that have positioned the country as the worst economic performing nation in all of Europe. Spain is excessively reliant on tourism. The sector represents 12.3% of its GDP and 12.7% of its total employment. Spain’s labor market duality and its multiple frictions and restrictions have led to a youth unemployment level of over 40%, being, once again, the highest of the whole Eurozone. Furthermore, over the last decade, Spain increased its international weight in terms of exports and imports relevance over GDP. This led to Spain’s exports and imports being 35.12% and 32.4% over GDP, respectively, according to World Bank data. The greater participation of Spain in the global economy was great news as part of the recovery process from the previous recession, but it might pose some problems when trying to recover from the present one due to the intense disintegration of global supply chains, that the pandemic is causing. 

When it comes to annual data, the European Commission recently estimated that the Spanish economy would contract 11% this year. Meanwhile, the German economy will contract by just 6.3%, which presents a new enormous differential between the two countries. These two economies are the perfect representation of the actual tendency of growth and recovery for North and South Europe. While Northern countries have controlled the pandemic much better and reopened their economies with greater caution- staying nearly fully active after the summer-, many Southern countries were unable to control the pandemic and reopened their economies without the required security measures and plans. This led to them having to close several sectors of the economy again. Consequently, some public expenditure programs were expanded. However, this spending was meant as a security net during the first phase of the pandemic but wasn’t designed to function as an automatic stabilizer, which is how it is being used now. 

This could completely lead to a two-speed recovery, whereby countries in Northern Europe, with greater fiscal space and capacity, can develop better social protection and recovery programs, which would incentivize a faster rebound, while heavily indebted countries (all of them from Southern Europe) will require greater financial support from European institutions and will incur in even higher debt levels. Recently, the Bank of Spain estimated that Spanish public debt levels would rise from 96.5% of GDP before the pandemic up to 128.7% by the end of 2022. In contrast, the German economy will reach just 75% of GDP public debt levels thanks to its constant and stable fiscal surpluses throughout the last years.  

On the other hand, temporary unemployment furlough schemes, as part of the Kurzarbeit German support program, have worked quite well lately. They prevented five million people from becoming unemployed, according to official government statistics. Similarly, the ERTEs program in Spain covered more than 3.5 million workers at the peak of the pandemic, and more than 2.7 million people have recovered their jobs through it. The danger with this type of program is that over 700,000 people are still protected by an ERTE. But this can’t be prolonged forever since its total cost has already been greater than the corresponding credit from the SURE fund of the EU, which intended to support furlough schemes costs provided Spain with 21.3 billion euros to cover these expenses. 

The first phases of the New Great Divergence are inevitable due to Spain’s economic structure and the effects of the pandemic, but the Spanish economy could perfectly increase its potential growth over the next few years, profiting from a rebound effect and perfect timing for doing several structural reforms (education, labor market, social security, public pensions system) which are necessary but have not been executed for several decades. It is the moment for action. Let’s transform the Spanish and European economies.