Euro Zone Is Imperiled by North-South Divide

Euro Zone Is Imperiled by North-South Divide

LISBON — Sara Vale Lima, sales manager at Eical, a Portuguese textile company, feels suffocated by the euro. The common currency once meant flush banks and easy credit, but these days it has laid bare a cold reality: Portugal shares the high wages and prices of richer northern European neighbors, but not their competitiveness.

The price of a Portuguese roll of cloth, in euros, often exceeds that of a similar product made in competing countries outside the euro zone, like Poland or Turkey, by 30 percent. Britain, once a big importer of Portuguese textiles, has effectively devalued the pound, and Eical now sells almost nothing there. “Things are quite difficult,” Ms. Vale Lima said.

Devaluation is the time-tested prescription for such ailments. But Portugal is shackled to a currency that seems better suited to the relative strength of Germany or France than to southern countries like Portugal, Spain and Greece, with their inefficient labor markets and tax systems and heavy debt.

The European Union and the 16 nations that use the euro face two crises. One is the immediate problem of too much debt and government spending. Another is the more fundamental divide, roughly north and south, between the more competitive export countries like Germany and France and the uncompetitive, deficit countries that have adopted the high wages and generous social protections of the north without the same economic ethos of strict work habits, innovation, more flexible labor markets and high productivity.

As Europe grapples with its financial crisis, the more competitive, wealthier countries are reluctantly rescuing more profligate economies, including Greece and Ireland, from fiscal and bank woes, while imposing drastic cuts in spending there.

Yet, even the staunchest defenders of the euro now acknowledge that the currency union cannot survive if its weaker members are caught in a perpetual hell of austerity budgets and declining incomes while the stronger countries are forced to tap taxpayers for financial rescues.

As the Continent faces more competition from emerging rivals, including Brazil, Russia, India and China — and low-wage Eastern European nations outside the euro — the problems of the euro’s southern tier threaten to become a vicious circle that could increase tensions and make the common currency untenable, some economists say.

Business people in the southern countries call it the euro bind. Oscar Turner, who runs a film company in Portugal, explained, “The euro’s great if you’re traveling around, but it’s an absurd idea to have the same currency in a country like Greece or Portugal as in Germany, which has totally different habits and culture.”

The highly indebted countries of the euro zone “can’t grow their way out of debt,” Mr. Turner said, nor can they devalue to make their exports more competitive. “No one in these countries can make the same product for a price that competes” with Hungary, let alone Turkey or China.

Francisco Gaya runs a family ceramics company in eastern Spain that is trying to survive by making niche products and shedding workers. But manufacturing is too expensive in southern Europe, Mr. Gaya said, in part because of stiff state requirements for benefits, taxes and labor protections.

“Unions, difficulties created by layoffs, social and financial charges have been exceedingly heavy,” Mr. Gaya said. Spain, he said, needs to allow companies to hire and dismiss workers much more easily. But “whoever does it will lose elections and not govern again for many years,” he said.

These southern countries, some of them relatively new democracies, took advantage of the euro to borrow money cheaply. They lived on a bubble of credit and real estate development that sent wages and debt soaring. But they did little to improve their productivity, labor markets or tax systems and are now paying a steep price in low growth or an actual decline, with no easy fix.

Governments have cut spending. But except for Greece, under the global gun, significant legal and economic change is still lacking. The imbalances plaguing the euro zone will not go away unless the south can cut costs, including wages, so its companies can compete. But that process, referred to by economists as internal deflation, is political poison.

Nouriel Roubini, an economist at New York University and the Cassandra of the economic crisis, is not optimistic about the euro zone. The problems of the periphery are essentially two, he said: “High deficit and debt, but also low growth driven in part by this competitiveness problem.” Currency depreciation is impossible and deflation is painful.

“If you have to reduce prices and wages by 30 percent over the next five years, deflation is associated with recession, and no country can accept it,” he said. “Doing the German solution of structural reform is going to take a decade, not fast enough to restore competitiveness. The only other option is for the euro to weaken sharply.” But with the German economy so strong and the American deficit so high, he added, that is also unlikely.

Economists agree that the biggest test for the euro is Spain, a country with an economy twice the size of those of Greece, Portugal and Ireland combined. “Spain isn’t off the cliff; it’s still a few miles away, but moving pretty fast,” Mr. Roubini said. “Can they do enough fiscal adjustments, structural reform, restoring growth, reducing the unemployment rate, restoring competitiveness in time to stop falling off the cliff? I’m not sure.”

Stéphane Garelli of the IMD business school in Switzerland studies competitiveness. He says the main difference is between countries with trade surpluses or deficits — between those that export more than they import and those that do the reverse.

Germany, like the United States, may have high debt, but no one doubts its ability to pay. That is not true of southern economies, Mr. Garelli said. “There was the illusion of economic growth, but it’s built on sand. You can’t build an economy on real estate, finance and tourism.”

The World Economic Forum has issued competitiveness ratings for 20 years based on increasingly sophisticated measures, including government, law, ethics, infrastructure, technology, debt and education, said its lead economist, Jennifer Blanke. Germany ranks fifth in the world of 139 countries, just after the United States. The Netherlands is 8th, France 15th, Austria 18th, Belgium 19th. But the southern economies of the euro zone are a different story. Ireland comes in at 29, Spain at 42, Portugal at 46, Italy at 48 and Greece at 83.

One can see the problem clearly in Badalona, an industrial suburb of Barcelona. Plásticos Juárez S.A. is a family business making decent profits through sophisticated compression plastics, often lacquered or metal-plated, for expensive cosmetics and perfume bottles. The company has three small plants in Badalona.

Europe’s economic crisis hit the company hard: sales to its mostly Spanish and French clients fell 30 percent, said its current director, Javier Juárez Bernal. Sales have largely recovered this year, but the company had to shrink. It reduced its permanent staff and now relies on workers with three-month contracts that can be renewed only once.

Mr. Juárez would like to hire more contract workers for longer terms, but says that government labor regulations make that impossible. Adding to the permanent work force, with strict restrictions on layoffs, is too risky.

On the factory floor, Dolores Fortunato Díaz, 24, is glad just to have a job. “I feel lucky to be working,” she said. “Most of my friends are not.” Spain has the highest unemployment rate in Europe, nearly 20 percent.

Another problem for the south is that big European companies are migrating to the most competitive parts of the euro zone. Continental, the German maker of electronic braking systems and tires, is no longer investing much in the south because wages have risen too high. It is now building in lower-cost countries like Hungary and Slovakia, where productivity is higher compared with wages and taxes.

Ralf Cramer, a member of the company’s executive board, said Portugal once had production costs about one-quarter to one-fifth the cost of German production. “But they caught up more to our level,” Mr. Cramer said. “So we’re not seeing Spain and Portugal as lower-cost labor.”

Changing the structure of an economy to make it more competitive is a far more difficult problem than establishing a permanent bailout fund, or even forcing austerity on countries with large deficits. The south needs a thorough economic transformation, and at the moment it does not have the growth — or the support from the north — to help it achieve that.

“Europe is divided,” said Mr. Roubini, the economist. In essence, he said, “a good fraction of the euro zone is still effectively in recession, and it’s not even a double dip; they never got out of the first one.”

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