Wednesday, November 7, 2012

Convergence between the core and the periphery economies in the Eurozone

Here is a quick follow-up to an earlier post on Germany's weakening economic activity. The convergence between the Eurozone core and the periphery in terms of economic growth is now clearly visible in the PMI data.

Under 50 means contraction (source DB)

We may be looking at a situation in which some periphery nations have become a cheaper option for manufacturing (and other business activity), as companies shift some of their production out of the Eurozone core. In response, France for example is now taking steps to improve competitiveness and try to keep businesses and jobs from leaving. The latest idea is to provide tax incentives to companies, paid by an increase in VAT and cuts spending.
WSJ: - A day after the release of a highly anticipated government-commissioned report that sounded the alarm on French companies' declining competitiveness, Socialist Prime Minister Jean-Marc Ayrault unveiled €20 billion worth of tax breaks over three years that will allow domestic firms to cut labor costs.

The resulting shortfall in the government finances, equivalent to about 1% of gross domestic product, will be funded in equal parts by spending cuts and by an increase in the value-added tax. During his election campaign, Mr. Hollande had ruled out a VAT increase, a move that was strongly advocated by his predecessor, Nicolas Sarkozy.
In effect the painful periphery adjustments are forcing the core to adjust as well, contributing to the convergence.
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