THE BLOG

Europe Has More to Worry About Than Greece

17/07/2015 17:28 BST | Updated 17/07/2016 10:59 BST

While the whole of Europe's attention has been fixed for months on the standoff between the Eurozone's weakest member, Greece, and its creditors, a possibly even greater threat to the future of the EU has been largely ignored.

Greece's economy makes up only 2% of the European economy. Portugal, Italy and Spain account for ten times as much - roughly a fifth Europe's GDP - and all have fundamental economic problems, which are not being sufficiently addressed, notably, mass unemployment and high levels of debt. These three Southern European states are among the dozen most indebted countries in the world, and they hold the ignominious honours of having the 2nd (Spain), 5th (Portugal), and 7th (Italy) highest levels of unemployment in the EU.

Economic growth may have finally returned, after a prolonged downturn in the aftermath of the crisis, but it remains fragile. Italy, for example, saw only a 0.3% increase in GDP in the first quarter of 2015, after around two years of contraction. While growth is welcome, especially in countries that so desperately need it, it can often mask the need to resolve fundamental weaknesses in the countries' institutions.

One of the main problems in Portugal, Italy, and Spain face is rigid, inflexible and 'dualised' labour markets, where those who have work are protected from wider economic circumstances, developments in technology and working practices, to the detriment of everybody else. When firms cannot change - either let employees go, trim hours or cut wages during a downturn - they will think twice about taking on permanent staff when the outlook is anything less than rosy (as it currently is). This creates a labour market of 'insiders' and 'outsiders' - the main losers are young people, who face almost insurmountable challenges in finding work. In Spain, half of all young people are unemployed. Half of those have been out of work for more than a year.

As my recent IoD report shows, the problem is wider than just long-term youth unemployment. When firms aren't hiring, people are forced into the shadow economy, where cash is paid, but no taxes are collected, and there are few protections for businesses, employees or consumers. Staff may earn a bit of money, but do not gain much else. Companies do not invest in training, and shadow workers find it difficult to move back into formal employment when there are large and unexplained gaps on their CVs. Because governments cannot collect taxes from those who are officially out of work, the government's coffers take a hit, debts cannot be paid off and the likelihood of default and contagion increase.

It can also mask brittle economic growth. As economies begin to rebound and grow, businesses, fearful of binding themselves into rigid employment contracts, take on temporary staff instead of full-time workers. This may boost the number of people in work and raise the headline employment rate, but these are shaky statistics. Prior to the crisis, Spain saw rapid wage growth and record levels of employment. But when the tide went out, it was clear Spain's economy was not wearing a swimming costume, leaving millions of workers exposed.

This is not just a problem for the countries involved. It should be a concern for the whole of the EU, including Britain. Southern Europe has seen an exodus of its best, brightest, and most able, as they up sticks for places that are growing and hiring, like the UK and Germany. 150,000 people arrived in the UK from Spain, Italy and Portugal in the year to March 2015 - a three-fold increase in just five years. This has resulted in a form of adverse selection, where those that are unable to emigrate are also unable to find work at home. They are typically young, with less skills and qualifications, and slip into long-term unemployment all too easily.

As countries across Europe search for their place in the new global and highly-connected economy, while battling for economic health, Spanish, Portuguese, and (maybe) Italian politicians are gearing up for national elections. The triumph of extremist parties is not unique to Syriza in Greece. We have also seen the rise of Podemos in Spain and Lega Nord in Italy; populist parties thrive on the support of those who have been left behind and see little alternative.

Tinged with anger at the European institutions, their rise threatens relations within the EU. But perhaps more damaging for the long-term health of national economies, it also stands in the way of much-needed reform. Podemos, for example, has explicitly stated that they would repeal recent reforms which have peeled back the most rigid elements of Spain's labour market.

Although growth in southern Europe is welcome, without fundamental change, it is superficial. The sun may be shining now, but unless the roof is fixed, the storm clouds on the horizon remain ominous. This is an opportunity for Britain to lead by example, work with its European partners, and make the case for a more competitive, flexible Europe for all of its citizens. The alternative is continued national, regional, and global stagnation, if not outright decline.

Michael Martins is an Economic Analyst at the Institute of Directors