december 2014 european subnational outlook 2015: pockets ...€¦ · 13/01/2015 · frankfurt...

ANALYSIS �� European Subnational Outlook 2015: Pockets of Growth

December 2014

European Subnational Outlook 2015: Pockets of Growth

Prepared byAnna [email protected]

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Abstract

Following a strong start to 2014, the European economy has disappointed and become increasingly susceptible to external shocks. The unstable situation in Ukraine and the mutual trade sanctions imposed by the European Union and Russia pose a particular risk to those European regions whose production or markets are exposed to EU-Russia trade.

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MOODY’S ANALYTICS / Copyright© 2014 1

ANALYSIS

European Subnational Outlook 2015: Pockets of Growth BY ANNA ZABRODZKA

Following a strong start to 2014, the European economy has disappointed and become increasingly susceptible to external shocks. The unstable situation in Ukraine and the mutual trade sanctions imposed by the European Union and Russia pose a particular risk to those European regions whose production or

markets are exposed to EU-Russia trade.

Within the European Union, the U.K. economy will be one of the best-performing economies in Western Europe in 2015. Growth also powers on in Central and East-ern Europe, while the overall euro zone’s underperformance will continue into 2015. The euro zone economy grew just 0.2% in the three months to September; Spain, France, and the smaller periphery coun-tries contributed to the growth, while Italy dragged on it and Germany expanded at a crawl.

labour markets still struggleLabour markets in the euro zone periph-

ery that have been most hit by the sover-eign debt crisis are still lagging, with Spain,

Greece and Portugal posting the highest unemployment rates.

In these countries the regional labour markets closely follow the national pattern, with almost all metropolitan areas exhibiting high unemployment rates (see Chart 1). Italy has a clear North-South divide, a continu-ation of a decades-long trend in which the more industrialized metro areas of the north experience better labour market conditions than the more rural south. An exception is Turin, located in the northwest. The metro area has a high unemployment rate and has struggled to climb out of recession, made worse by Fiat’s announcement earlier this year that it would move its administrative headquarters from Turin to the Nether-

lands and its tax base to Britain.

Germany’s re-gional unemploy-ment rates, like the national average, look strong, especially compared with those of other euro zone members. Still, after 25 years of reunifica-tion, Germany still struggles with the East-West divide. Despite the govern-

ment’s efforts at redistribution, consider-able inequalities remain. According to the German Institute for Economic Research, or DIW Berlin, the country has the euro zone’s highest Gini coefficient—a common gauge of income inequality, measured between 0 and 1, with 1 denoting maximum inequal-ity. In 2012, Germany’s coefficient stood at 0.78, compared with 0.68 in France and 0.61 in Italy. In the third quarter of 2014, unemployment rates were much higher in the metro areas of former East Germany: 10.3% in Berlin, 9.7% in Leipzig, 9.9% in Magdeburg, and 8.5% in Dresden. Mean-while, unemployment averaged 3.9% in the western metro area of Munich and 4.3% in Stuttgart. While the east’s economy is growing, the pace is slow and eastern metro areas will not catch up to those in the west soon.

In the U.K., whose national unemploy-ment rate has dropped steeply since the beginning of the year, the outlook for nearly all metro areas is brighter than those for most of the country’s continental peers. This includes Central and Eastern Europe, where despite robust growth some regional labour markets are ailing. While the metro areas surrounding the capitals have lower jobless rates, those metro areas near the eastern borders, which rely on agriculture rather than industry, continue to have elevated

1

Chart 1: Unemployment High in Weak CountriesUnemployment rate, %, metro areas, 2014Q3

Sources: National statistical offices, Eurostat, Moody’s Analytics

<6.1

8.2 to 10.7

>10.7

6.1 to 8.1



rates. This is particularly visible in Poland, which shows the same East-West divide as Germany.

Despite the subnational variation, unem-ployment rates have improved in nearly all regions over the last six quarters, even with Europe’s recent economic slowdown fol-lowing a strong start to the year (see Chart 2). A striking exception is Italy, where the unemployment rate increased in virtually all metro areas compared with mid-2013. Italy’s unemployment rate jumped to a record high of 13.2% in October from a revised 12.9% in the previous month, as a result of the contracting economy and uncertain outlook. Even in the wealthier and more industrial-ized north, most regional labour markets have struggled.

In Spain, metro area employment has re-bounded in line with the national economy, although the number of active workers is still well below prerecession levels and in

some areas it will take years to regain those numbers. Spain’s housing market crash had a devastating effect on the labour market and especially on the metro areas which de-pended on tourism and construction as their main employers. These metro areas will have to cope with stubbornly high unemployment rates for some time.

Wages and spendingWhen the global financial crisis hit, wages

and public jobs were cut, pushing jobless-ness up in nearly all European metro areas. Irish metro areas’ wages fell first, followed by those for Spanish and Greek areas. Shrinking output and deteriorating competitiveness forced Spain’s government to cut wages while introducing labour market reforms, especially after the sovereign debt crisis un-covered the structural problems.

From 2009 to mid-2014, personal in-comes fell 3% per year on average in Seville,

Barcelona, Malaga and Zaragoza (see Chart 3). Wage ad-justments were most severe in the south-ern metro areas of Spain, which depend on tourism, while the more industrialized areas felt less of an impact. Similarly, Greek metro areas improved their com-petitiveness, with wage incomes falling

at average annual rates of 7% in Athens and Thessaloniki. The Baltic metro areas followed this path as well.

With slow income growth, households are reluctant to spend more. Consumer spending has plummeted in Spanish, Portu-guese, Greek, Irish and most Italian metro-politan areas (see Chart 4). Although falling wages put a considerable drag on household consumption, the restructuring of wage rates is necessary to return troubled metro area economies to a sustainable growth path. Consumption has also been weak in the Czech Republic. Although the country al-ready had been running a very prudent public finance policy, the government decided to introduce harsh austerity measures, which led to a slump in domestic consumption and a prolonged recession. Only recently have European officials acknowledged the dev-astating effect that excessive fiscal tighten-ing has had on economic growth, and thus agreed to some easing. The contraction in retail sales mostly bottomed out at the end of 2013 and sales started to increase in most of these troubled metropolitan areas, though the pace is slow and is unlikely to pick up measurably in 2015.

shifts in growth drivers On the whole, the main gateway met-

ropolitan areas of London, Paris, and the big five in Germany will continue to power Europe’s economic expansion, although some smaller metro areas will gain impor-tance. Moreover, the broad move for many metro areas from a finance-led economy

3

-10

-5

0

5

10

0 5 10 15 20 25 30Avg unemployment rate, %

Avg

annu

al w

age

grow

th fr

om

2009

Q1

to 2

014Q

2, %

Athens

Alicante

Warsaw

Tallinn

VarnaSofia

Vilnius

Thessaloniki

SevilleValenciaMadridDublin

Naples

LisbonBerlinAustrian areasLondon

Frankfurt Turin

y=-0.24x + 3.8R-squared=0.34

Chart 3: Spanish and Greek Areas Cut Wages

Sources: Eurostat, Moody’s Analytics

Cork

4

Chart 4: Weak Wage Growth Hinders SpendingRetail sales per capita, annualized % change, 2009 to 2013


>2.50 to 2.5

Decline

By metro area

2

Chart 2: Some Regions Still StruggleChange in unemployment rate, 2013Q2 to 2014Q3, ppts


Decline, more than 1

-0.2 to 0.2>0.2

-0.3 to -1

By metro areas



to an innovation-led economy has required industries and metropolitan areas to adapt. Financial and professional service firms are now competing with tech firms for the best graduates. High-tech information and com-munication technologies, or ICT, have cap-tured an increasing share of the labour force and are quickly becoming powerhouses of growth for the metro areas.

To analyze which industries drive the economy of a particular metro area, a simple measure called a location quotient can be used. The LQ calculates the relative concentration of an industry in a metro area versus its concentration across the European Union. Moody’s Analytics uses employment by industry data, which utilizes the NACE Rev. 2.0 classification system. An industry with an LQ greater than 1.2 is deemed a “basic” industry that has the potential to lead the economy. Additional conditions require a stable or rising LQ in the last de-cade and a positive outlook for the next five years.

Of the metropolitan areas where ICT pre-dominates and that fulfill the LQ conditions, Berlin emerges as a leader. The metro area is traditionally the educational, cultural and legislative heart of Germany, but is now see-ing an explosion in high-tech and IT startups. Professional, scientific and technical services have registered an LQ of 1.5 in recent years, while IT industries have a quotient of 1.3. The opening of a Google-backed startup hub this year called the Factory, which houses 22 companies including SoundCloud and Twit-ter, will support this trend.

In the U.K., Manchester’s re-covery has gained momentum led by the expansion of digital and technol-ogy industries. The metro area’s Medi-aCity is one of the biggest digital hubs in Europe, leading the BBC—the U.K.’s public broadcasting service—to relocate jobs numbering in

the thousands from London. Following large-scale public and private investment, Manchester is at the forefront of cloud com-puting, with major global technology com-panies such as Cisco located in the metro area. In Ireland, most of the foreign invest-ment attracted by the country’s competitive corporate tax rate has gone to Dublin’s ICT sector. Google and Twitter have set up of-fices in the metro area, creating highly paid jobs for skilled workers.

outsourcing in the ceeThe largest increase in ICT sector employ-

ment, however, is in the metropolitan areas of Central and Eastern Europe. From the Bal-tics to Bulgaria, employment in information and communication, or IC, grew in all large metro areas and has LQs above 1.2. The out-look is also positive.

The cities benefit from a large pool of a highly educated young population and significantly lower labour costs than in the west. The share of the IC industry in total employment across these metro areas has increased markedly in the last five years (see Chart 5) to 5%, nearly double the EU average of 2.8% in 2013. The upward trend is predicted to continue for most of these metro areas.

Sofia leads the boom with the highest LQ for IC in the region—above 2—as Bul-garia, which joined the EU together with Romania in 2007, has the lowest wages in the union. The Sofia metro area is also at-tractive thanks to its highly educated work-force and its proximity to Western Europe.

Several leading international IT companies, including IBM, Hewlett-Packard, SAP and Siemens, have already partnered with Bulgarian companies or set up their own local offices.

This is a fundamental change in trend. While in the past car manufacturers moved their production to the CEE region because of lower costs, now IC firms are attracted by the well-educated and highly skilled workforce in the region. So far, the growth has largely been driven by business process outsourcing, which keeps top-level decisions, research and development at firms’ main headquarters in the west. But this is likely to change in coming decades, as more head-quarters are being established in the CEE metro areas.

The CEE metropolitan areas will also benefit as the biggest beneficiaries of the EU Cohesion Fund, which accounts for the single largest part of the EU budget for 2014-2020 (€351.8 billion out of a total €1,082 billion). Supported by investment in infrastructure, we expect the CEE metro areas to grow at a steady clip in coming years.

russian embargo poses a riskDespite an expected recovery next year,

Europe faces serious risks to the outlook. The impact of trade sanctions between Rus-sia and the EU are particularly worrisome; to pinpoint where these risks lie, Moody’s Analytics examined smaller regions across countries using Eurostat’s NUTS2 regional definitions to identify the areas where risks are most concentrated.1 First, gross value added (the regional measure for output) in manufacturing as a share of total regional GVA is calculated to see where manufac-turing plays the greatest role in regional economies. We then calculate the local regional risk index by multiplying the manu-facturing share of output in each region by the national share of GDP accounted for by the export of sanctioned goods to Russia. The regional risk indexes are then ranked, and the regions are grouped into quintiles based on their rank.

1 Steven G. Cochrane, “Regional Patterns of Risk From the EU-Russia Trade Sanctions,” Moody’s Analytics, September 2014.

5

Chart 5: ITC Has Gained Importance in CEE

0 1 2 3 4 5 6 7

EU avgWroclaw

RigaBratislava

PragueBudapestBucharest

TallinnLubljanaWarsaw

Sofia

20092013


Employment in ITC as share of total employment, %



The same index is calculated for agricul-ture, given Russia’s embargo on food prod-ucts from the EU.

Not surprisingly, the three Baltic coun-tries have the most to lose from trade dis-ruptions as a result of their deep economic ties with Russia (see Chart 6). Moreover, the industrial belt that stretches from central and southern Germany through Austria and the Czech Republic likely faces one of the greatest risks. Trade patterns also pose some risk to the Nordic regions outside of their capital cities, and to all regions of Romania. The index estimates only risks based on direct trade with Russia. The manufactur-ing regions of western Poland and western Slovakia could also take a hit, as they often produce intermediate goods for use in final assembly in Germany. If production slows in Germany, it will certainly slow among Germany’s suppliers as well. If the sanctions on manufactured goods remain in place for a prolonged period, or if they are widened to include more types of goods, the indirect impact will extend into western Poland and western Slovakia.

Russia’s ban on EU agricultural goods catapults the three Baltic countries into the high-risk quintile (see Chart 7). Nearly all of Poland, including Warsaw, would face risk as the country relies more heavily on agri-culture than do western EU countries. The same is true for all regions in Hungary except Budapest. This contrasts with Hungary’s low-risk index for manufactured goods. The index for regions in Sweden and Norway is somewhat overstated, since forestry and

fishing are included in the NACE 2 agricul-ture industry classification.

Nearly all central and eastern EU re-gions, it appears, face considerable risks from a clampdown on agriculture or manu-facturing. Further, these risks will intensify if oil prices do not rebound in the coming year and the Russian economy suffers a severe recession.

unfavourable demographic trendsEurope’s population is aging, and for

some metropolitan areas this will have seri-ous consequences in the long run.

Portuguese, Greek and many Spanish metropolitan areas have been shrinking as the difficult living situation in these troubled countries has driven people to emigrate (see Chart 8). Even Germany’s metro areas, despite their relatively strong economic performance, have seen their populations dwindle. This trend is expected to continue and will curb the potential growth of these areas.

Most Central and Eastern European metropolitan areas face similar popula-tion declines due to the low birth rates and significant wage emigration which followed the accession of CEE countries into the EU. This could hurt

the business process outsourcing sector, as the pool of educated young people slowly dries up.

National and regional governments across Europe should step up their efforts to strengthen infrastructure and improve the prospects for young jobseekers if they are to stem further brain drain from Europe’s metropolitan areas.

outlook The main gateway metropolitan ar-

eas of London, Paris, and the big five in Germany will continue to power Europe’s economic recovery next year, thanks to strong population, employment and in-come growth (see Table 1). Spanish, Por-tuguese and Greek metro areas are also reviving, though their recovery has a long way to go. The periphery’s harsh austerity measures drove down wages and hence domestic consumption, which only recent-

6

Chart 6: Manufacturing Risk IndexRanked by quintile, highest risk to lowest risk, 2013


3rd quintile

4th quintile

5th quintile

1st quintile

2nd quintile

By NUTS2 regions

7

Chart 7: Risk Index for Agriculture Ranked by quintile, highest risk to lowest risk, 2013


3rd quintile

4th quintile

5th quintile

1st quintile

2nd quintile

By NUTS2 regions

8

Chart 8: Many European Areas Are ShrinkingPopulation, metro areas, annualized % change, 2009 to 2013


>0.50 to 0.5

Decline



Table 1: Economic Outlook, European Metropolitan Areas% changeMetropolitan areas defined by Eurostat; 50 largest ranked by population size, 2013

Employment growth Population growth Income growthMetro Area Country 2013 2014 2015 2013 2014 2015 2013 2014 2015London United Kingdom 2.4 3.2 1.2 1.2 1.1 1.1 2.7 4.5 4.9Paris France 0.6 -0.1 0.2 0.5 0.6 0.5 1.4 2.1 2.3Madrid Spain -4.0 -0.9 -0.1 -0.7 -0.3 -0.3 -3.0 0.4 0.5Barcelona Spain -2.8 2.0 -0.5 -0.8 -0.6 -0.6 -3.4 0.2 0.2Ruhrgebiet Germany 0.6 0.5 0.1 -0.3 -0.4 -0.5 1.7 2.6 2.9Berlin Germany 2.1 1.7 1.2 1.2 1.0 0.9 3.8 3.5 3.1Milan Italy 1.9 0.6 1.1 0.7 0.6 0.6 2.1 3.3 3.7Rome Italy -1.6 1.6 1.5 1.0 0.9 0.8 1.4 3.2 3.3Athens Greece -5.2 1.6 1.7 -0.4 -0.4 -0.3 -10.7 -1.5 2.0Warsaw Poland -1.4 1.4 1.7 0.6 0.6 0.6 4.4 5.4 4.2Hamburg Germany 2.4 1.7 0.8 0.7 0.5 0.5 3.4 3.5 3.4Naples Italy -0.3 -1.6 -0.7 -0.1 -0.2 -0.2 0.3 2.2 2.7Budapest Hungary 0.7 4.4 0.4 0.2 0.2 0.2 5.8 6.0 5.9Brussels Belgium -0.2 0.3 1.4 0.7 1.0 1.0 3.1 3.3 3.8Lisbon Portugal -4.2 1.8 0.1 -0.4 -0.2 -0.1 -2.5 1.7 3.9Katowice Poland -0.3 -1.0 1.2 -0.5 -0.5 -0.5 2.0 3.6 2.2Munich Germany 3.4 2.0 0.7 1.4 1.2 1.2 3.2 3.6 3.5Manchester United Kingdom 0.6 3.6 1.6 0.4 0.5 0.5 5.3 3.9 4.3Wien Austria 0.5 0.9 1.3 1.2 0.9 0.8 2.9 3.7 4.6Stuttgart Germany -0.5 0.0 0.3 0.6 0.4 0.3 2.7 3.0 3.0Lille France -0.2 -0.3 0.0 0.0 0.1 0.1 1.2 1.9 2.1Frankfurt Germany 1.0 0.5 0.1 0.6 0.5 0.4 3.8 3.7 2.9Prague Czech Republic 0.4 0.3 0.8 0.3 1.0 1.0 -1.0 3.7 3.6Valencia Spain -2.6 0.5 -0.3 -0.7 -0.5 -0.5 -3.8 -0.4 -0.4Birmingham United Kingdom -0.2 2.5 0.7 0.6 0.7 0.7 3.0 2.8 3.2Amsterdam Netherlands -1.0 -0.8 1.5 0.7 0.7 0.7 0.8 0.7 2.5Turin Italy -2.6 -1.0 0.5 0.5 0.4 0.4 1.6 2.5 3.0Bucharest Romania -2.7 -7.2 1.9 0.2 0.2 0.3 9.1 6.8 10.3Greater Stockholm Sweden 2.5 1.4 1.6 1.7 1.6 1.6 3.4 4.6 3.9Marseille France -1.2 -0.4 0.1 0.3 0.3 0.3 2.1 2.9 3.1Copenhagen Denmark 1.4 0.8 0.8 1.0 0.7 0.7 1.4 1.3 1.0Sevilla Spain -3.6 -2.0 0.5 0.0 0.1 0.0 -4.1 0.3 0.4Cologne Germany 2.0 1.2 0.4 0.5 0.4 0.3 2.0 2.9 3.2Alicante Spain 0.6 0.2 0.3 -0.1 0.2 0.1 -3.5 -0.1 -0.1Glasgow United Kingdom 2.0 2.1 0.5 0.2 0.2 0.2 1.2 3.4 3.9Dublin Ireland 1.0 3.2 2.0 0.6 0.7 0.2 -1.7 2.0 0.9Lyon France 0.4 1.5 1.5 0.8 0.9 0.9 1.7 2.5 2.7Sofia Bulgaria -0.4 1.0 1.1 0.2 0.4 0.4 7.6 7.0 9.5Malaga Spain -2.2 3.0 2.3 0.3 0.8 0.7 -3.6 0.9 1.0Greater Gothenburg Sweden 0.7 1.7 0.7 0.9 0.6 0.7 3.0 4.2 3.6Helsinki Finland -0.3 0.1 -0.3 1.2 1.1 1.1 -2.0 -0.8 -0.5Düsseldorf Germany 1.4 0.7 -0.0 0.2 0.0 -0.0 2.4 3.3 3.6Liverpool United Kingdom 0.6 1.1 0.4 -0.0 -0.0 0.0 4.5 3.2 3.6Bordeaux France 1.6 2.6 1.6 0.8 0.8 0.8 2.1 2.8 3.1Blackburn-Blackpool-Preston United Kingdom -2.7 -0.6 0.3 0.1 0.1 0.1 4.5 3.9 4.3Krakow Poland 1.4 3.2 2.4 0.4 0.3 0.3 3.2 4.3 2.7Murcia Spain -3.7 0.7 1.4 0.1 0.5 0.5 -3.1 1.0 1.1Zurich Switzerland 0.8 2.6 4.3 1.5 1.4 1.4 1.9 2.5 6.3Rotterdam Netherlands -2.7 -1.9 1.3 0.2 0.2 0.2 0.6 0.5 2.4Nantes France -1.3 1.5 0.8 0.8 0.9 0.9 2.6 3.3 3.5

Source: Moody’s Analytics



ly has bottomed out. The measures were painful, but necessary to return troubled metro area economies to a sustainable growth path.

Irish metropolitan areas, by contrast, have outperformed other peripheral euro zone members. Economic activity in Dub-lin has strongly rebounded recently, with most of the foreign investment that is at-tracted by Ireland’s competitive corporate tax rate pumped into the country’s capital. Similarly, metropolitan areas in Central and Eastern Europe have been outperforming their western peers. Employment growth in

these metro areas has been supported by an increasing concentration of ICT, thanks to the highly educated workforce and ultra-low labour costs.

Although 2015 should be a better year for European economies, we are guarded in our optimism. Baltic countries could lose footing if their strong trade ties with Russia falter. If political tensions between the EU and Russia intensify, the economic fallout would batter other Eu-ropean regions. Prolonged or expanded EU sanctions, which include bans on the export of many manufacturing goods into

Russia, would cudgel the industrial belt that stretches from central and southern Germany through Austria and the Czech Republic. Meanwhile, the Russian embargo on agricultural products from the EU that is already in place would pummel the Pol-ish, Hungarian and Bulgarian agriculture-producing regions.

Longer term, the greatest risk is demo-graphics. Declining populations across many Portuguese, Greek, Spanish, German and CEE metropolitan areas will hinder potential output growth as the available labour force, especially young workers, dwindles.


AUTHOR BIO �� www.economy.com

About the Author

Anna Zabrodzka Anna Zabrodzka is an economist at the Moody’s Analytics Prague office. Her responsibilities include providing commentary and research

on key economies in the euro zone and Central and Eastern Europe. Before joining Moody’s Analytics, Anna worked as a trainee for the European Central Bank, focusing on the analysis of monetary policy operations and euro money markets. Anna holds a master’s degree in quantitative economics from Goethe University in Frankfurt am Main and a BSc in economics and finance from Queen Mary University of London.

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