One of the classical narratives in the Greek (tragedy) story is how Greece is the outlier in an otherwise successful implementation of austerity and adjustment programs throughout Europe. Other European countries thoroughly introduced and implemented austerity policies, liberated their labor and product markets, adjusted their economies towards an export and investment-led growth model and are now enjoying the benefits of their efforts.

In this short essay I would like to point at two important problems for this story. The first one is that the periphery experienced large and persistent output gaps during the European crisis since 2011. Spain had a negative output gap of 8.5% in 2013 while Italy and Portugal registered gaps more than 4% of potential product. All number were significantly larger than the relevant numbers at the start of the crisis during 2011.


An increase in the output gap is consistent with a rebound in economic growth in the immediate years during which the gap closes. Obviously this does not mark a policy of increasing output gaps and inflicting recessions as «successful», nor is a rebound not expected as soon as fiscal and monetary policy are relaxed. This is made clear from economic growth projections for 2017-18 period during which the closing of output gaps will lead to a significant decrease of output growth compared to 2015-16.


The second point is the fact that a clear indicator of success for an adjustment policy is not economic growth during the period when output gap closes but rather if the adjustment has permanent positive effects on potential output. An adjustment program which is supposed to increase productivity, efficiency, growth prospects and lower macroeconomic imbalances would be assumed to lead to a corresponding increase of potential output.

Yet recent research suggests that austerity policies implemented during the Eurocrisis have had permanent negative effects on potential output which actually increase overtime:

The results show a coefficient close to one for 2014 and around 1.6-1.7 for 2019. This suggests that every 1% fiscal-policy-induced decline in GDP during the years 2010-11 translated into a 1% decline in potential output by 2014 and even more for 2019. The results are significant for both samples and the coefficient is similar for the Europe and Euro.


If one takes a look at potential output for various European countries (base = 2011) the results are that crisis countries had a serious blow on their economic potential. Only Spain will achieve a level equal to 2011 by 2018, while Italy and Portugal will still be quite lower than their 2011 levels. At the Euro-12 level, potential product will be only 6% higher than 2011, a result driven to a large extent by the positive dynamics of the German economy (an increase close to 11%). If Germany is excluded from Euro-12, growth falls to 4% with half the increase occurring during 2017-18 (the 2016 level is only 2% higher than 2011).


Obviously there are other structural factors playing a role in these developments (such as labor force growth dynamics), yet these results, especially compared to the German outcome, clearly suggest that adjustment programs did not provide a medium term boost to potential product. Claiming to return countries on a path of sustainable, strong growth yet keeping potential at 2011 levels for almost a decade can hardly be regarded as a sign of success.