Convergence or disintegration in Europe? The problem of structural polarization

20 March 2018

The current economic upswing masks continued underlying challenges; ensuring long-term convergence and stability will require coordinated fiscal, wage and industrial policies.

By Philipp Heimberger

  • EU countries are stuck on different trajectories in their economic development. Core countries, periphery countries, Eastern European countries and financialized countries have responded differently to the openness shock of European integration.
  • This leaves Europe mired in structural polarization: economic developments are related to the sectoral development and the evolution of technological capabilities, which are of prime importance in the long run.
  • We cannot expect a natural convergence process to take place in Europe. Counteracting polarization and promoting convergence requires a coordinated strategy including fiscal, wage and industrial policies.

Dangerous upswing optimism in Europe

Numerous commentators have expressed a rather optimistic view about economic developments in Europe in recent months. Much of this may well be driven by relief: finally, after several years of crisis, a solid recovery of the European economy is underway. Finally, the economies of many countries are growing at significant rates, and substantial labour market improvements are visible. Even the American Nobel-prize laureate Paul Krugman, who is a critical observer of economic developments in Europe, has recently joined the chorus of upswing optimism: “Europe 2018 looks very different from Europe 2013. For now, at least, Europe is back as a functioning economic system.”

Although the current economic upswing in large parts of the EU is certainly to be welcomed, it should not serve to mask the underlying structural polarization in Europe, which is still a large danger for regional cohesion in the medium- to long-term: in structural terms, Europe in 2018 does not look much different from Europe in 2013. The reason is that under given political and institutional constraints, the technological capabilities of a given country are the most important determinant of its long-term development. Technological capabilities in EU countries, however, are distributed very unequally. EU countries remain structurally polarized, i.e. they are stuck on different developmental trajectories, which contradict the political goal of ensuring convergence and stability in the EU. Notwithstanding short- and medium-term cyclical developments, existing differences in technological capabilities will continue to fuel a process of economic disintegration in the bloc if policy-makers fail to counteract the polarization trend by introducing a coordinated policy strategy that should include fiscal, wage and industrial policies.

Path dependent developmental models in the EU

In a recent study, we highlight the relationship between the process of European integration and existing economic polarization tendencies in the EU. For member states, European integration has brought an increase in trade and financial openness.

We show that macroeconomic developments (measured in terms of common indicators such as GDP growth, unemployment, investment and current account balances) have not responded uniformly to the openness shock of European integration in all the EU’s member states. Based on our empirical analysis, we are able to distinguish four country groups in terms of how they have responded to the openness shock of European integration: core countries, periphery countries, Eastern European countries and financialized countries.

Figure 1 summarizes which EU country belongs to which group. The core group consists of Germany, Austria and some other countries with above-average levels of GDP per capita, strong industrial production and technological capabilities, and low unemployment (relative to other EU countries). Unsurprisingly, the periphery comprises the Southern Eurozone countries, which are characterized by relative low export shares, large debt burdens, a tendency towards current account deficits and high unemployment rates. The third country group consists of the Eastern European catch-up countries, which have relatively low wage and GDP per capita levels (relative to other EU countries). Furthermore, the industrial sector and foreign direct investment play an important role for the developmental model of the Eastern European group. The fourth country group in our taxonomy represents the financialized countries Luxemburg, Netherlands, Malta and Ireland, in which the financial sector plays a particularly outsized role and indebtedness of the private sector is high.

Source: Gräbner et al. (2018), Structural change in times of increasing openness: assessing path dependency in European integration, wiiw Working Paper No. 143, p.18.

Technological capabilities and structural change: The rich get richer

In the four country groups described above, economic developmental trajectories are related to a change in industrial structures across Europe, which has fuelled polarization tendencies. Indeed, technological capabilities (proxied by data on the complexity of exported goods) are distributed unequally among European countries.

Figure 2 shows that those European countries with higher levels of technological capabilities in 1999 have, on average, accumulated further structural gains; but countries with weaker initial technological endowments have further lost ground in terms of their capabilities. This result suggests that self-reinforcing processes, which favour countries that can be considered economic powerhouses, characterize the current European economic regime, while relative laggards (which are mainly to be found in the periphery and in Eastern Europe) are unable to keep pace in terms of their technological capabilities. Notably, some countries have indeed managed to catch-up in terms of technological capabilities in relation to the core (e.g. the Czech Republic or Ireland). Nonetheless, the path dependency of the European integration process has on average favoured those with a more favourable initial starting position (represented in terms of the x-axis value of the respective countries on product complexity in Figure 2).

From Figure 2, it can bee seen that there are still considerable differences within the four country groups proposed above. First, core countries differ in their structural development, mirroring the fact that some of these countries are struggling to hold on to their position (e.g. Finland and Belgium), while others have managed to expand their technological dominance (mostly Germany, but to a smaller extent also Austria). Second, we cannot find a single periphery country in Figure 2 which has undergone decisively positive technological development over the period covered. Third, while some of the Eastern catch-up countries have managed to improve their technological capabilities (e.g. Czech Republic, Hungary, Slovakia, Poland), others have not. What the countries in Eastern Europe that have gained in terms of technological capabilities have in common is their proximity to Germany and massive integration into the supply chain of the manufacturing core. This indicates that the economic catch-up process of Eastern European countries is not necessarily tied to a technological catch-up process, as evidenced most forcefully by the outliers Bulgaria and Lithuania. Fourth, the differences among financialized countries that can be seen in Figure 2 are particularly large, but can arguably be explained by their different financialization strategies: Ireland’s role of a corporate tax haven manifests itself in a massive technological upgrading, while the more asset-based strategies of the Netherlands and Malta are associated with a tendency for deindustrialization. Finally, while the empirical analysis in our study on how macroeconomic developments in EU countries have responded to increased European integration suggests that France is currently part of the periphery, the country remains on the edge and might also be loosely considered as part of the core.

Source: Gräbner et al. (2018), Structural change in times of increasing openness: assessing path dependency in European integration, wiiw Working Paper No. 143, p.15.

Macroeconomic divergence in Europe is fuelled by existing differences in technological capabilities. Results from the economic complexity literature suggest that technological capabilities are of prime importance for assessing the future developmental trajectories within given political and institutional constraints. As a consequence, the lack of structural convergence in the existing European system raises prospects for increasing economic tensions in the future.

A coordinated economic policy strategy for Europe

It is highly likely that the differences in developmental trajectories that can be observed within the EU represent a ‘lock-in-effect’ in economic development, which can only be broken open by targeted policy interventions; there will be no ‘natural convergence process’. The country taxonomy, which we develop in our study, also proves useful in thinking systematically about what needs to be done to promote convergence and counteract economic disintegration in Europe. Against the background of the long-run importance of technological capabilities for economic developments, the core of such a policy plan must include targeted industrial policies.

Our proposals, which should be viewed as a starting point for more in-depth policy discussions, are summarized in Figure 3. In particular, the periphery countries need an investment initiative that serves to diversify and modernize their industrial structures. Targeted industrial policy should be geared towards improving non-price competitiveness to improve the prospect of sustainable development in the long-run. Such an investment initiative could be financed either by additional European taxes or by external funding sources. Additional tax revenues may come from a European corporate tax or a European wealth tax. In terms of external financing, the European Investment Bank could for example issue investment bonds that could be bought by the ECB.

In our view, a sustainable strategy also requires policies that allow for a continuation of the catching-up process in Eastern Europe. In this context, measures should be geared towards allowing for higher wage growth in the Eastern European countries relative to other EU countries. Furthermore, labour standards should gradually be adjusted to the higher levels in the core countries. Such an adjustment of wage and labour standards would not only provide a stimulus to aggregate demand; it could also help to reduce inner-European tensions related to migration and job displacement. To make sure that the respective countries retain and further improve their competitiveness, the strategy for Eastern Europe should be complemented by targeted (vertical) industrial policies.

The core countries (especially Germany) have been running significant current account surpluses for several years. This means that they possess considerable resources to improve the social cohesion of their societies by reducing unemployment and tackling social inequality through policies that support the domestic economy and reduce current account surpluses. One of these policies consists of increased spending on public infrastructure in order to create more equality of opportunity while at the same time reducing unemployment by adding to aggregate demand. Another possibility is to pursue policies that lead to higher wage growth for the low- and middle-class (e.g. by minimum wage laws, wage bargaining and labour union legislation).

Finally, in terms of moving towards more sustainability in Europe, we argue that it is necessary to push for re-regulation of the financial sector in the financialized country group. Particularly low corporate taxes in the financialized countries (which attract corporate profits through tax incentives) make it clear that a European initiative leading to a substantial increase in the corporate tax rate is required to counteract the existing race-to-the-bottom in regulatory standards. Increasing corporate taxes would also provide the public sector with the necessary resources to pursue targeted industrial and social policies.

Source: Gräbner et al. (2018), Structural change in times of increasing openness: assessing path dependency in European integration, wiiw Working Paper No. 143, p. 26

Conclusion: Europe needs a coordinated policy to achieve sustained convergence

Observers should not be misled by temporarily higher growth rates in some EU countries. Europe needs a coordinated policy strategy to counteract structural polarization and macroeconomic divergence. We have proposed a set of crucial elements of such a strategy in terms of fiscal, wage and industrial policies, which should be viewed as a contribution to a broader public debate on coordinating European policies to avoid economic disintegration.


This article is based on the results of the following working paper:

Gräbner, C.; Heimberger, P.; Kapeller, J.; Schütz, B. (2018): Structural change in times of increasing openness: assessing path dependency in European integration, wiiw Working Paper No. 143.

More in-depth research results on structural polarization and macroeconomic development in the Eurozone are available from this study:

Gräbner, C.; Heimberger, P.; Kapeller, J.; Schütz, B. (2017): Is Europe disintegrating? Macroeconomic divergence, structural polarization, trade and fragility, wiiw Working Paper No. 136.