Social Conflict and Growth in Euroland

The differing political institutions of the members of Euroland contribute to differences in economic growth. This is because those that have a lower capacity to absorb external shocks are likely to suffer greater instability in the event of such shocks occurring. The findings appear in a paper published by the Centre for Economic Policy Research in which two leading economists take previous studies of asymmetric shocks a stage further. Paul De Grauwe and Frauke Skudelny of the Catholic University of Leuven use as an example the effects of deterioration in the terms of trade on individual countries.  It emerges that southern EU countries suffer more from a negative terms-of-trade shock than do their northern partners, mainly because of their weak bureaucracies. One critical finding is that inefficiency in the detection of fraud and the imposition of penalties tends to amplify the effect of a negative terms-of-trade shock on output.

De Grauwe and Skudelny base their research and theoretical conclusions on recognised differences in social and political structures. This develops earlier work which shows, for example, that higher inequality leads to lower long-run growth and is also an indicator of instability. The authors create a series of potential instability indicators which include ethno-linguistic fragmentation, and the frequency of changes of prime minister and governments. These are then tested against known outcomes. In order to test the way different countries manage conflict, the authors use an established bureaucratic index that measures the inefficiency of the judiciary, and red tape and corruption.

The findings show that most of the indicators do affect the ability to deal with shocks adversely. An interesting finding is, moreover, that the higher the ethnographic fragmentation of a country, the higher its growth rate. Surprisingly, though, countries that have less homogeneous ethnic populations are not necessarily rendered more unstable when faced with external shocks. This could be the result of what the authors call the ‘American melting-pot effect’.

De Grauwe and Skudelny have combined studies of the transmission of shocks in Euroland with the wealth of research into social conflicts and growth. This has enabled them to present a theoretical system which gives considerable support to the empirical conclusions revealed by their research.

Notes for Editors:

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The Authors:

Paul De Grauwe is Professor of Economics at Katholieke Universiteit Leuven and a Research Fellow in CEPR’s International Macroeconomics research programme. Frauke Skudelny is based at Katholieke Universiteit Leuven.