Archive for May 14th, 2012

A few days ago the European Union published its updated economic forecast. All in all, the outlook is far from sunshine and roses:

The EU economy is estimated to be currently in a mild recession.

The picture presented in the interim forecast in February is broadly confirmed for 2012, with real GDP projected to stagnate in the EU and to contract by -0.3% in the euro area. For 2013, growth is forecast at 1.3% in the EU and 1.0% in the euro area.

Looking at the detailed statistics, we find huge cross-country differences in per capita income growth. Furthermore, we see that the EU had to lower its forecast for 2012 by about 0.7 percentage points: instead of 0.4% growth, per capita income is now expected to fall by 0.3% this year. With these adjustments we also observe severe cross-country differences. Slovenia’s per capita GDP forecast changed from +0.8% to -1.6%, while Germany’s outlook only changed from 0.9% to 0.6%.

The question is, do these tiny differences actually matter? Does it make a big difference whether a country’s GDP per capita grows by, say, 1.0% or 1.5%?

The answer is simple: Differences in growth rates do matter. And they matter a lot.

Consider the following illustrative example: Suppose we have six countries with a per capita income of 100 in the year 1960. What would have happened to their GDP per capita if they had grown at different rates?

Different growth paths

The figure reveals the striking impact of differences in growth rates. While all countries started at a level of 100, the richest would now have 465 while the poorest country is still at 130.

So, what is the lesson here?

If the EU lowers its economic forecast by 0.7 percentage points, that is certainly not a minor adjustment. Although it may not have a huge impact for one year, it certainly affects long-term prosperity.

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