Conventional wisdom says that while southern Europe continues to struggle, core Eurozone countries have mostly recovered from the economic crisis and are now being hampered more by the instability caused by the periphery than by their own finances. Germany especially is rebounding strongly, but the perception that France is doing significantly better than its southern neighbors may be unfounded. Analysis from Natixis researcher Patrick Artus shows that both may be suffering from ‘Dutch disease,’ which would make a lasting recovery impossible.

Dutch Disease

Dutch disease, coined by The Economist in 1977 to describe the manufacturing slowdown in the Netherlands, normally refers to a situation where an influx of cash affects a country’s exchange rates, making exports less competitive and damaging the manufacturing sector. The effect is usually seen in developing countries that discover mineral wealth, bolstering their currency and eviscerating the manufacturing sector, though it can also be caused by the sudden infusion of foreign aid or foreign direct investment.

That’s not exactly what’s happening in France and Italy, but according to Artus it amounts to the same thing. “France’s and Italy’s underlying problem is the discrepancy between the high level of labour costs and the low level of sophistication of production,” he says.

italy france value added deflator

On the surface this sounds quite different, but Dutch disease is insidious because it makes the manufacturing sector less attractive as an investment, creating a period of deindustrialization and falling productivity. Companies simply don’t have a strong incentive to make capital investments, and the product sophistication lags ever further behind. Exports and manufacturing value-added have fallen in both countries, and the recent recession isn’t enough to account for all of it. Since neither country is able to devalue its currency, and increasing product sophistication is easier said than done, there’s no obvious way to close the gap.

Dutch Disease italf france manufacturing

That’s not to say France and Italy are in exactly the same position; a quick look at real GDP tells you how much healthier the French economy is, but if they can’t fix the imbalance between the unit cost of labor and product sophistication that good health will be fleeting. “If Dutch disease persists, there cannot be any real improvements in the economies,” says Artus.

italy france real GDP