Europe Economy

These European regions haven't recovered from the financial crisis, and are now a populist breeding ground

On Sept. 29, 2010, the second anniversary of Lehman Brothers' bankruptcy, the firm put their artwork up for auction at Christies. The auction comprised the artwork that hung on the walls of Lehman Brothers' offices in Europe.
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Key Points
  • Certain regions of Europe have not recovered from the financial crisis and face prolonged economic stagnation, rendering them hunting grounds for populists.
  • A concentration of weak economic regions in southern EU states could cause problems for monetary policymaking, impacting growth and inflation prospects and applying downward pressure on interest rates.

Over a decade on from the collapse of Lehman Brothers, the European economy has largely recovered.

But many local economies throughout Europe are in a state of prolonged stagnation, rendering them an ideal hunting ground for populists, according to a report from ING senior economists Bert Colijn and Joanna Konings.

Employment levels within the European Union are now 2% above where they were in 2008, but some regions have not seen this recovery, and have yet to show signs of bottoming out. Even within nations which have apparently recovered, there are pockets of regional weakness.

While Germany has shown strong employment growth, regions such as Saxony-Anhalt and Thuringia have been in steady decline for the past decade. In Italy, the northern regions and the area surrounding Rome present a picture of recovery, but job creation in the south has been dire.

The scars of the crisis are still impacting regional labor markets, with structural disparity driven in part by the region's digital infrastructure, education, innovation and vulnerability to globalization.

The impact is evident in regions which maintain a higher-than-natural unemployment rate, and growth in these areas is influenced by a number of structural factors outside of the business cycle, the ING report found. In particular, digital infrastructure and research and development (R&D) investment offer important foundations for growth.

Areas with the highest percentage of broadband access saw stronger employment growth over the decade and became regional centers of economic activity, with large parts of Bulgaria, Romania, Portugal and Italy lagging behind and remaining in gradual decline. Investment in digital infrastructure was directly proportionate to economic recovery.

Similarly, investment in research and development (R&D) is strongly correlated to employment growth over the past decade, suggesting that regions which are "knowledge hubs" create jobs at a faster pace than those which are not. Cities with 1,000 euro ($1,118) or more R&D spend per capita form a roughly diagonal belt from Liverpool to Vienna, along with several Nordic regions.

Winners and losers

The ING "Employment Strength Index" plots the relative strength of European regions based on employment growth over the last decade, and shows larger metropolitan areas and industrial centers coming out best, with weaker regions concentrated in southern Europe.

Brussels, Luxembourg, Braunschweig in north-central Germany, Hovedstaden, the capital region of Denmark, and the southwestern German city of Stuttgart were the five most successful regions for job creation.

Meanwhile the Bulgarian region of Severozapaden, the poorest in the European Union, performed worst, alongside the Centro region of Portugal, and the Italian regions of Calabria, Molise and Puglia. The top 20 weakest regions all come from Italy, Greece, Spain and Portugal with the exception of Severozapaden.

With many regions at risk of prolonged stagnation, the ING report suggests that an even larger focus from the European Commission on the underlying themes of structural weakness may be necessary. However, Colijn and Konings suggested this was unlikely due the impact of the U.K.'s exit on the European budget, and the potential resistance of richer countries and regions to redistributive policy.

"The likely persistent regional divide in employment prospects may be cause for continued or even increased support for populism in the weaker regions in coming years," Colijn and Konings' report suggested.

This was evidenced in the 2018 Italian general election, in which southern regions demonstrated a surge of support for the anti-establishment Five Star Movement.

In the U.K., employment levels in the Lincolnshire and North East Lincolnshire regions remain below where they were in 2008, and score negatively on ING's employment strength index, showing little sign of a turnaround — Lincolnshire contained many of the areas with the highest percentage of votes to leave the European Union in the 2016 referendum.

The upcoming European elections will function is a gauge of the appetite for a populist vote, but with the regional economic divide expected to continue, "support for populism is unlikely to diminish significantly in the years ahead," the ING report concluded.

Interest rate pressure

While well-managed redistribution at a national level could dampen the overall effects of regional divergence, the geography of weak areas makes this solution difficult to implement.

"As many of the structurally weak regions are concentrated in a few countries across the EU, with many in the euro zone, this is more problematic from the point of view of monetary policymaking as this will have an impact on growth and inflation prospects, resulting in prolonged downward pressure on interest rates," the report outlined.

Colijn also told CNBC via email that this "could have a longer term effect on the euro unless reform and investment agendas are successfully implemented."

Stronger redistribution my become a more pressing fiscal matter which could lead to political backlash and/or facilitate more fiscal spending, ING economists hypothesize, meaning weaker countries could face an increased risk premium.