Competitiveness and wages in the Eurozone

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Martin Sandbu has a useful piece in the Financial Times entitled Free Lunch: getting real about competitiveness. It makes many points that we regularly make here: most fundamentally, that we should not confuse the competitiveness of companies with the so-called ‘competitiveness’ of countries. (To get a first sense of this, ponder the difference between a failed company and a failed state.)

Sandbu’s focus is not on ‘tax competitiveness‘ or on the ‘competitiveness’ of a country’s financial sector policies, but on exchange rate and wage issues, and the Eurozone. He describes the ‘conventional wisdom’ going like this: countries in the Eurozone with large trade deficits cannot adjust their currencies so they have to restore ‘competitiveness’ by driving down wages. Then he sets about challenging the conventional wisdom, on several fronts.

First, as Paul Krugman famously noted: the competitiveness of countries is nothing like the competitiveness of countries. National prosperity depends heavily not on something called ‘competitiveness’ relative to others, but on productivity.

Second, focusing on ‘competitiveness’ narrows our attention to those tradeable sectors (like manufacturing, or agriculture) but ignores sectors that aren’t tradeable internationally, like haircuts or housing. Sandbu:

“There is a widespread belief the peripheral eurozone countries priced their exports out of global markets and that this is what made their external deficits widen. In fact the exports of these countries held up just as well as those of Germany during the euro’s early boom years, and for good reason: costs did not particularly run away in tradeable sectors. The large cost increases were in non-tradeable sectors, and the deficits were racked up by import booms, not export erosion.”

That’s a decent-sized myth busted, and there’s a nice graph to illustrate it.

Third, the competitiveness prism focuses on ‘unit labour costs’ – how much workers are paid per unit of production. You can apply unit labour costs to companies or even sectors – but not to whole economies.

“What is the labour compensation involved in producing one unit of gross domestic product? It boils down to labour’s share of economic output.”

Which depends heavily on how powerful the capitalist bosses are in relation to the workers and their unions. As he put it:

“The theoretical abuse of applying the unit labour cost concept at the whole-economy level camouflages the capital-labour distributive conflict in the language of efficiency.”

And he also points to a really interesting paper on this, called Unit Labour Costs in the Eurozone, which makes these points and other related points: not least that the narrow focus on unit labour costs should be complemented with something they call Unit Capital Costs, which also affect so-called ‘competitiveness’.

“We conclude that a large reduction in nominal wages will not solve the problem that some countries of the eurozone face.”

Sandbu also points to another paper, by Jordi Galí and Tommaso Monacelli, suggesting that unless monetary policies come to the rescue, wage moderation and wage ‘flexibility’ often lead to less prosperity, especially in a currency union.

And he concludes:

“The policy implications of this analysis are considerable. They undermine the core of the eurozone policy programmes shared by the European Commission, the European Central Bank and the International Monetary Fund, to the extent these focus on labour market liberalisation designed to make wages more flexible.”

If you’re going to do structural reforms, he continues, then reform product markets to make goods and services cheaper, and stimulate demand, rather than forcing austerity down everyone’s throats.


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