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Posts Tagged ‘Berlin View’

Labour Costs: Who is the Outlier?

September 11, 2014 11 comments

Spain is today the new model, together with Germany of course, for policy makers in Italy and France. A strange model indeed, but this is not my point here. The conventional wisdom, as usual, almost impossible to eradicate, states that Spain is growing because it implemented serious structural reforms that reduced labour costs and increased competitiveness. A few laggards (in particular Italy and France) stubbornly refuse to do the same, thus hampering recovery across the eurozone. The argument is usually supported by a figure like this

2014_09_Labour_Costs

And in fact, it is evident from the figure that all peripheral countries diverged from the benchmark, Germany, and that since 2008-09 all of them but France and Italy have cut their labour costs significantly. Was it costly? Yes. Could convergence have made easier by higher inflation and wage growth in Germany, avoiding deflationary policies in the periphery? Once again, yes. It remains true, claims the conventional wisdom,  that all countries in crisis have undergone a painful and necessary adjustment. Italy and France should therefore also be brave and join the herd.

Think again. What if we zoom out, and we add a few lines to the figure? From the same dataset (OECD. Productivity and ULC By Main Economic Activity) we obtain this:

2014_09_Labour_Costs_1

It is unreadable, I know. And I did it on purpose. The PIIGS lines (and France) are now indistinguishable from other OECD countries, including the US. In fact the only line that is clearly visible is the dotted one, Germany, that stands as the exception. Actually no, it was beaten by deflation-struck Japan. As I am a nice guy, here is a more readable figure:

2014_09_Labour_Costs_2

The figure shows the difference between change in labour costs in a given country, and the change in Germany (from 1999 to 2007). labour costs in OECD economies increased 14% more than in Germany. In the US, they increased 19% more, like in France, and slightly better than in virtuous Netherlands or Finland. Not only Japan (hardly a model) is the only country doing “better” than Germany. But second best performers (Israel, Austria and Estonia) had labour costs increase 7-8% more than in Germany.

Thus, the comparison with Germany is misleading. You should never compare yourself with an outlier! If we compare European peripheral countries with the OECD average, we obtain the following (for 2007 and 2012, the latest available year in OECD.Stat)

2014_09_Labour_Costs_3

If we take the OECD average as a benchmark, Ireland and Spain were outliers in 2007, as much as Germany; And while since then they reverted to the mean, Germany walked even farther away. It is interesting to notice that unreformable France, the sick man of Europe, had its labour costs increase slightly less than OECD average.

Of course, most of the countries I considered when zooming out have floating exchange rates, so that they can compensate the change in relative labour costs through exchange rate variation. This is not an option for EMU countries. But this means that it is even more important that the one country creating the imbalances, the outlier, puts its house in order. If only Germany had followed the European average, it would have labour costs 20% higher than their current level. There is no need to say how much easier would adjustment have been, for crisis countries. Instead, Germany managed to impose its model to the rest of the continent, dragging the eurozone on the brink of deflation.

What is enraging is that it needed not be that way.

Blame the World?

August 15, 2014 5 comments

Yesterday’s headlines were all for Germany’s poor performance in the second quarter of 2014 (GDP shrank of 0.2%, worse than expected). That was certainly bad news, even if in my opinion the real bad news are hidden in the latest ECB bulletin, also released yesterday (but this will be the subject of another post).

Not surprisingly, the German slowdown stirred heated discussion. In particular Sigmar Gabriel, Germany’s vice-chancellor, blamed the slowdown on geopolitical risks in eastern Europe and the Near East. Maybe he meant to be reassuring, but in fact his statement should make us all worry even more. Let me quote myself (ach!), from last November:

Even abstracting from the harmful effects of austerity (more here), the German model cannot work for two reasons: The first is the many times recalled fallacy of composition): Not everybody can export at the same time. The second, more political, is that by betting on an export-led growth model Germany and Europe will be forced to rely on somebody else’s growth to ensure their prosperity. It is now U.S. imports; it may be China’s tomorrow, and who know who the day after tomorrow. This is of course a source of economic fragility, but also of irrelevance on the political arena, where influence goes hand in hand with economic power. Choosing the German economic model Europe would condemn itself to a secondary role.

I have emphasized the point I want to stress, once again, here: adopting an export-led model structurally weakens a country, that becomes unable to find, domestically, the resources for sustainable and robust growth. And here we are, the rest of the world sneezes, and Germany catches a cold. The problem is that we are catching it together with Germany:

GermanDomesticDemand

The ratio of German GDP over domestic demand has been growing steadily since 1999 (only in 19 quarters out of 72, barely a third, domestic demand grew faster than GDP). And what is more bothersome is that since 2010 the same model has been  adopted by imposed to the rest of the eurozone. The red line shows the same ratio for the remaining 11 original members of the EMU, that was at around one for most of the period, and turned frankly positive with the crisis and implementation of austerity.It is the Berlin View at work, brilliantly and scaringly exposed by Bundesbank President Jens Weidmann just a couple of days ago. We are therefore increasingly dependent on the rest of the world for our (scarce) growth (the difference between the ratio and 1 is the current account balance).

It is easy today to blame Putin, or China, or tapering, or alien invasions, for our woes.  Easy but wrong. Our pain is self-inflicted. Time to change.

Look who’s Gloomy

October 28, 2013 2 comments

Wolfgang Munchau has an excellent piece on today’s Financial Times, where he challenges the increasingly widespread (and unjustified) optimism about the end of the EMU crisis. The premise of the piece is that for the end of the crisis to be durable, it must pass through adjustment between core and periphery. He cites similar statements made in the latest IMF World Economic Outlook. This is good news per se, because nowadays, with the exception of Germany it became common knowledge that the EMU imbalances are structural and not simply the product of late night parties in the periphery. But what are Munchau’s reasons for pessimism? Read More

Would Eurobonds be Enough?

October 7, 2013 4 comments

George Soros writes a piece on Project Syndicate, that is both pedagogical and very clear in outlining a possible answer to the current EMU crisis. He starts with a diagnosis of the EMU imbalances that rejects the “Berlin View”, and argues for the existence of structural imbalances

Normally, developed countries never default, because they can always print money. But, by ceding that authority to an independent central bank, the eurozone’s members put themselves in the position of a developing country that has borrowed in foreign currency. Neither the authorities nor the markets recognized this prior to the crisis, attesting to the fallibility of both. Read more