Archive for September, 2014

Draghi the Euro Breaker?

September 29, 2014 26 comments

Update (9/30): Eurostat just released the September figures for inflation: Headline: 0.3%, Core, 0.7%

Hans Werner Sinn did it again. In the Financial Times he violently attacks Mario Draghi and the ECB. To summarize his argument (but read it, it is beyond imagination):

  1. The ECB gave too much liquidity to banks in peripheral EMU countries since 2008, thus fueling a spending boom.
  2. Then, with the SMP and the OMT programs it “lowered the interest rates at which overstretched eurozone members could obtain credit and reversed the losses of their foreign creditors, triggering another borrowing binge”
  3. Finally, “The ECB’s plan to purchase [private borrower’s] debt could end up transferring dozens if not hundreds of billions of euros from eurozone taxpayers to the creditors of these hapless individuals and companies.”
  4. Last (but not least!!) he claims that deflation is necessary in EMU peripheral countries to restore competitiveness

I am shocked. Let me start from the last point. Even assuming that competitiveness only had a cost dimension, what would be required is that the differential with Germany and core countries were negative. Deflation in the periphery is therefore only necessary because Germany stubbornly refuses to accept higher inflation at home. And no, the two things are not equivalent, because deflation in a highly leveraged economy increases the burden of debt, and  triggers a vicious circle deflation-high debt burden-consumption drop-deflation. I refuse to believe that a respected economist like Hans Werner Sinn does not see such a trivial point…

As for the rest, the spending binge in peripheral countries began much earlier than in 2008, and it is safe to assume that it was fueled by excess savings in the core much more than by expansionary monetary policies.

Further, does Sinn know what a lender of last resort is? Does he know what is “too big to fail”? Where was he when European authorities were designing institutions incapable of managing the business cycle, while forgetting to put in place a decent regulatory framework for banks and financial institutions?

And finally, does Mr Sinn remember what was the situation in the summer of 2012? Does he remember the complete paralysis of European governments that were paralyzed in front of speculative attacks to two large Eurozone economies? Does he realize that were it not for the OMT and the “whatever it takes”, today Spain and Italy would not be in the Euro anymore? Which means that probably the single currency today would not exist? Maybe he does, and he decided to join the AfD

Labour Costs: Who is the Outlier?

September 11, 2014 30 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


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:


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:


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)


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.