Sunday, March 7, 2010

The endgame for Europe: wage cutting and the battle for exports

Yesterday I argued that Latvia's cost-cutting efforts are evident compared to a cross-section of European Union countries. Latvia's efforts, while commendable, were very much a function of the emergency IMF loan in December 2008 and the ensuing recession in 2009.

After an email exchange with Marshall Auerback, and thinking more about the cross-section of Europe, I now see a very scary trend emerging across Europe: the fight for exports.

To be sure, Latvia's efforts are of note, as the acceleration in hourly labor costs dropped from a 22% pace spanning 2007-2008 to just 2.8% in the first three quarters of 2009 compared to the same period in 2008 (the Eurostat data are truncated at Q3 2009).

But look at the similar wage-cutting behavior occurring across the European Union, especially in the Eurozone hopefuls (Latvia, Lithuania, and Estonia are preparing to adopt the euro in coming years).

The battle for exports has begun. Compared to the same period in 2008, Q1-Q3 2009 annual hourly labor costs growth are down 4.9% in Lithuania, 0.8% in the U.K., and 0.5% in Estonia. In fact, every country across the 26 countries listed except Belgium, Germany, Greece, and Spain, saw the rate of hourly wage growth decrease since 2008. The currency is pegged, so the only mechanism to increase external competitiveness is through price (wages) declines. To be sure, this growth model cannot work for the Eurozone as a whole.

Latvia's model: drop wages to increase export income. Greece: drop wages to increase export income. France, Germany, Spain, Portugal, etc., etc. It's impossible that the whole of the Eurozone will drop wages to increase export income. It's especially bad for countries like Latvia or Hungary, where the lion's-share of trade occurs withing the boundaries of Europe.

And what happens when export income does not provide the impetus for aggregate demand growth? Well, there's not much left. Can't devalue the currency (via printing money), and tax revenues will fall faster than a ten-pound weight: rising deficits; rising debt; rising debt service (via surging credit spreads). Sovereign default seems like a near-certainty somewhere in the Eurozone!

Rebecca Wilder


  1. Your system think comments with far less than 3,000 characters have more than 3,000 characters.

  2. I just increased the character limit to 5,000. Are you writing in Word first? If so, there may be added characters that are not visible in the text. How many characters were you trying to insert? Rebecca

  3. Rebecca writes:
    Sovereign default seems like a near-certainty <span>somewhere in the <span>Eurozone</span>!</span>
    It's like a game of Chess. There is no latitude for compassion. The rigidity of the conundrum requires that failure to meet the criterium means explusion.

    Greece may yet put her house in order...but God knows how. For the sake of most of the rest, and to get Sweden, Denmark and later, Norway to join, then the criteria must be met. They'd be idiots to join otherwise. The EU's biggest failing was mandating expansion, and then mandating a timetable to join the eurozone. Perhaps that's two failings?

    Whatever, Greece's demise should come as no surprise to the majority of Germans who were against the single currency. France can also be profligate, but France is at the core, and productivity is surprisingly high by OECD standards. France more than pulls her weight in many ways. Greece certainly doesn't. It's a shame to see Greece in a bind, but she put herself there. No-one else did.
    As to this forum's character count, it is a problem with a number of forums. It is infuriating on a limited character posting. You're damn careful to be concise, to squeeze it all in without being a 'twitter', and then the forum software plays games with it.

    The Times of London is one of the worst. Incompatibility of java may be on of the factors. Using FF as a browser and a Linux OS is almost a guarantee of some forms of incompatability, the irony being that Linux is actually the de-facto system of the internet.

    Increasing the character count is generous on your part, Rebecca, but it is akin to widneing traffic lanes to make up for stearing that doesn't work properly.

    Uh oh...speak of the devil! My spell-check is not working in this window!

    Apologies for the rampant mistakes...must run, no time to use a magnifying glass to find them.

  4. how would you quantify this eurozone risk in relation to the US ? I've read that could have three times the impact on the US economy over the next year as the housing bubble collapse had over the past two years. Can anyone confirm, deny, or correct that assessment?

  5. Rebecca - thanks for the info as it has been known for a long time now that countries are running out of both fiscal and monetary tools to get us through this downturn - i just lacked the data to backup the claim. I had a similar discussion on currency devaluation and I argued that if it was only the US trying to devalue the $ to increase exports, perhaps we had a chance - but in this case, there is practically everyone trying to implement the same policy, including traditional exporters like Germany and Japan (let's always keep in mind that the US is a traditional importer) so, at the end of the day, they will cancel each other out. Bottom line: even monetary policies appear very weak to fight weak demand and market activity overall.

  6. ok, i have problems with wage comparation. it doesn't tell everything, does it? for example country A have 10% rise in wages but also 15% rise in productivity. country B has 2% decline in wages but 0% rise in productivity. which one becomes more competitive?

  7. George J. GeorganasMarch 8, 2010 at 1:11 AM

    If only your views were widely accepted ...
    There would be a run of funds from the euro and sovereign default ...
    Leading to the very export surge you consider impossible ,,,
    Since Germany would become more competitive, it would recover from its present slump ...
    ... leading it to buy more from the likes of Hungary.

  8. You are right: copying and pasting from Word can be dodgy. I'll try notepad next time. My proposed comment only had about 300 characters.

  9. Rebecca: you claim that “To be sure, this growth model cannot work for the Eurozone as a whole.” Yes it can: the big difference between the Eurozone as a whole and individual Euro countries is the former can increase competitiveness by devaluing the Euro (indeed this will happen automatically).

    You then say “And what happens when export income does not provide the impetus for aggregate demand growth?” My answer is: “no problem”. The solution is for the ECB to pump more money into the system: exactly what it has been doing. I am 99% sure that Marshall Auerback, an advocate of modern monetary theory, would agree with me on that.

    Stamos: what makes you think that “monetary policies appear very weak to fight weak demand and market activity overall”? The total amount of new money injected by all the major central banks is a minute proportion of the total damage done to household balance sheets in the last three years. If someone’s house burns down and it’s not insured, they lose say £200,000.  Giving them £1,000 won’t get them to go on a spending spree: they’ll be saving up for a new house, and in the process they will cause "paradox of thrift" unemployment. (Incidentally, I’m using the phrase “monetary policy” very loosely: to include both monetary and fiscal policy.)

    I’m not suggesting that central banks print enough new money to get household balance sheets back to exactly where they were three years ago, but certainly their efforts to date have been pathetic. For example, this article claims that the “stimulus” is the U.S. is essentially NON EXISTANT !!!

  10. The problem is, is that the euro won't drop enough for Greece and will drop too much (perhaps) for Germany, for example.

    Think about what Greece would likely be doing right now if it weren't part of the european monetary union. It would likely be printing money in order to pay creditors. This can't last long, given the state of Greece's external and domestic finances; and eventually the currency would crash. The currency would crash while leaving all healthier governments (Germany, France for example) alone. In fact, Germany and France in this case would start importing from Greece.


  11. Hi pero,

    You are right - cut wages, increase productivity, they are essentially the same in terms of reducing costs and passing on the effects to relative final goods prices. Increasing producivity is likely occurring, as hours worked is dropping in many of these countries. But it is unlikely to be simply enough since wages in the private sector are falling (or slowing to a crawl) as well. Europe typically has a very tough time raising productivity during a recession (unlike the US in this recession).


  12. Hi Stamos,

    I was thinking the same, and planning to write about this. The one thing that global markets weren't expecting is a stronger dollar coming out of this, which would hurt the US in its transition over the near term. Europe is just a subset of the global fight for exports.


  13. Hi James,

    I would say that the US commercial real estate problem is at least under the umbrella of one sovereign government and one autonomous monetary agent. Therefore, policy would (could) tackle the problem better than if Italy, for example, had a brewing wave of defaults coming due. Cannot confirm your next to last sentence, but that is rather dire!


  14. Hi Stephen,

    <span>"Greece may yet put her house in order...but God knows how."</span>

    It's a depressionay-type scenario with help from the EU or the IMF.

    I think that the character problem was one with copying/pasting from Word.

    Best and have a nice day in Canada! Rebecca

  15. Can we not solve this debt problem with world-wide inflation? That is what happened after the oil shocks in the '70's. Our outstanding mortgages on our houses became insignificant by the '80's.

  16. "<span>My answer is: “no problem”. The solution is for the ECB to pump more money into the system: exactly what it has been doing. I am 99% sure that Marshall Auerback, an advocate of modern monetary theory, would agree with me on that."</span>

    The problem is, they have not done essentially anything. They want to lend money to the banks, so that they could lend money to the economy. But in economic situation like this, who wants to borrow? Peoples feel poorer and firms don't want to invest 'cos there is not enough demand. Their economic models say that only way to have non-inflationaty monetary growth is to lend it to the economy. Which is wrong model, not working and doing more of the same wont help anything. What we do need is some serious quantitave easing, money created not as debt, but just created.

    I have to wonder about ECB's priorities. Is fighting (imaginary) inflation really more important that preventing unemployment and economic catastrophe throughout eurozone? Wouldn't fighting possible future inflation be easyern than dealing with massive output gaps? What's the point in central bank independence if they can't take care of their dual mandate of inflation stability and employment?

  17. <span>Bruce Bartlett at has answered the question of inflating away the govt debt, but does this apply to housing debt and consumer debt ? What about inflation to solve consumers' problems (created by the banks & loose money that allowed them), and coordinated sovereign default by all indebted nations would solve the government debt. </span>
    <span>"Unfortunately the portion of the national debt held in the form of long-term securities has fallen over time, and the percentage in short-term securities has grown. As of Sept. 30, 2009, three-fourths of the privately held public debt matures in less than five years. This debt can't be inflated away because investors will demand higher interest rates to compensate for inflation when it rolls over, which will raise federal spending on <span>interest payments</span>. Also a growing portion of the debt is now indexed to inflation. Known as Treasury inflation-protected securities, more than $500 billion have been issued."</span>

  18. Rebecca, didn't eastern europe have higher increase in productivity before the crises than western europe? i would presume it's lot easier to increase productivity if you are catching up. isn't that essentially chinese story? there wages are going up but productivity is going even higher. so i would add that to equation.

  19. james:

    <span>Elizabeth Warren on the Coming Commercial Real Estate Crisis; 3000 Community Banks at Risk</span>
    "<span>Nearly 3,000 community banks -- 40 percent of the banking system -- have a high proportion of commercial real estate loans relative to their capital, said Warren, </span>whose committee issued a report on commercial real estate last week. "Every dollar they lose in commercial real estate is a dollar they can't use for small businesses," she said. Individuals -- who saw their home values drop in the residential mortgage crisis -- would not feel that kind of loss, but, Warren said, a large-scale failure would "throw sand into the gears of economic recovery."
    elizabeth warren on charlie rose:

    i believe that sheila bair put the number she expects to fail at 1000...

  20. i misspoke: should be "she expects could fail"

  21. I think it's a matter of priorities.  Over the last,say, four decades, during what you could call the Era of Deregulation, gov's have come to identify their interests and the interests of banks very closely, while direct economic intervention of the type common after wwII has fallen out of favor.  Now, facing the sort of economic difficulties which those post war systems were designed to prevent and stabilize, governments lack the motivation to create jobs and encourage imports at the expense of investment balance-sheets.  Such seemingly senseless behavior is the inevitable result of government making such a strong alliance with any sector of society that it loses the ability to distinguish between their interests and its own.

    Then again, I'm a historian, not an economist, and lacking technical knowledge on the subject, I may be off base in my analysis.

  22. Alastair McKinstryMarch 8, 2010 at 11:36 AM

    Can you please clarify for the non-economists, what this means "labor cost growth is <span>down</span> 4.9%" : does it mean that labor costs are still growing, but at a slower rate (positive first deriviative, -ve second derivative) or labor costs are falling (-ve first derivative). It would be clearer to give a simple example (eg XX euro in 2007, YY euro today) in the text.

    And by the way, "fall faster than a ten-pound weight:" all weights fall at the same rate, assuming you're not using feathers or something else silly with high air resistances.

  23. Thanks for picking that up! I corrected the text. Hourly labor costs (in levels) are down (not just the growth rate, but the levels, so first-derivative) for those three economies.

    Okay, okay Newton!


  24. This is silly. The first 3 quarters of 2008 is non-recession while the first 3 quarters of 2009 is in recession. Of course there were less wage increases in 2009. This is an overall effect.

  25. Thanks rjs! I didn't see.

    I should note that this article received a lot of attention in the last two days:

    Kevin O'Rourke, Paul Krugman, Brad Delong, and still they are coming in. Who knew that Latvia could create such a stir!

    Also, Marshall Auerback writes a nice complementary piece (although much more intelligently written, of course).


  26. i wondered what happened...this place suddenly turned into grand central station...

  27. Sovereign Default is an impetus for developing The One Euro Government. As current sovereign nations default on their national debt, they like Greece, will have Seigniorage for their govenmental spending provided by an ever increasing federalized and feudal, economic, monetary, and political authority with leadership in Brussels and Germany.

    The Club of Rome, in 1974, called for ten regions of global governance. Two of these regions are The North American Continent and The European Continent.

    The Security and Prosperity Partnership of North America, the SPP, announced at Baylor Baptist University in March 2005, was a Leaders Agreement, that established a Framework Agreement, for state and corporate rule over Canada, The United States and Mexico, thus forming a North American Union.

    Likewise, Peter Ludlow reported in Vol 7.6 how Herman von Rompuy secured a Framework Agreement supporting Greece at the European Council on February 11, 2010, this One Euro Government Framework Agreement, established federal, monetary, economic, political rule by Leaders in Europe

    For more news on the birthing of the One Euro Government:

  28. One wonders however if Greece would have been in such bad debt outside the zone. They would never have taken so much on at much higher rates, I'm assuming. They've been in bad trouble before and worked their way out of it. But low and stable rates for loans allowed the gov't to borrow for a sustained period of time.

    Now the austerity measures are cutting much deeper. so, the way I see it: as part of the union, a country may see higher highs and lower lows.

  29. rebecca, just another heads up: <span><span>Guest Post: No One’s Issuing Credit—Why Are Auerback and Parenteau?</span> </span><span>- </span>Why, in <span><span>their article on Latvia’s austerity budget</span></span>, are Marshall Auerback and Robert Parenteau giving Latvia credit for warm, fuzzy feelings?

  30. Everybody's got their opinion! Rebecca

  31. Lol the wet dream of american conservatives and dem but cons more, a divided Europe.haha this is beyond pathetic who made you people economist


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