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  • Monday, March 7, 2011

    Change or lose Europe

    Frank Hoffer
    Friederike Spiecker














    When asked what he thought of Western civilisation, Mahatma Gandhi replied: “I think it would be a good idea.”
    After an agonising depression and another devastating war, Europe finally followed Gandhi’s advice and moved from centuries of antagonism, war and “beggar thy neighbour” policies to a world of cooperation and integration. Reintegrating post-nazi Germany, bringing the former Portuguese, Spanish and Greek dictatorships into a democratic Europe and opening up to Eastern Europe are milestones in this complex integration process based on political will, cooperation and regulated markets. But it was only after the ideological shift in the 1980s and 90s that mainstream thinking changed and concluded that the best form of cooperation was fierce competition and radical market liberalisation. However, deregulation, the common market and single currency did not create the promised land of prosperity, but resulted in declining wage shares and greater inequality.
    The benefit of a single currency in a large market across several countries lies in a common employment and growth-oriented monetary policy for all member countries, rather than a monetary policy narrowly focussing on the needs and priorities of the anchor currency as in the former European exchange rate mechanism. However, in a world dominated by deeply rooted neoclassical and monetarist beliefs, this benefit had no chance of materialising.
    Relinquishing internal exchange rate flexibility deprives governments of an adjustment mechanism to respond to unequal economic performance. This increases the need for 1) coordinated wage, fiscal and especially tax policies to avoid a race to the bottom which would inevitably have a negative impact on overall growth; and 2) joint infrastructure and industrial policies to improve productivity and reduce regional development differences.
    With the euro, balanced trade requires that wages in all member states grow in line with national productivity plus targeted inflation rate of the ECB. Otherwise countries with relative higher growth in unit labour costs will systematically lose market share and build up trade deficits. The case for a coordinated wage policy to avoid imbalances, beggar thy neighbour policies and a waste of potential growth is overwhelming; it is alarming that it has been ignored for so long. Those who let unit labour costs rise too fast are equally responsible for the explosion of imbalances after the abolition of the exchange rate mechanism as those who gained market shares through wage restraint. This lack of policy coordination resulted in rapidly growing trade imbalances after 1998 (Table 1).
    Table 1
    Prior to the euro, Germany’s above-average productivity growth and export surpluses were frequently adjusted through currency appreciation. Trade imbalances stayed within 2% of GDP and – contrary to today – German workers benefited from German competitiveness as the ‘Deutschmark’ (DM) appreciation made imported goods and sunny holiday destinations abroad cheaper.
    Under the new currency regime, however, it was almost exclusively businesses that benefited. This mercantilist strategy was costly to Germans. Wage dumping translated to export growth, depressed domestic demand, and the lowest growth rate in the Eurozone. Given these German wage developments, even France, who achieved wage growth in line with productivity (Table 2), suffers from a growing trade deficit with Germany (Table 1).
    Table 2
    Regardless of government actions, rebalancing is bound to occur. The question is how and with what consequences for growth, distribution and ultimately political stability. Realignment can be achieved through either wage cuts in deficit countries, a rise in wages in surplus countries, or constant transfers from the former to the latter. However, it makes a world of difference whether the realignment occurs by “deflationary” means, forcing everybody to follow the German example, or within an overall growth regime that avoids the pitfalls of wage deflation.
    Three scenarios are possible:
    1. Deflationary cost cutting.
    This is what European institutions and surplus countries currently impose on deficit countries. The result will be a deflationary depression in deficit countries with high unemployment, negative growth, and public debts accelerating as share of GDP. Internal devaluation will require a massacre of public services and nominal wage cuts of 20 – 30% for countries like Spain, Greece, Italy or Ireland. Their economies will shrink and so will the inner-European export market for surplus countries. Ultimately, after having sold and privatised what is left of public assets in a depressed market, countries will default. Ironically, this “no bailout policy” will cause involuntary transfers, as creditors will have to write off part of the credits. These banks – mainly from surplus Germany – will again claim their systemic relevance and German taxpayers will be asked to save them. This “solution” might be as costly for taxpayers as direct transfers to Greece or Ireland. The outcome of such an austerity policy is unfortunately a negative sum game within Europe, and its only rationale is the unlikely prospect that the shrinking internal market will be overcompensated by export surpluses outside the Eurozone.
    If popular resistance does not force European governments and the EU to change policies, it is difficult to see how the Euro and ultimately European integration can hold.
    2. Constant public transfers.
    This is the reality within the German currency union since 1990. The constant “trade deficit” between West and East Germany is closed through a stream of public transfers. Such a transfer system on a European scale currently looks politically impossible, even if some form of European unemployment insurance would be desirable further in the integration process.
    3. Wage-led growth.
    A wage-led growth oriented policy coordinated by Eurozone member states is the only realistic way to avoid repercussions deriving from deflation. Such a policy must be based on 1) rapid extension of domestic demand in surplus countries through wage, income and fiscal policies; 2) giving all Eurozone governments access to low interest euro bonds; and 3) productivity-enhancing investment in pan-European infrastructure. Only if surplus countries drive economic growth and increase aggregate demand can deficit countries regain market shares and avoid a long and painful depression. However, even under the favourable conditions of economic growth, rebalancing will only be possible if deficit countries accept below average unit labour cost growth over a longer period of time, and if surplus countries change their aggressive export strategy and strengthen internal wage growth so that unit labour costs rise above average. During this period, nominal wage growth in deficit countries must stay positive. Wage policy must act as a barrier against downward pressures on wages that risk pushing countries into deflation, as seen in Japan. Realignment within an overall regime of nominal wage growth would allow the reduction and eventual reversal of permanent German trade surpluses.
    The necessary policy changes cannot be understood within a narrow enterprise logic, viewing wages merely as costs and not as income and demand (an irreplaceable condition for sustainable, productivity-enhancing and equitable growth). Democratic governments need to focus on the common good of full employment and provide a framework to achieve collective bargaining wage settlements that ensure wages growing in line with productivity. This should include:
    • a legal minimum wage at 50% of the average wage;
    • government support for co-ordinated or centralised collective bargaining and universal application through legal extension mechanisms;
    • labour market regulations minimising all forms of precarious atypical employment and limiting the excessive power of employers in the labour market;
    • that governments, as the largest employer, investor and procurer ensure public sector wages grow in line with the defined wage norm and provide contracts only to companies that adhere to collective bargaining agreements;
    • productivity enhancing public investment;
    • a progressive European tax on trade surpluses overshooting 2% of GDP in two consecutive years to give surplus countries the choice either to stimulate their own economy or to provide transfers to neighbouring countries that pursued a balanced functional wage policy, but lost market shares because of the mercantilist strategies of surplus countries;
    • a tax on enterprises that try to gain a competitive advantage through wage depression instead of innovation. Unlike the Polish government who introduced the Popiwek tax against wage inflation in the 1990s, enterprises would have to pay a 50% tax on the gap between the actual increase of the hourly wage and a wage increase fully reflecting productivity growth and targeted inflation rates to avoid wage deflation. This would encourage employers to share productivity gains with their employees and would ensure wage growth in line with macroeconomic requirements for sustainable growth.
    To support such an inclusive rebalancing strategy, the European Central Bank should 1) raise its inflation target to 3-4% to provide more space to adjust without making deflationary nominal wage cuts; and 2) aim at co-ordinated exchange rate policies between the major trading blocks to ensure that internal balancing does not result in external imbalances.
    For Europe, adopting a coordinated wage policy oriented towards lower inequality, balanced trade and economic growth is not only necessary and possible: it would in fact be a good idea.

    Download this article as pdf

    Frank Hoffer is senior researcher at the Bureau for Workers' Activities of the ILO.
    Friederike Spiecker is a macroeconomist and independent consultant. She has published widely together with Heiner Flassbeck, chief economist at UNCTAD, on German, European and international economic policy.

    Posted in: Competitiveness,Financial Crisis,Tax,Wage
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    6 Comments:

    Edward Sussex says:
    March 11, 2011 at 5:30 PM Reply

    The first scenario, which the authors call "deflationary cost cutting", is undesirable and possibly not feasible in all the eurozone countries presently in crisis. I believe that the scenario is called "internal devaluation" by the EU and "toughing it out" by Paul Krugman, a US economist.

    On the other hand, the authors' call for "co-ordinated or centralised collective bargaining and universal application through legal extension mechanisms" will be difficult to achieve in practice. Co-ordinated bargaining is in some countries controversial even among trade unions, and there are legal obstacles to extending collective agreements.

    A further problem is the single monetary policy for countries in very different economic situations. The ECB's policy is likely to be adjusted to the largest economies, especially Germany. In the past, that has been too expansionary for some of the periphery countries, resulting in property booms and/or unsustainable wage increases. If the ECB begins to raise rates soon, it will be too restrictive for those countries.

    I suspect that successful integration would have to rely more on scenario 2 than the authors propose; i.e. constant public transfers. Those would be social transfers and infrastructure spending. I agree that the politics are difficult.

    A positive point: Table 2 suggests that since 2007, the German unit labour cost trend has converged with those in France and Southern Europe. So the Eurozone's prospects could improve over the longer term, if policy makers can somehow muddle through with elements of all three scenarios.

    Frank Hoffer says:
    March 12, 2011 at 6:18 PM Reply

    The increase in unit labour costs in Germany following 2007 is due to the massive capacity underutilization when Germany’s export industry was hit by the crisis. As the table shows with the recovery of the export industry in 2009 unit labour costs are falling again. So little hope that German wage growth and convergence are already under way.

    Yes, in some countries some trade unions do not support coordinated wage policies. This is particular the case for small unions with strong bargaining positions, who put their narrow interests above a broader concept of solidarity. Doctors, Pilots, air traffic controllers, locomotive drivers etc. are the usual suspects.

    However, if trade unions reject coordinated bargaining the competitive pressure will further increase. Yes some specialized minority groups might do better in such a situation, but is that what the labour movement wants and needs?

    Edward Sussex says:
    March 14, 2011 at 1:13 PM Reply

    I have noted a change in the discussion of the job market by the German mainstream media, television to be more precise. Over the past few months the emphasis has shifted from unemployment (job shortages) to labour shortages, especially of skilled workers. That could mean that the balance of power is moving from employers to workers. Over the past decade or so, employers have had an advantage, due to the effects of German reunification, socio-economic reforms and globalisation. However, if labour shortages continue to mount, they could translate into faster German wage growth. Perhaps I'm being too optimistic.

    Frank Hoffer says:
    March 14, 2011 at 4:08 PM Reply

    Unfortunately you are too optimistic

    See the latest study of the Macroeconomic Policy Institute

    " In 2009, hourly labour costs in the German private sector were 29 Euros. This puts Germany in seventh place, and hence it remains in the middle of the EU states. While labour costs in Germany increased by only 2.3 percent, they increased by 2.9 percent on average for the euro zone. This means that, once again, labour costs in Germany rose at a below average rate.

    The higher short-term increase in German labour costs in the early phase of the economic crisis was caused by shorter working hours and short-time work. However, labour costs have, by the third quarter of 2010, gradually declined and have almost returned to the initial low trend increase. Unit labour costs developed in a similar fashion. After an initial short-term increase in the unit labour costs - statistically also shown as a productivity slump - they adjusted again to the below average trend in comparison to the euro area."

    http://www.boeckler.de/show_product_imk.html?productfile=HBS-004934.xml

    Edward Sussex says:
    March 15, 2011 at 1:08 PM Reply

    Well, we'll see what happens, Frank.

    I wish to return to and more clearly support the authors' demand for an extension of collective agreements to all workers in their scope.

    This is also an essential measure to fight pay discrimination against foreign workers, including posted workers, as has been shown with some success in Norway and Switzerland.

    The relevant ILO instrument (Recommendation 91) provides for and sets down some rules for the extension of collective agreements. A point worth noting at a time when economic policy-makers are pushing in the opposite direction.

    Graf Zahl says:
    March 12, 2012 at 4:06 PM Reply

    The Trade after 1990 goes down in GDP % but as far as i know Germany had even in this time on yearly basis no trade deficit.

    http://www.bpb.de/wissen/4OHFAY,0,Au%DFenhandel.html

    this was the German reunification and a high domestic demand.
    but on yearly basis there is no trade deficit. never.

    Ofcourse in %GPD it will be after reunification probably smaller because Germany's GDP will be bigger just because 17Million more people. but those mostly dont export nearly as much as the West.

    or I'm wrong with this?
    How was Germany's ULC to expensive, or how was Germany not competitive with 120billion DM (buying Power like back then in the south of 120billion €).

    As the Euro is introduced, Germany had a credit crunch, someone could call this monetarism maybe because money was flooded into south.maybe

    http://www.google.com/publicdata/explore?ds=z8o7pt6rd5uqa6_&met_y=unemployment_rate&idim=country:de&fdim_y=seasonality:sa&dl=en&hl=en&q=arbeitslosenquote#!ctype=l&strail=false&bcs=d&nselm=h&met_y=unemployment_rate&fdim_y=seasonality:sa&scale_y=lin&ind_y=false&rdim=country_group&idim=country:de:fr:it&ifdim=country_group&hl=en&dl=en

    its very good to see that the unemployment that just came down after the integration of East Germany was completed. it goes with the euro up to a new all time record high.

    In this time was also the EU East expansion, at the all time high Agenda2010 is created.

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