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!
This article is crossposted at News N Economics
Rebecca Wilder
Rebecca,
Your analysis is spot on. Well done.
The truth sucks.
Many countries in the eurozone have no altenative. They must increase their exports in order to pay the big foreign debts the have accumulated in the good years.
“I now see a very scary trend emerging across Europe: the fight for exports.”
Reminiscent of the 1930s, right?
OT but want people to know:First pick up here on Friday, http://krugman.blogs.nytimes.com/2010/03/04/malaysian-memories/ second was Sunday. http://krugman.blogs.nytimes.com/2010/03/07/competitive-deflation/
So, if I have this straight, the best the politicians and economists can suggest is that the path to prosperity and a glorious future for humanity lies in a race to the bottom? And bringing up the point that most countries will, of necessity, lose that race (a zero sum contest if there ever was one) is rude?
Maybe we need to find an enemy and surrender.
Not to mention that Krugman just noted on *his* blog that the real effect of this deflationary spiral in Europe is to raise real interest rates as the various economies enter deflation. How, exactly, is raising real interest rates supposed to help? Is magic sparkle pony dust supposed to just suddenly erupt from stripper volcanos across the land and all is rainbows or something? I guess this just goes to prove that American politicians aren’t the only ones in thrall to neo-Austrian claptrap, but discouraging. It’s as if stupidity is contagious, and Europe has caught the Andrew Mellon Flu.
— Badtux the Economics Penguin
Over the last year in the US nonfarm business sector unit labor cost fell 4.6% while prices rose 0.7%. This 5.25% spread between prices and labor cost is the largest spread on record. it is showing up in soaring profits. The bulk of the lower labor costs stemmed from productivity improvements, not wage cuts.
But are the countries trying to cut wages reducing labor cost enough to offset the US 4.6% drop in labor costs even though wages are still rising? If not, how can they expect export, at least to the US to expand?
It is like the liberaterian argument that wage cuts lead to job gains when the actual data shows that all wages cuts have achieved historically is a downward spiral in employment and incomes.
Indeed, this isn’t just Europe. Incomes, hours, “productivity increases,” all point to the same downward spiral in the US.
There’s no way to take it back without revolution, we’re headed into a very bloody period in history, I suspect.
Of course, I’ve been suspecting that for a good decade and a half at least. Eventually I’ll decide I’m wrong.
I should clarify: Blood period in the west. It’s already been a bloody period in history in a lot of the developing world. Where there hasn’t been war and famine, there’s been AIDS, avian and swine flus, and short unhappy lives. The four horsemen have always been here, and now they’re coming home to roost.
I think that trade will impact the race to the bottom for many countries that must buy essentials offshore. For those that don’t there may be movements to replicate essential industries in countries like the US which would push employment back up.
The backdrop to these thoughts is that consumption in the US has a long way to drop yet to come into line with the rest of the developed world and that drop, assuming it comes, is going to clearly show the population problem emerging in our world….not enough real jobs to go around.
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.
Kind of, if you look at it more globally! It does seem like protectionism is a risk; it is likely low in probability, but nevertheless a risk!
Rebecca
That’s the way that I am seeing it, too. What else can they do? They could raise productivity, but that would mean serious layoffs for some whose unemployment rates are already 13+. Recently, (I plan to post about this soon) productivity has surged on a Q.Q annualized basis – but NOT in Greece. In Q3, Greece’s productivity (per employee) fell 1% annualized over the quarter in Q3. US productivity has been growing at 7% +- since Q2. Rebecca
Hi Spencer,
Intresting point! Productivity across the eurozone has only just started to grow (in Q3 and a post probably tomorrow) – that means wage cuts have been the eurozone model to date. That could change, and probably will change given that not every economy can grow competitiveness simply by lowering wages and dropping incomes. That does not bode well for the unemployment rate in the eurozone.
Rebecca
Thanks for stopping by News N Economics, MG! Rebecca
Why is devaluation prestened as an “impossible due to the Euro” alternative. Stupid anti Euro bias. Just like wage cuts to increase exports cant work for everyone, devaluations to increase exports cant work for everyone as well.
I think this is the necessary conclusion to the integration of developing countries into the world economy.
Cheap labour increases the exports share of countries with low wages, and leads to a trade deficit in countries with uncompetitive economies. When these countries can no longer take on more debt, they must lower their wages to become competative again. The end result is the equalization of wages across countries.
This is a scary thought. There are far more Indian PhDs earning 15 dollars an hour than you might think.