| || ||Kip Beckman |
Principal Research Associate
The world’s attention is fixed on the debt and banking crisis in Europe and how this will play out over the next few months. Greece, Portugal, Italy and Spain piled up the debt after they joined the euro-zone. When the severe global recession then hit in 2008-09, these countries began having problems meeting their financial obligations. They have been forced to seek financial aid from the European Union, IMF and the European Central Bank (ECB). The Germans and, to a lesser extent the Finns and the Dutch, have been forced to help bail out the weaker euro members in order to save the common currency from breaking apart.
But there is another huge problem the euro-zone must contend with that has received far less media attention. Lop-sided competitiveness has resulted in large trade and current account imbalances within the euro-zone. This problem initially emerged when the euro was launched in 2000, and it has subsequently been exacerbated by the ultra- efficient German economy. If anything, the competitiveness problem will be even more difficult to resolve than the ongoing debt drama because major, long-term structural reforms will be needed to tackle this issue.
Germany has attained far higher productivity growth compared with other euro zone countries, due in part to thorough and, in some cases, painful labour market reforms implemented in the early to mid 2000s. The German government made it more difficult for the unemployed to collect benefits for extended periods of time and also increased the flexibility for small businesses to let workers go during economic downturns. Since 2000, German unit labour costs have increased at a pace close to 30 per cent lower than unit labour costs in Italy, Spain, Greece and other euro zone countries. This wide gap has left Germany with a large intra-Europe trade surplus, while other countries are running significant deficits.
If each country had its own currency, movements in exchange rates could help to address the imbalances. But because these countries are locked into a common currency, the adjustment will have to take place through other changes in policy and structures.
How can this problem be fixed? One solution is for the deficit countries to engineer a productivity miracle of their own, while the Germans stand pat. Higher productivity growth in countries like Greece would improve the competitiveness of their exports and start to chip away at its current account deficit. However, the chances of this happening are slim to none, given that it will take years (if not decades) for the euro-zone laggards to reform their dysfunctional labour markets that currently restrain productivity improvements.
Alternatively, the Germans could implement a huge stimulus program and end policies promoting wage restraint. The wage discipline in Germany was remarkable between the early 1990s and 2008, especially at a time when wages in their European trading partners were increasing steadily. German wages were virtually frozen during this period and employee compensation as a per cent of GDP was lower in 2009 compared with the early 1990s.
Fiscal stimulus measures and higher wages would encourage German consumption and help reduce current account deficits in other euro zone countries. However, these policies would run counter to Germany’s steadfast determination to contain inflation—policies that have been around since the end of World War II and are part of Germany’s economic fabric. Also, Germany’s economy is geared towards the export market—a model that has served the country well over decades and has accelerated recently. In 1999, exports comprised less than 30 per cent of German GDP; that share is currently close to 50 per cent.
The other solution to the trade imbalance problem is for the weak euro-zone countries to accept deflation and a subsequent sharp decline in nominal wages and prices. While deflation would help to restore international competitiveness, it is generally associated with long, painful recessions—something that the euro-zone is tumbling into. Unfortunately, unless some of the weak euro-zone members decide to leave the euro—a decision that also brings with it some equally damaging economic ramifications like a meltdown in savings—deflation is likely the only way out of this bind.
In sum, the euro zone has a huge, visible Greek and Italian debt problem that is closely linked to years of failed economic policies. But it also has a far less visible but no less serious problem associated with Germany—a country that is a victim of its own success. And that problem will be hard to fix, since fundamental structural changes in the euro-zone will be required.
Alan Blinder, “The Euro Zone’s German Crisis,” The Wall Street Journal (December 2011).
The Economist, The Lives of Others (August 2009).