Sunday, April 15, 2012

A Warning from Barry Eichengreen

The ECB is preoccupied by moral-hazard risk – the idea that supporting spending will relieve the pressure on governments to act. But it should also worry about meltdown risk – about the danger that its own failure to act, by leading to a deep recession, will undermine political leaders’ ability to take the steps needed to put their economies on a sound footing.
Eichengreen notes that German wage increases may improve the competitive position of southern-tier states:
The leading German trade union, IG Metall, has called for a 6.5% wage increase in the next annual round of negotiations. And German public-sector workers obtained an agreement at the end of March that boosts wages by 6.3% in the coming two years.
But this increase in German labor costs is, in fact, precisely what Europe needs to accelerate its rebalancing, because it will help to realign the competitive positions of the northern and southern European economies.
Southern Europe needs to enhance its competitiveness and export more, and has been criticized (not without justification) for failing to do more along these lines. But what matters are southern Europe’s costs of production relative to those of Germany, Europe’s export champion. That is why the prospect of rising German labor costs, after a decade of stasis, is actually one of the few positive economic developments on the European scene – hardly something that the ECB should resist.
One of the pressures that Hollande is likely to face after his election is from unions that have been keeping an eye on German wage increases. They would like to see the same thing happen in France. But France has not been the export champion that Germany is and has in fact been losing ground in key export markets to southern countries such as Spain and Italy. Consider this graph:

What this shows is a sharply deteriorating French trade position with Spain in Standard International Trade Code 7 (machinery and transportation equipment) and a less drastically deteriorating position in Code 6 (manufactured goods classified chiefly by material). Labor costs are not the only reason for this deterioration, but they are a factor, and wage increases after the election will compound matters. So Hollande may not be in a position to reward union expectations, and that could be a problem.

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