Competitiveness will not save the euro

ΠΗΓΗ: FT

By Wolfgang Münchau

After Germany’s 2002 elections, its government embarked on a series of economic reforms, mostly to the labour and welfare sectors. The German economy continued to stagnate until about 2005 but experienced a solid recovery, interrupted by the 2009 recession. These are the facts. But the story told across Europe is that the reforms have caused a new German economic miracle.

The argument is a logical fallacy of the post hoc ergo propter hoc variety: after this, therefore because of this. First the reforms, then growth, hence causality, hence universal applicability. Every European official seems to have bought into this chain of argument. And they are now applying their flawed logic to France.

Last week a report by Louis Gallois, former chairman of EADS, suggested measures to render France more competitive. The report and the debate that came with it reflect a wider intellectual muddle about the nature of reforms. I detect a triple misdiagnosis – about the effects of reforms in Germany; about the kind of reforms that are now needed in France, and in Italy and Spain; and about the focus on competitiveness.

The first of the three fallacies concerns Germany. Throughout the postwar period, Germany’s economy performed strongly in fixed exchange rate mechanisms. Its first economic miracle occurred during the Bretton-Woods era of the 1950s and 1960s, as it managed to devalue its real exchange rate against other members of the system. It should come as no surprise that Germany prospers in the eurozone doing exactly the same thing. The recovery that followed the financial crunch in the early part of the last decade was caused by a long period of wage moderation.

So is there a link between reforms and wage moderation? If that were so, one could establish causality between the reforms 10 years ago and the subsequent increase in economic performance. To answer this question, one needs to look at the nature at the trade-off between wage policies and unemployment, and at other factors that were present. While German unions accepted lower wages to prevent job losses, the nature of the trade-off between inflation and unemployment – the so-called Phillips curve – has proved stable over time. German unions and employers moved along the curve to a position where wages were lower and employment higher, but the reforms did not change the nature of the trade-off itself. So could reforms then at least have contributed to that movement along the curve – by making unions accept such a trade-off in the first place? That question is harder to answer but my intuitive explanation is that the process of outsourcing to central Europe, an external shock, was the main reason trade unions acted as they did. In a country with low regional labour mobility, the closure of a factory would otherwise produce persistent unemployment.

Second, to fix the economic problems of France, one should apply a clear-headed and targeted approach. France and Spain suffer from high youth unemployment. The problem is well understood. It is caused by a fragmented labour market, which protects workers with a permanent labour contract but discriminates against outsiders and the young. With youth unemployment at 52 per cent in Spain, this should be the priority for economic reform. We should therefore distinguish between reforms that serve a specific and well-defined purpose – such as the introduction of a single labour contract, or a pension reform – from reforms with unproved effects. We should also separate specific reforms from those that stem from pure rightwing ideology.

Lastly, why do we always focus on competitiveness? Businesspeople talk endlessly about it but it is a less useful concept on a macroeconomic scale. It conflates two concepts: macroeconomic competitiveness, as expressed by the real exchange rate, and total factor productivity, or TFP, a proxy for a country’s technological dynamism. A cut in unit labour costs is only a gain if you achieve it but nobody else does. Once you advocate it as a policy for everyone in the eurozone, you end up in a zero-sum game. We cannot all devalue at the same time. If we are saying that the eurozone should reduce unit labour costs to the level of Germany, why do we think that Germany will not do the same?

So that leaves TFP. This would be fine, but then it would be better to focus on it specifically, rather than through the distraction of the nebulous concept of competitiveness. Furthermore, we may not know as much about TFP as we think.

Specific reforms can be useful, but nobody should fool themselves that structural reforms could solve what is ultimately a balance-of-payments crisis. You have to resolve this crisis first – rather than seek refuge in the age-old debate Europeans love to waste their time with: on institutional reforms and structural reforms. They are both not irrelevant, but they are irrelevant to the resolution of this crisis