In my earlier post on the failure of the Eurozone to understand the lessons of the Great Depression, I talked about Germany becoming ‘too competitive’. From some comments it seemed this was a contradiction in terms: how can a country ever be too competitive? I think it was obvious then that I was talking only about relative prices: being competitive in quality is something else. The problem is that Germany did become too competitive in price terms from 2000 to 2007 relative to pretty well all its Eurozone partners.
Graphs that compare some measure like unit labour costs over this period in Germany and some periphery country are ubiquitous. The discussion normally moves on to talk about how this was a problem of the periphery country’s own making alone: for whatever reason demand was too strong, which put upward pressure on inflation. However, as Francesco Saraceno points out, the really notable outlier here is Germany. Germany did not just increase its competitiveness relative to particular periphery countries; it also became more competitive with its immediate neighbours. From 1999 to 2008, whole economy unit labour costs were flat in Germany, compared to average annual increases in France of 2%, in Italy 3%, in Belgium 2.1%, in the Netherlands 2.3%. (Source OECD Economic Outlook Annex Table 22.)
The reason for this was a remarkable degree of real wage restraint in Germany. The chart below plots annual increases in real wages in Germany (either relative to the CPI or the GDP deflator) compared to labour productivity. Although these two series do not always move together, divergence between real wages measured relative to the GDP deflator and labour productivity are unusual because they imply a changing share of labour income.
|German real wages and productivity: source OECD Economic Outlook|
Whatever the reason behind this unusual wage restraint, it is bound to cause problems within a monetary union if other countries do not do the same. Unless Germany entered the Euro at an exchange rate that was unsustainably uncompetitive (and there are good reasons for doubting this possibility), and unless there is a structural deterioration in Germany’s non-price competitiveness that needs to be offset (which seems unlikely given its huge current account surplus), then these competitiveness gains have to be reversed. German inflation, which was below the rest of the Eurozone, will have to be above inflation in the rest of the Eurozone for some time. These are the rules of the game for a monetary union.
As Germany is the outlier, this is a problem of Germany’s making. I’m normally reluctant to mix macroeconomics with morality, but those that suggest that it should be other countries that have to adjust towards Germany have things completely wrong here. Even if you believe that German real wages had to fall to reduce structural unemployment, Germany has no right to impose the same policy on other countries. A price it should pay for undercutting its neighbours is to experience a period of above ECB target inflation (e.g. 3% CPI inflation, which probably means nominal wage increases of something between 4% and 5%). If that is not going to happen, Germany should stimulate its economy to ensure it does. Anything else is the monetary union equivalent of anti-social behaviour.