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Saturday
Dec222012

The Fairy Tale of Rising Competitiveness in the Euro Periphery

Contributed by George Dorgan, a macro-based fixed-income and currency overlay portfolio manager based in Switzerland, and the main editor of the blog SNB & CHF.

In our post we look on two questions concerning competitiveness for the European periphery:
  1. When will local production be cheaper than imported products?
  2. Do people have the money to buy these local products?
It does not help reducing labor costs if local production costs still more than imported products. The second aspect is: even if local products were cheaper than imported ones, do people have the  money to buy them?

The eurocrats continue to claim that Greece and other weaker members are following the best route to gain competitiveness, especially because labor costs are falling. Labor, however, is only one part of the competitiveness story, the countries also need other production factors, notably capital, which is missing in the current capital crunch. Furthermore the labor share is about 50% and contains still pension schemes, unemployment insurances and other taxes, additional costs that might increase with austerity measures.

The best indicator of competitiveness is actually production prices: only if prices of the local industrial production are lower than imported German or Chinese goods, the weak countries will achieve competitiveness. We realized, however, that industrial production prices are rising far more quickly in the periphery than in Germany:

 Source Eurostat. Light green: countries with low labor costs and high price increases; Red: countries with debt issues and high price increases; Dark green: Low price increases and no debt issues; Yellow: debt issues and low price increases; Sept. 2012

Two weeks ago, Eurostat released the industrial production price indices for October: just the Greek production prices started to fall (+4.1% YoY instead +5.1% in September), but the other problem countries still have similar high price increases as in September. On Monday, Eurostat published labor costs and wages.  According to eurostat, labor costs rose by 2% in the euro zone in the third quarter. The ECB’s expectation of falling inflation seems to be still far away.

Moreover the Eurostat data shows that except from Greece and Slovenia, there is no country in which nominal labor costs are actually falling. After falling nominal wages in 2011, Ireland exhibits rising wages in 2012.

Euro zone labor costs Q3/2012 (Greek Q3 data not available, below we use Q2 data)

 

The ECB claims that labor costs are falling


Unit Labour Costs Eurozone 2011

Real Unit Labor Costs Eurozone 2011 (based on ECB ”own calculations, page 41″ and Kattoo)

The ECB regularly claims that labor costs in the periphery are falling. In 2011, they used the strong rises in Spanish inflation, that includes the strong rise in Spanish production prices, to prove that Spanish labor costs were falling. They used real (inflation-adjusted) costs and the falling number of produced units: a nice “recursive trick” to calm the public.

Spanish nominal labor costs, however, were rising, as the Eurostat data shows.

Europe labor costs Q2 2011 (source Eurostat)

 

Labor costs compared to real wages

In the following we compare the change in nominal labor costs (in blue below) with real wages (in red). This gives an impression how much labor costs are rising in the different European countries, but also if people have still the needed purchasing power.

Instead of an inflation adjustment (“real”) with the consumer price index, we opted for the producer price index  (PPI”). The reason is that it gives a better impression of competitiveness and it gives an impression if employees are able to buy the goods they produce. In order to be competitive a peripheral country must be able to produce at a cheaper price than the competitors. Otherwise retailers prefer to import the goods from Germany or China.

The comparison gives the following picture:

European labor costs Q3 2012 vs. real wages (inflation-adjusted by PPI)

 

We had to leave Greece out because it did not fit onto our graph: PPI-adjusted Greek wages fell by 12.3%.

Cyprus sees slightly higher nominal wages, but producer prices rose by over 6%, hence Cypriot real wages are down by over 5%. A similar picture in Portugal, Spain and Italy, where real wages fell between 1% and 3%.

Real wages descend most interestingly also in the Netherlands, in Belgium, Slovakia and the UK. The reasons are the bursting Dutch and Belgium real estate bubbles and the slowing in global trade and a tax increase in Slovakia. As for the UK, we already know about sticky inflation pressures.

Despite the slowing global growth, real wages are strongly rising in Austria, Germany, Finland, Sweden and in the Eastern European countries with their cheap-labor costs. The United States is situated somewhere in the middle (wage data FRED). Thanks to falling producer prices, Japan’s real wages are on the rise, despite the bad Japanese GDP data in the third quarter and Abe’s bashing of the BoJ and the yen.

Summary

The data makes clear that competitiveness for the peripheral countries is a very long way away. The first thing to be destroyed is purchasing power, consumer spending and then employment, because people do not have the money to buy the goods.

Only after that nominal wages will fall. After a long years, production prices will start to fall (relative to Germany). Finally also the combination of quality and production prices might show a better mix.  Slovenia is now the next country that has joined Ireland and Greece in reducing nominal wages. As we have seen, yet without success in reducing production costs and becoming competitive.

By the next Eurostat labor costs release at the beginning of 2013, even Spain and Portugal should finally see lower nominal wages.  But success in reducing production costs and real competitiveness will still be far away.

We think that most peripheral countries will need at least twenty years inside the euro corset to achieve this final goal, if they ever succeed.

The second take-away from this post is that there is no euro crisis, but just a European periphery crisis. At least, as long the real bubble in France does not follow the Spanish, Danish and Dutch housing bust. Cross-posted from SNB & CHF.

Also by George Dorgan: He Who Says No To Austerity And Global Imbalances Must Say Yes To The Northern Euro

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Reader Comments (1)

1. The statistical data we use for this kind of stuff are simply rubbish. Look at ECB and Eurostat as far as the productivity goes they are worlds apart (or it is in the definitions they donot mention, which is as bad). Which one is correct or are they both garbage (at least one is)?

2. Laborcosts are often used as they also give usually a good indication for other costs. As mentioned here in this case it is not. And probably take several years before wagescosts are seen in lower prices (and subsequently cost).

3. Which would open anopther can of worms (in a few years time and if things have not collapsed beforehand). If you have deflation in half the EZ the rest will have high inflation to get to get to the usual 2%. And 4-5% inflation is likley a problem there mainly political. Difficult to see that the German public will accept 4-5% inflation for several years in a row. Germans donot care about EZ inflation they care about German inflation.

4. Economists asume that replacement, extend existing and totally new investments are similar. I doubt that that will be the case here. To get the average PIIGS economy going again you likley need a lot of new export focussed investments. The decisionmaking process is simply different. New mainly export oriented looks at cost competition (and seeing the EU as one big market, Eastern Europe is still much cheaper). Existing assumes that you are already there and opening somewhere else splits your enterprise for instance. And they look at growth potential local home market (which also is simply not good certainly compared to Eastern Europe).

5. PIIGS (except Ireland) have come into the part of the worldmarket (as a producer) that is now totally overcrowded with Asians and other EMs. While their labour and other costs are much higher. They simply forgot while building houses to move up the value added ladder.

6. Education levels are (again except Ireland) low. An average university education in Spain is simply not similar with one in Germany or Sweden. And hardly anything has been done on this issue. Similar with language skills, which are usually inferior as well.
Similar with R&D they are simply 2 classes lower and nothing really has been done. Apparently it was more important to keep paying entitlements and keeping your ineffective cousin in a well paid government job than work on these 3 issues.

7. Fully agree that this will take 1 or 2 decades under the present conditions. Which also indicates that it is not going to happen this way. Austerity fatigue will tear the thing apart long before that.

8. Keynesian approach here is imho also completely counterproductive.
-It takes the attention away from the structural issues.
-The 'solutions' often assume that money has to come from one thing. But because of the set up mainly it is often Germany paus and Spain/Italy/Greece receives. It would be difficult to do within say Italy but assuming that Germany and Greece have one wallet is simpoly ridiculous.
-An economy can imho only achieve slightly more than the combination of quality and quantity of workforce and business allows unless you put it on steriods (which was done with most PIIGS). That basis looks much lower than the present GDP suggests. A lot of Keynesians seem not to see that.
December 23, 2012 | Unregistered CommenterRik

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