Tuesday, 9 April 2013

Improving EZ periphery competitiveness with less austerity.


The basic flaw in the current system for improving periphery competitiveness is that austerity accompanied by high unemployment is imposed so as to bring down periphery costs. That contrasts sharply with what a country with its own currency does to improve competitiveness: to devalue. Under devaluation, the cost of the relevant country’s exports and imports adjust which solves the competitiveness problem, while there needn’t be ANY AUSTERITY  in the form of excess unemployment. In short, the solution for periphery countries currently being implemented in a sense puts the cart before the horse.

For a periphery country to properly mimick devaluation, it needs to cut wages and profits (in money terms). That would be administratively expensive to implement, but then the costs of the current so called cure for periphery problems is pretty horrendous.

The Financial Times’s leader yesterday was entitled “Europe needs more creative thinking”. So I’ve obeyed FT instructions.

First, the FT’s own attempts at creating thinking are woeful. Their basic idea is to promote bank lending to small and medium size enterprises (SMEs). Problem there is that the evidence is that difficulty in obtaining finance is not the biggest problem facing SMEs. The latter alleged problem comes way behind lack of orders and is approximately second equal with four or five other problems: labour costs, transport costs, red tape, and so on.

So here’s a better solution. Unfortunately it requires the population of a periphery country to behave like adults rather than children. And that is a tall order. But anyway, here goes.

Competitiveness is key.

The basic problem facing Euro periphery countries is poor competitiveness as explained here. And competitiveness can be improved by cutting costs.

Costs can of course be cut, as the FT points out in a variety of ways: they cite “structural reforms” and “liberalised labour laws”. But as the FT also points out, those reforms can take time to materialise. And in any case, some labour laws (e.g. minimum wages) are implemented to achieve what we believe to be an optimum balance between efficiency and social considerations. If that alleged optimum is to be maintained, watering down labour laws is not an option.

The basic or ultimate cost.

There is one very simple basic or ultimate cost: labour. That is, while the cost of producing anything is often split between labour, capital equipment, materials and so on, the cost of capital equipment itself is made up of the costs of labour, capital equipment, materials and so on. In short, if you go back far enough, labour accounts for about 100% of the cost of everything: that’s “labour” in the broadest sense of the word, i.e. it includes the so called labour of the entrepreneur – that is, profits.

So…the EZ periphery problem could be solved simply by a 20% or so cut in wages and profits (in Euro terms as opposed to real terms).

The existing cure.

The cure currently being implemented for periphery problems actually aims to cut costs, although the Euro authorities are not very specific on EXACTLY HOW they expect each periphery country to cut its costs. But certainly wage restraint is PART OF the solution: wages have been frozen if not cut in some periphery countries.

But there is one glaring flaw in the existing attempted cure: aggregate demand is cut in periphery countries with a view to causing costs to be cut. I.e. the solution comes VIA AUSTERITY.

Now that is in stark contrast to where a country with its own currency devalues. In the latter scenario, there is no absolute need for austerity at least in the sense of increased unemployment (although as has been pointed out a thousand times, a bit of austerity helps devaluation do its job).

But nevertheless, and to repeat, IN THEORY improving competitiveness via devaluation does not absolutely have to be accompanied by reduced demand, i.e. austerity.

So . . . that raises the obvious question as to whether it would be possible to do something similar for EZ periphery countries: that is, try cutting costs without cutting demand. And the answer is “yes” – nirvana – if it works. Here is how.

As explained above, the basic cost is the cost of labour: wages. So all a periphery country needs to do is implement a wage freeze lasting a few years, or a wage cut of 5% a year each year and lasting a few years.

Now there are obvious problems there. Cutting the wages over which government has direct control is easy enough. Same goes for large firms. But controlling wages in smaller firms is difficult – well this solution isn’t perfect! But it doesn’t have a high bar to surmount if it is to beat the disastrous so called “solution” currently in force.

Anyway, public sector employees and employees of large firms can be told that if they think working for a small firm is so wonderful, they are free to quit their job and get a job with a small firm.


As to profits, it would be impossible to control the profits made by each individual firm. However, there is away round that problem as follows.

Government could announce that the POST TAX profits as a share of GDP will remain constant for the next five years or so. In other words, if profits looked like creeping upwards, government could respond simply by raising taxes on profits.

Periphery country residents need to be told this.

So, periphery country citizens need to given the following message (and this is simply a repetition of the above material put in simple language).

“Hi folks. You’ve had the dubious pleasure of austerity for a few years now – aimed at curing your country’s lack of competitiveness vis a vis European core countries. It won’t have escaped your notice that this cure is slow to work. And no immediate end to austerity is in sight.

Do you want to try a quicker cure? Because there is one available. It’s as follows.

Basically, periphery countries need to do the same as a country with its own currency does when it devalues its currency. Devaluation does not bring austerity in the sense of raised unemployment. Or at least it certainly NEEDN’T. In contrast, to the extent that a country is reliant on imports, there WILL BE some austerity: the cost of imported goodies will rise.

But then a country which has been uncompetitive for some time is a country that has been living beyond its means. And if you think you can convert from living beyond your means to living WITHIN your means without make any sacrifice at all, then you’re living I cloud cuckoo land – a bit like those French voters who actually believed Francoise Hollande when he said he could deliver France from austerity.

So if your country mimicks devaluation in a better way than it is doing currently, it can regain competitiveness without suffering excess unemployment. That is, while there will still be SOME AUSTERITY, it will less than you are currently “enjoying”.

The way for an EZ country to mimick devaluation is for it to simply to cut wages and profits. To repeat, if the wages and profits of a firm are cut by X%, that means the price of its products also decline by X%. So to that extent, there is no effect on living standards. In contrast, and to repeat, you WILL FIND that imported products are less affordable.

In the case of an exporting firm, the cut in its wages and profits makes it more competitive, which means the country’s exports improve. I.e. its competitiveness improves. So that solves that problem.

So on balance, there is less austerity under the solution set out above because there is no austerity deriving from the excess unemployment which is very much a feature of the so called “cure” for periphery countries currently being tried.

Of course if you don’t like the idea of the above wage cuts, then feel free to throw a tantrum and organise a riot: but you’ll just be shooting yourself in the foot.”

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