Economic discussion paper 2011/07

HOW THE STRAIGHTJACKET FOR WAGES IN EUROPE CONTINUES TO BE BUILT

Europe is launching one policy proposal after the other. From EU2020 to economic governance to the Euro Competitiveness Pact. For the casual observer,this avalanche of policy initiatives may be confusing. However, there exists a clear link between the Competitiveness Pact on the one hand and, on the other hand, the proposal on excessive imbalances that is part of this economic governance package. The Competitiveness Pact intends tostrategically move the goalposts for economic governance further. Through the Competitiveness Pact, the Council is putting decisive pressure on the Commission to transform the excessive imbalances procedure into a disciplinary straightjacket for wages.

This strategy is working already: On the 16th of March, only a couple days after the heads of governments of the Euro Area signed up to this Competitiveness Pact, DG ECFIN produced an actualized version of a previous note on the so called alert mechanism and the scoreboard of indicators. Both are to be used once the draft regulation on the prevention and detection of excessive imbalances has been approved by the European Parliament.

In this actualized scoreboard, the Commission has takena decisive turn in how it defines the practical implementation of the excessive imbalance procedure: Pushing down wages has now clearly becomea key target.

Whereas a previous version of the Commission’s note introduced wages in the scoreboard in a rather indirect way, by using a highly technical indicator called the Real Effective Exchange rate, the Commission is now openly and directly includingunit wage costs. This wage indicator will start to flash from the moment unit wage costs increase by 9 percent or more over the period of the last three years (the 9 percent threshold is augmented to 12 percent for the non euro countries). These figures are purely based on the statistical distribution of the dataset. From the point of view of the ECB s price stability objective, which would yield a threshold of 6 and not 9 percent, this could even be seen as constituting a rather generous criterion. However, the key point to note is that by defining the threshold of the unit wage cost indicator in this way,the Commission is exclusively focusing on upwards wage dynamics that supposedly have gotten out of hand while the problem of stagnation or indeed the collapse of wage dynamics is simply being ignored. Blinded by the quest for (the wrong type of) competitiveness. the Commission is letting countries that have pursued a systematic strategy of wage dumping, completely off the hook, even though such a strategy risks undermining both the openness of the internal market as well as at the price and financial stability of the Euro Area. This approach however is fully in line with the CompetitivenessPact. The Pact also limits itself to controlling high and sustained wage increases while forgetting about the dangers and risks of wage stagnation.

In practice,the Commission’sa - symmetrical approach results in two striking conclusions (see also table):

  • In the recent crisis, all countries, bar 6,haverecordeda unit wage cost indicator that is startingto flash. In response to the collapse in demand, many labour markets reacted by hoarding labour. In many cases, this was supported by schemes of short time work backed up with public subsidies. In this way, productivity was driven down and unit wage costs spiked. The alternative however would have been even higher increases in unemployment. In future the effects of this policy will be picked up in the unit wage cost indicator and the risk is that policy recommendations will be issued which would limit member states recourse to these short time work schemes, which have proven their usefulness in the downturn.
  • Even more seriously however is the fact that, as was described above, countries where wage dynamics have stagnated for a decade are completely being overlooked by this indicator. In particular in Germany, and remember that this is about the cumulated change in unit wage costsover a period of three years, the indicator stayed close to 2 percent at the start of this decade, and fell in the middle of the decade. Although this sort of wage dumping policy is partly responsible for the financial turmoil that the Euro Area is now struggling with, the Commission’s indicators are completely oblivious to it. The ‘quest’ for cost competitiveness seems to be more important for the Commission and the Council than securing the survival of the single currency.

To illustrate the extent to which the strategy of wage dumping is now being exempted from any attention or responsibility for corrective adjustment, the following comparison can be made. The Commission’ s figures on unit wage cost dynamics (using the three year percent increase) in Germanytest the extent to which they break the price stability target, in the downwards direction. This means introducing a minimum threshold of 6 percent unit wage cost increase and not only a maximum threshold of 9 to 12 percent. The results are shown in the graph below. It can be seen that the breaches of the ECB s price stability target over the past decade have been huge. In some years nominal unit wage costs fell in nominal terms where they should have increased by a measure of around 2 percent. (Comparisons for Austria and Finland would yield similar conclusions, although the extent to which the price stability target is breached from below is not as radical as in Germany). Again,the economic governance indicators that the Commission is putting forward simply ignorethis type of beggar thy neighbour price instability wage policy.

Unit wage costs threathening price stability from below

Two remarks to conclude with:

  • Unfortunately, this is probably not the end of the story. One can expect thatas the proposals on the excessive imbalance indicators are finalised, even more elements of the Competitiveness Pact will be built into them. The Commission’s note for example already announces further proposals to undertake relative wage comparisons between member states and according to specific sectors of the economy. Since competitive wage improvements of one European country are to a large extent the competitive losses of another EU member state, the former implies promoting the wage race to the bottom in an official way. The lattermay well boil down to a policy of increasing wage inequalities, with wages in services and construction sectors staying behind industrial sectors where productivity improvements are more robust. In the same vein, it can be expected that the maximum threshold of 9% unit wage cost increase will be substantially cut and brought into line with the other wage criteria of the Competitiveness Pact (zero nominal unit wage cost increase or wages in line with productivity but corrected for the necessary competitive adjustments).
  • Finally, there’s the Commission’s argument of ‘economic judgment’. The Commission may brush these critiques from the table by claiming that these indicators are simply intended to function as early warning signals. Policy recommendations would not be based on the indicators as such, but on in-depth economic analysis. However, we have been there before. Exactly the same was said when the Maastricht Treaty with its criteria on public deficits and public debts were introduced. Instead of being embedded in an analysis that “takes into account all relevant factors” (the wording at that time), in practice, these criteria have started to live their own life. From the moment they are published by the Commission or the ECB, media, employers and politicians pick up the difference between the reference criteria and the actual figures and the pressure for a tough fiscal consolidation strategy almost automatically increases. The same will happen with wages: Any in depth analysis (which, in any case, will be undertaken by those policy actors that are “true” believers in competitiveness and deregulated labour markets) will have huge difficulties in countering the initial impression of simple, straightforward looking wage cost indicators.

Ronald Janssen

ETUC Brussels

11/04/2011

ATTACHMENT: EXPORT MARKET SHARES

The other indicator that the Commission is introducing, also at the ‘request’ of the Competitiveness Pact,is losses in export market shares. This indicator would start to flash from the moment the loss in export markets over a five year period reaches 6%. Again, note the asymmetry in the approach: Member States building large external surpluses by winning export market shares at the expense of other EU or Euro area members are not considered to be a problem or worth paying due attention to (see table).

Moreover, this indicator runs the risk of systematically being misunderstood by media and “easy minded” policy actors. In a globalizing world, it is not abnormal for industrialised countries to lose world export market shares. The entry of emerging economies in world trade per definition implies that relative exports are falling. The point however is that exports from industrialised countries may still improve radically since the total pie (world trade) is increasing, even if the share they have of this total pie is falling.

Second indicator market shares

Conclusion more to follow

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