Wednesday, March 28, 2012

Olivier Blanchard and TINA

by Micahel Roberts

Olivier Blanchard is the chief economist of the IMF and he has a blog on the IMF website.  Blanchard’s latest post ( takes up the question of whether there is any alternative to the austerity programme imposed on Greece and other southern European governments to get their economies out of the depression they have entered.  Blanchard argues the position of mainstream economics and the dreaded Troika (the EU Commission, the IMF and the ECB), namely that the governments of Greece, Portugal, Ireland, Spain and Italy have amassed too much government debt to fund lifestyles they don’t earn.  They need to reduce that debt and that can only be done by increasing ‘competitiveness’.
According to Blanchard, there are two ways to become more competitive: become much more productive or reduce wage and non-wage costs.  “The first way is much more appealing. But there is no magic wand.. it is hard to identify where and how progress can be made.”   So Blanchard says that leaves only one way: “a decrease in relative wages, at least until higher productivity can kick in… otherwise competitiveness will not improve, demand will not increase, the current account deficit will continue and unemployment will remain very high.”

For Blanchard, there is no alternative (TINA), to use the infamous aphorism of that ideological flagholder of ‘neo-liberal’ capitalism, Margaret Thatcher.   Such is the view of the Troika, the European leaders and mainstream economics.  But there is an alternative.  I have tried to outline this in previous posts (An alternative programme for Europe, 11 September 2011, Europe: the path to growth, 14 March 2012).

Blanchard is firmly with TINA. “Were there less painful alternatives? I do not believe there were, or are.  For example, the notion which is sometimes floated that large infrastructure projects might boost growth, increase productivity, and improve the fiscal and current accounts, is fanciful. The problem of Greece is not primarily a problem of physical infrastructure. Projects financed by state funds would do little to impact growth in the short term, would make the fiscal deficit worse and would only delay the inevitable adjustment.”

Yet there is plenty of evidence that you get the best bang for your buck (euro) from investment (see or What these studies show is that government investment can make a significant difference to economic growth, as long public sector debt is not too high.  If it is, then financial markets will drive up the cost of servicing that debt as they fear that budget deficits will get out of hand.  The answer here is to renegotiate a restructuring of that debt with bond holders.  The investment accelerator or multiplier, as it is called, is actually the way economies recover!  Public investment is the most effective way to do that.  Infrastructure projects mean jobs; and they deliver better transport, education and health – all long-term components for higher productivity and better ‘competitiveness’.  Instead, the chief economist of the IMF rejects that and seeks to slash public investment to the bone and privatise public sector assets.

Blanchard then rejects the Keynesian solution of raising wages to boost consumption. “This might indeed increase demand and thus growth in the short run. The increase in disposable income may lead consumers to spend more, although it is likely to be partly offset by a decrease in investment. But the wage increase would exacerbate the problem of competitiveness. Indeed, as imports increased and exports decreased, it would lead to a larger current account deficit. It would just delay and amplify the scope of the inevitable adjustment.”

There is some truth in this criticism.  But my objection to the Keynesian solution would not be that wages should not be increased but that the Keynesian alternative puts the cart before the horse.  What the likes of Greece or Portugal need is investment.  That leads to jobs and then to higher incomes and spending.  Sure, boosting incomes would help demand but it would not provide sustainable growth if the increased income merely eats into profits, curbing private investment.  Increasing wages is not enough or even counter-productive if investment decisions remain under the control of the private sector.

Blanchard rejects the idea of Greece solving its problems by leaving the euro.  “Leaving aside the large costs of no longer belonging to the Eurozone, the dislocations from a disorderly exit—from the collapse of the monetary and financial system, to the legal fights over the proper conversion rates for contracts—would be very, very large.”  I have discussed this alternative in previous posts (Europe: default or devaluation, 16 November 2011).  It is not an alternative on its own. I argue that an alternative policy to the Troika’s should be one of investment financed by public ownership of the banks  and renegotiating the government’s debt burden with Europe’s banks. Leaving the euro and devaluation on its own would not provide sustainable growth.

But is Blanchard right to say that the likes of Greece, Portugal, Spain or Italy can only get out of their mess through being more ‘competitive’?  What does that mean?  Presumably it means being able to sell more goods and services in world markets than others.  If your prices are too high, then you lose market share.  Why would your prices be too high?  Because your costs of production are too high.  What is the biggest component of those costs: labour costs.  That’s why the usual measure of a lack of competitiveness is unit labour costs, or the cost of labour per unit of production sold.
The argument is that the weak capitalist economies of southern Europe have allowed a sharp rise in labour costs or wages, making the goods they produce uncompetitive compared to the super-successful exporter, Germany (see graphic below  showing the change in various countries’  unit labour costs since the start of the euro (1999 =100).

But is this right?  For a start, export growth for Spain, Germany and Greece since the start of the euro in 1999 up to the beginning of the global crisis has been more or less the same, with Spain doing even better than Germany.  And yet Greek unit labour costs rose over 70% in this period, Spain’s were up 13%, while Germany’s fell.  How is that possible?   The answer is revealed if you go back further in time than 1999 and measure unit labour costs from say the early 1980s, it shows that for the 25 years up to 2005-6, the level of unit labour costs in southern Europe was lower than in Germany.  The graphic shows unit labour costs relative to Germany from 1980.

For over a decade, low wages and reasonable productivity growth made exports from the likes of Greece or Spain cheaper than Germany’s.   But during a long period of ‘internal devaluation’ from the 1990s onwards, Germany’s labour costs stopped rising.  So the huge competitive edge that other European countries had over Germany was gradually eroded by the convergence of their unit labour costs with Germany’s.   But the overshoot of peripheral countries’ unit labour costs only occurred in the last few years and is now (painfully) being eliminated.

This not to say that there is not an export problem for the peripherals to be dealt with.  But it is a great deal more finicky to understand.  The southern European economies export much the same range of goods in manufactures, chemicals and autos as Germany.  The differences are in services; tourism looms large in the south and software and business services in the north (Ireland and Germany).  But, after all, there is nothing wrong with offering vacations, if that is where your competitive advantage lies.

It is only when you drill down to another layer of detail that the real export problem appears.  The degree of technical specialty that captures the ability to set price in global markets is very low in the exports of the southern European economies and very high in core Europe and in Ireland (see Jesus Felipe and Utsav Kumar, Unit labour costs in the Eurozone: the competitiveness debate again, Levy Economics Institute, Working paper 651, February 2011).  This matters because of the speed at which emerging market producers like China are moving up the value-added chain.  German capitalism is staying one step ahead; the weak capitalist states of Greece, Spain and Portugal are not.  To do so, they have to become more innovative.  This is a story of the need for better education and more investment in human and machine capital, areas where capitalism in Southern Europe has failed.
But if the Greek or Portuguese people are as lazy as the common perception would have it, no amount of innovation and education will work.  But are they lotus-eaters?  Not if you measure the hours of work they put in – way higher than in Germany (graphic: annual hours worked).

Perhaps the Greeks and Spanish are asking for too much of share of the value they produce with labour grabbing an increasing share of national income at the expense of capital.  Again, that’s not true.  In all these countries, the share of wages in national income fell from 1991-07, with the biggest falls in Ireland, Italy and Portugal.  In 2007, the wage share was lower in Greece, Italy and Ireland than in Germany (see graphic of wage shares to GDP).  So much for the lazy or greedy theory.

What has failed is the capitalist sector to invest and innovate, not workers failing to toil or accept a lower share of value created.  Nevertheless,  mainstream economics sees the solution only in ‘internal devaluation’  to make these economies ‘competitive’.  The problem is that, as the IMF admits in its own review of Greece, “Restoring competitiveness by way of internal devaluation has proved to be a difficult undertaking with very few successes.”   And yet this is the pillar of the Troika’s programme.
The IMF says that governments must reduce the tax burden of corporations to persuade them to invest and exports to generate growth.  And it wants huge ‘deregulation of labour rights and conditions to achieve even cheaper labour costs (via internal devaluation) to help fuel investment and boost profits: “reforms to facilitate investment are being accelerated to allow firms to take advantage of cheaper labour once financing conditions stabilise.”  But will private sector investment and exports tehn deliver?

Blanchard and the Troika want to rely on faster export growth through cheaper labour costs (competitiveness) to get Southern Europe out of its depression.  But if every country had to grow by expanding exports faster than imports, then they would all have to obtain a net export balance with the moon!  Take Portugal for example.  In the last quarter of 2011, real GDP was down 2.8% yoy.  Exports were up 5.8% yoy while imports fell 13.5% yoy, giving an overall boost to real GDP growth from net trade of 8.4% pts.  But you can see that this boost from trade was mostly due to a collapse in imports as Portuguese households stopped buying foreign consumer goods and companies stopped importing as much machinery and raw materials to expand production. Indeed, domestic final sales fell 8.1% yoy, much worse than at the nadir of the financial crisis in 2008 when it fell only 3.2% yoy.  Fixed investment by the Portuguese capitalist sector was down a stunning 16% yoy and has fallen a cumulative 31% from its pre-crisis peak.  A classic capitalist slump.  And yet, Olivier Blanchard and the Troika are relying on private sector investment and exports to turn this round through cutting real wages and stopping all government investment.

Private investment is in free fall in these weak European economies.  There is a clear case for public investment.  This can be financed by public ownership and control of the banks to direct credit to infrastructure projects and to revive small businesses.  Governments can reduce their debt burdens by restructuring (defaulting on) their debts with Europe’s banks that caused the mess in the first place.  This is the alternative to taking Troika money to bail out the banks and complying with fiscal austerity, ‘internal devaluation’ and depression for a decade or more.

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