Euro-Zone Imbalances Persist

06.01.2012 14:11

WSJ: The European Central Bank delivered some holiday cheer last month to beleaguered crisis-fighting policymakers; the ECB’s move to provide long-term loans to euro-zone banks helped drive down yields on government debt, assuring officials that their Christmas vacations wouldn’t be interrupted by another spasm of the crisis.

But largely unnoticed was a fly in the eggnog: data from Eurostat showing limited competitiveness gains by countries in the euro-zone periphery relative to Germany and other countries in the currency bloc’s core.

The key metric to watch is the evolution of wages in the periphery, which need to fall relative to wages in the core to make exports from periphery economies more competitive. According to the data* published last month, Greece has actually made progress: private-sector wages fell 5.4% in the third quarter from a year earlier and 12% since their peak in the first quarter of 2010. Euro-zone wages on average rose 2.7% since the third quarter of 2010.

Ireland too has made some progress, with wages down 4.7% since their peak in the fourth quarter of 2009. But considering that wages rose nearly 60% since Ireland adopted the euro, they need to fall much more for the Irish economy to regain much of its lost competitiveness.

Elsewhere, labor cost developments have been truly puzzling. Spanish wages were 3.4% higher in the third quarter than they were a year earlier. This despite terrible labor force conditions, with an unemployment rate topping 20%.

Spanish wages rose faster than in the euro-zone on average and faster than in Germany (+3.1%). Spanish wages appear to be extraordinarily “downwardly rigid,” the term economists use to describe how wages in most labor markets rise easily but rarely fall.

Why are wages continuing to rise despite the nosebleed Spanish unemployment rate? Labor market structures might play some role; for example, wide-spread indexation of wages to inflation keeps them rising even if unemployment is high, or high levels of unionization could prevent employers from cutting wages. But this explanation seems incomplete: wage indexation is common in a number of EU nations, and Spanish union density is relatively low.

Portuguese wages rose about 1% over the past year. That’s less than the euro-zone average, but it also means that the adjustment will probably take many years, leaving Portugal with festering double-digit unemployment.

The situation highlights the challenges facing the euro zone. Even if governments can convince financial markets that they have a plan to backstop Italy and Spain, the currency bloc will still be afflicted with fundamental imbalances that are harbingers of slow growth and persistent unemployment.

It’s enough to make policymakers to reach for another glass of highly alcoholic eggnog, with or without flies.

Follow @DJMatthewDalton on Twitter.

*This document contains data that is adjusted for working days but is not seasonally adjusted. My numbers use data from the Eurostat database that are adjusted for both, except for Ireland, which only publishes unadjusted data.