Weaker eurozone manufacturers losing competitiveness

The eurozone’s manufacturing sector is growing at its fastest pace in two years.  However, there are dramatic differences in how manufacturing is faring within the eurozone which point to the currency as a major source for the loss of competitiveness in Greece, Spain and Ireland.

The eurozone manufacturing purchasing manager’s index came in at 52.4 for January, which is the fourth monthly rise and indicates that the manufacturing sector is expanding in the eurozone as a whole. But expansion is not a uniform condition. At Europe’s old 1957 core, things are looking bright. France is expanding at the fastest pace in nearly a decade, while the Benelux countries, Germany and Italy are also expanding. However, in Spain, Ireland and Greece, the manufacturing contraction continues apace.

The fact is weaker manufacturing nations are steadily losing competitiveness and this is hurting their ability to compete.  In a recent piece on the tensions these differences are creating, Ambrose Evans-Pritchard notes:

German goods are flooding the South. In the 12 months to November, Germany-Benelux had a current account surplus of $211bn: Spain had a deficit of $82bn, Italy $74bn, France $57bn, and Greece $37bn.

So the Germans and the Benelux nations have an enormous eurozone internal market surplus. Yes, German or Dutch workers are still more expensive than Spanish or Greek ones.  However, when looking at German productivity, the cost differences vanish.  The problem?  The euro.

For example, the Spanish and the Irish had increasing productivity competitiveness pre-euro. Post-euro, a credit bubble ensued due largely to a monetary policy built for a core Europe of France, Germany and the Benelux. In Spain and Ireland, this diverted productive resources to LESS productive parts of the economy as overheating was manifest in asset prices instead of consumer prices. Now that this misallocation of resources is plain, the result is being felt in lost competitiveness.

Spain, Greece and Ireland all have had enormous credit bubbles that burst catastrophically. Pre-euro, this would have induced currency depreciation as a means of restoring competitiveness. However, this release valve is absent with the euro fixing exchange rates internally.  Externally, despite recent weakness, the euro is still relatively high, making it even more difficult for those countries losing manufacturing competitiveness.

Niels Jensen’s comments from last February bear noting:

The problem, as I have already alluded to, is poor discipline amongst several of the member states. Ever heard of the four PIGS? This less than flattering acronym stands for Portugal, Italy, Greece and Spain, four members of the euro zone which are all in much deeper trouble than they are prepared to admit. They are often considered the ‘antidote’ to the BRIC countries, the fast growing emerging market economies of Brazil, Russia, India and China. Let’s take a closer look at the unit labour cost index for various countries (see table 1).

Table 1: 2007 Unit Labour Cost Index (2000=100)

2007 Unit Labour Cost Index

Notes: *2006. PIGS countries in bold. Source: http://stats.oecd.org/

Since the introduction of the euro, the PIGS have failed miserably to keep up with Germany on this measure of competitiveness. So has Ireland by the way, hence its current predicament. On the other hand, Brazil (the only BRIC country which the OECD reports unit labour costs on) scores very well on this account, a fact which is not going to make life any easier for the PIGS.

EU countries outside the euro zone, such as the UK, have also lost out to Germany in recent years, but the UK has been able to play a card which is not at the disposal of the euro zone members. That card is called devaluation.

Britain and Denmark, have that card; the others do not. In the face of the strictures of the euro, “external devaluation” is impossible. “Internal devaluation” is clearly what is needed. Edward Hugh’s comments about Spain are instructive here:

The problem is Spain can only create jobs through exports. The problem is, with Brussels prices we cannot attract investment to build new factories to create high volume unskilled employment. At this stage in the game we are not in competition with Brussels, but with Bratislava. That may not be a pleasant truth, but it is simply like that. We have attracted a large quantity of people here to work in unskilled low-value employment. The industry that gave them work just permanently disappeared out of sight. We need, urgently to find alternatives since we cannot pay them all 420 euros a month for ever. This is more than a simple academic exercise, it is now a question of life and death for the Spanish economy.

Basically we need to go back to 2000 wages and prices and start again. Maybe you don’t like this idea, but can you point me to anyone who has an alternative?"

But we are not going back to 2000 wages and prices because wages are sticky. Call it money illusion, call it whatever you want – people are not going to take a pay cut in a depression when debt burdens are high without serious social unrest.  So I see the problem worsening.  This is the reason Greece is now under pressure – and why if the problem is not solved, it will escalate and create major contagion for Ireland, Portugal, and Spain at a minimum.

Question: How are you expected to get out a depression when debts are high, labour costs are high and you are tied to a fixed exchange rate? The EU’s internal politics make an EU-led bailout a thorny subject. If you bail out Greece, you will have to do the same in turn for Spain, Ireland, and Portugal. As I suggested in October regarding Ireland, the IMF should be the next stop for these countries. Edward Hugh agrees as his last post on Greece bailout news attests.  Clearly, the limitations imposed by the euro are killing these countries.  Unless a palatable solution is found – one that involves sovereign debt reduction and money transfers to the debtor nations, things are going to get much worse.

21 Comments
  1. daniel says

    “However, when looking at German productivity, the cost differences vanish. The problem? The euro.”
    The problem is not the euro, the problem is their productivity. In the german manufacturing sector, there’s a general agreement that wages shouldn’t rise faster than productivity. It works. Companies usually don’t pay bad. Why wouldn’t it work for them?

    1. Edward Harrison says

      The problem is indeed the Euro. The Spanish and the Irish, for example, had increasing productivity competitiveness pre-Euro. Post-Euro, a credit bubble ensued due largely to a monetary policy built for core Europe of France, Germany and the Benelux. This diverted productive resources to LESS productive parts of the economy. Now that this misallocation of resources is plain, the result is being felt in lost competitiveness.______________Edward Harrisonhttps://pro.creditwritedowns.com/

    2. Edward Harrison says

      And Daniel, the chart on labor costs is based on 2000 at 100. It is clear that labor costs in Spain and Ireland are too high. How are you expected to get out a depression when debts are high, labor costs are high and you are tied to a fixed exchange rate?

      If the Euro didn’t exist, the obvious route would be devaluation.

      1. Marshall Auerback says

        In a message dated 2/1/2010 08:49:30 Mountain Standard Time,
        writes:

        And Daniel, the chart on labor costs is based on 2000 at 100. It is clear
        that labor costs in Spain and Ireland are too high. How are you expected
        to get out a depression when debts are high, labor costs are high and you
        are tied to a fixed exchange rate?

        If the Euro didn’t exist, the obvious route would be devaluation.

        And Spain would have total freedom to conduct fiscal policy without the
        crazy politically imposed constraints of the euro zone.

      2. Ger says

        I’m Irish I work in the private sector, I’ve taken a 10 per cent pay cut, wages in my company have been frozen for the last 2 years. The company has shed 20 per cent of its workers, by hook and by crook we are becoming competitive again. The problem was not the euro, the problem was we though borrowed money was making us rich. When we get through this we will be all the stronger.

        1. Edward Harrison says

          If more people in Ireland are willing to make the sacrifices you made, Ger, then you can get through this. And certainly, Ireland is showing Greece how to get it done on that score.

          But, the borrowed money you speak of is a result of excess credit growth. When it was obvious that the Irish housing market was overheating in 2005 or 2006, the normal course of action would have been higher interest rates.

          However, the Euro ties you in to a one-size-fits-all monetary policy. Again, it is in this respect that the problem is the Euro. People borrow a lot for a reason. It usually has to do with constant to declining debt service costs. And when this is driven by lower interest rates, it means high levels of debt.

          See:
          https://pro.creditwritedowns.com/2009/12/on-the-sovereign-debt-crisis-and-the-debt-servicing-cost-mentality.html

          If you are willing to live with the consequences of that, then more power to you. Eventually, I suspect your economies will be harmonized.

          1. Marshall Auerback says

            In a message dated 2/1/2010 10:09:31 Mountain Standard Time,
            writes:

            If more people in Ireland are willing to make the sacrifices you made,
            Ger, then you can get through this. And certainly, Ireland is showing Greece
            how to get it done on that score.

            Really? Heaven help the Greeks if they follow the Irish example. And to
            what end?
            Ireland’s economic data is well-known now and shocking. Its unemployment is
            over 12 per cent; it endured a national output loss of 11.3 per cent on
            its level a year ago; and its inflation rate is minus 3 per cent (that is, a
            serious deflation) which will further impoverish indebted house owners.
            Consumption spending has dropped by 20 per cent since the onset of the crisis.
            The Irish government has injected €54 billion into the main financial
            institutions as insolvencies “more than doubled in 2009″. House prices “have
            fallen by 26.7 per cent since February 2007 and now stand at October 2003
            levels”
            Here is what Bill Mitchell had to say about Ireland
            (_http://bilbo.economicoutlook.net/blog/?p=6929_ (http://bilbo.economicoutlook.net/blog/?p=6929) _
            Ireland was the protype asset price boom fuelled by an out of control
            banking sector. The Times reports that by 2007 “the country’s houses were the
            most overvalued in the Western world and construction accounted for one
            fifth of national output.”
            The automatic stabilisers in Ireland have been signficantly responsible
            for driving the budget deficit towards 12 per cent of GDP so dramatic has the
            collapse in income generation.
            The problem though for Ireland is that it is part of the Euro Monetary
            System (EMU) and its 12 per cent deficit (as a percentage of GDP) is according
            to the Maastricht rules out of order irrespective of the state of the
            economy.
            The government already tightened discretionary fiscal policy in April 2009
            by withdrawing €3 billion (increasing taxes and cutting spending). Most of
            the new spending initiatives since the crisis has been to prop up its
            financial institutions.
            In November, the EC gave the Irish government one year extension (to 2014)
            to get its budget deficit back in line with EMU rules.
            So with that sort of outlook why would you entertain a “stinging budget”?
            Why not follow Japan’s example of fiscal leadership and underwrite
            aggregate demand to get employment growing.
            But in the last week, the Irish government has delivered its “harshest
            budget in the republic’s history” which is a direct consequence of being in
            the Euro system.
            The problem is that Ireland is an example of a country which moved to a
            fiat monetary system after the collapse of Bretton Woods in 1971 but,
            subsequently, decided to impose voluntary constraints on their fiscal capacity and
            act as if they are still operating in a “gold standard” world. In this
            case, the constraint is that the Eurozone governments voluntarily conceded
            their currency monopolies to the European Central Bank without also ceding
            their fiscal responsibilities.
            They also decided, as a consequence, to voluntarily impose the Stability
            and Growth Pact (SGP) which represent a denial of the essential opportunities
            available to a sovereign nation.
            In contrast to countries operating with their own sovereign fiat
            currencies, such as Japan, Eurozone countries must formally borrow in order to run
            deficits. Thus the intertemporal government budget constraint applies to
            Eurozone countries, and will severely limit the capacity of the public sector
            to fund recovery plans.
            Ireland will eventually emerge from the recession when investors resume
            building capital but it will take much longer than it should as a consequence
            of its membership in the EMU.
            In the meantime, people will become impoverished and a generation of youth
            will lose access to employment and skill building opportunities and endure
            life-time disadvantages as a consequence.

        2. Edward Harrison says

          Ger, as Marshall is pointing out, what is being proposed for Ireland and Greece is EXACTLY what Latvia is getting. It’s called a debt deflationary bust. So when I say:

          “If more people in Ireland are willing to make the sacrifices you made, Ger, then you can get through this.”

          I mean that you will get through this if you are willing to suffer a debt deflationary bust of major proportions. I would not be so inclined – and I suspect many Irish people are going to be of the same mindset when they realize what this bust will entail.

        3. Marshall Auerback says

          In a message dated 2/1/2010 10:51:51 Mountain Standard Time,
          writes:

          I’m Irish I work in the private sector, I’ve taken a 10 per cent pay cut,
          wages in my company have been frozen for the last 2 years. The company has
          shed 20 per cent of its workers, by hook and by crook we are becoming
          competitive again. The problem was not the euro, the problem was we though
          borrowed money was making us rich. When we get through this we will be all
          the stronger.

          Yes, building up private debt is always problematic and when you pay it
          back, you do feel stronger (although the process of repaying can often sap
          one’s economic vitality).

          But you’re mixing cause and effect. Ireland voluntarily agreed to submit
          itself to the arbitrary constraints of the Stability and Growth Pact via EMU
          and thereby lost its fiscal independence. This forced a greater reliance
          on PRIVATE DEBT to sustain growth. You’re right. That’s fundamentally
          unhealthy, but you’ve got the causation wrong in my opinion.

        4. gnk says

          Ger – what would your views have been if you were part of the 20% that were sacked? In that regard, a 10% paycut and payfreeze is better than unemployment, no?

          I’m with Ed and Marshall on this one. The Euro disproportionately favored one sector of Europe over another. The consequences will be felt by all nonetheless – more for some than others.

          (full disclosure – I am of Greek heritage and though I have my criticism of Greek society – and yes, there are many faults – I also laud their willingness to stand up to the hypocrisy of the global financial system.)

  2. daniel says

    “This diverted productive resources to LESS productive parts of the economy.”
    hm, I will think about it, but I’m not really convinced. Let’s say Seat were an independent auto maker and not part of VW. Could they really somehow blame the housing bubble if they lost competitiveness?

    “How are you expected to get out a depression when debts are high, labor costs are high and you are tied to a fixed exchange rate?”
    Good question. The main problem is that the housing bubble in Spain employed especially a lot of people with low education. That’s why the “bunch” of illegals were not such a big problem for spain (the black africans, the romanians, the people from south america etc). I don’t think that there’s a realistic chance to get a lot of “low education” jobs back, even with a devalued currency. If a company really only wanted low wages, it could go to latvia (or asia).

    Furthermore, I don’t know if things are really that bad in spain. I’m always amazed about the huge obvious grey/black market which everyone seems to tolerate. I haven’t been there since the bubble imploded, but the economy might also have moved even further into the grey market. At least that’s what happened last time when spain had a 20%+ employment rate for over a decade.

    1. Edward Harrison says

      Daniel on malinvestment and poor resource allocation from below market rates of interest, see this:

      https://pro.creditwritedowns.com/2010/01/bubbles-employment-and-recalculation.html

      Also see the following:
      https://pro.creditwritedowns.com/2008/03/us-economy-2008.html

      This is a post from two years ago now which predicts very well what we have seen thus far. Where you look at Spain, wages have been bid up as a result of excess consumption that flows from excess credit growth caused by low interest rates. That axiomatically means ALL industries feel the wage pressure including producers like SEAT.

      Why do you think East Germans are having a problem with competitiveness vis-a-vis Czech or Romania, etc? It’s not because the Romanians are “more productive.” Again, its the currency. The Ostmark-Deutschmark currency union has left the East German economy wages too high and this means poor competitiveness, unemployment and loss of manufacturing, just as it is now doing in Spain.

      1. daniel says

        “That axiomatically means ALL industries feel the wage pressure including producers like SEAT. ”

        thanks for the links and the fast answers, that makes sense.

        But as an engineer, I’m still convinced that in the long run, productivity (and innovation) is more important than a devalued currency. ;)

        I wanted to find a chart that proves my view. Unfortortunately, the chart I found doesn’t. It shows that the UK has made big gains by devaluing their currency

        http://www.spiegel.de/images/image-36902-galleryV9-ijhf.jpg

        We’ll see if their manufacturing sector can profit.

  3. Ger says

    Well Government policy was relentlessly pro cyclical during the last 10 years. And to be fair the country as a whole cheered them on.
    The Euro was a enabler in our own foolishness, as we can all see now.
    But fiscal irresponsibility among house holders and the government was, IMHO the real reason.
    Leaving the Euro is not an option that’s on the table at the moment, wage and price deflation are the only options we have, its not going to be pretty, but we’ve been through worse.

    1. Marshall Auerback says

      In a message dated 2/1/2010 11:11:27 Mountain Standard Time,
      writes:

      But fiscal irresponsibility among house holders and the government was,
      IMHO the real reason.
      Leaving the Euro is not an option that’s on the table at the moment, wage
      and price deflation are the only options we have, its not going to be
      pretty, but we’ve been through worse.

      Fiscal irresponsibility? I agree. None of the goverments in the EMU
      spent enough, so employment was always suboptimal. In addition to the so-called
      “PIIGS” countries, the larger — and wealthier — European economies have
      never reduced their unemployment rates below 6 per cent and the average for
      the EMU since inception is 8.5 per cent (as at July 2009) and rising since.
      The average for the EMU nations from July 1990 to December 1998 (earliest
      MEI data for the EMU block available) was 9.7 per cent but that included the
      very drawn out 1991 recession. Underemployment throughout the EMU area is
      also rising , reaching 20% in Spain and double digits in Portugal, Italy,
      Ireland, and Greece. And yet the nations of the euro zone were constrained
      from dealing with this problem adequately through stupid self-imposed
      fiscal rules which have no theoretical economic justification, let alone the
      misery that they continue to inflict.

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