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)
Notes: *2006. PIGS countries in bold. Source: https://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.