Munich Economic Summit 2015 Compe//veness and Innova/on - May 2015 - Restoring compe//veness: what has gone right, what has gone wrong? Daniel Gros Munich, 21 May, 2015
Issue: Loss of compe//veness in euro area periphery during boom, then bust. What were the ul/mate drivers during the boom, the bust and the recovery? Focus of the Presenta0on: 1. Causes of loss of compe//veness: policy or capital inflows? 2. External adjustment and compe//veness 3. PuOng the fiscal adjustment in perspec/ve: the 07 13 cycle 4. The key role of exports: Portugal vs Greece, role of compe//veness 5. Concluding remarks 2
General remark: Most comparisons are look how awful things are today compared to 2007/8. But these years were not sustainable. Decline in GDP, increase in unemployment unavoidable when capital inflows stop. Need to look through boom and bust! 3
Second General Remark: What caused the intra- EZ CompeIIveness gap? Most common answers are: 1. Wage modera/on in Germany 2. Divergences in produc/vity: this requires structural reforms e.g. compe//veness pact Centre for European Policy Studies www.ceps.eu 4
Impact of loss of compeiiveness on exports? 7,0 Exports of Good and Services as % of EU27 exports 6,0 5,0 % of EU27 exports 4,0 3,0 2,0 1,0 0,0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Ireland Greece Spain Portugal Centre for European Policy Studies www.ceps.eu 5
2. Divergences in producivity In principle, in a common currency area, higher growth of produc/vity = gain in compe//veness (at constant wages). => Higher produc/vity growth should mean lower rela/ve unit labour costs. BUT Data show higher produc/vity associated with higher unit labour costs. Centre for European Policy Studies www.ceps.eu 6
140 ProducIvity and compeiveness in EU Unit Labour Cost (cumulated growth rate 1996-2008) 120 100 80 60 40 20 0 Italy Spain Malta Portugal Denmark Cyprus Luxembourg France Belgium Bulgaria Netherlands United Kingdom Sweden Finland Czech Republic Hungary Ireland Greece Slovakia Austria Germany 0 5 10 15 20 25 30 35 40 45 Poland Slovenia Romania Latvia Lithuania Estonia - 20 Labour ProducIvity(cumulated growth rate 1996-2008) NOTE: Unit Labor Cost is an inverse measure of competitiveness Centre for European Policy Studies www.ceps.eu 7
Causes of loss of compe//veness: The macro view Countries do not chose to become uncompe//ve. Wages/prices set in markets. Observed: strong demand growth + high wage/price increases + current account deficits. What was driving what? My presump/on: demand growth drives wages and current account deficit at same /me. Why demand up? IRL + SP construc/on boom (not policy), GR: fiscal policy (=policy choice), PT: in between. Centre for European Policy Studies www.ceps.eu 8
Demand and competitiveness Strong posi/ve correla/on between private consump/on growth and loss in compe//veness (ULC). Change in unit labour costs 1999-2007 200,0 180,0 160,0 140,0 120,0 100,0 80,0 60,0 40,0 20,0 Greece Cypus Ireland Portugal y = 2,5092x + 5,6687 R² = 0,80638 0,0-10,0 0,0 10,0 20,0 30,0 40,0 50,0 60,0 70,0 Change in private 9inal consumption 1999-2007 Source: European Commission Services (AMECO), 2013. 9
Growth and current account before the crisis Bulgaria Latvia GDP growth and current account before the crisis 70 60 Lithuania Estonia 50 40 Romania 30 Ireland 20 Greece Spain 10 Real GDP growth 2000-2007 above EU average UK 0-25,0-20,0-15,0-10,0-5,0 0,0 5,0 10,0 15,0 Current account change 2007-2000 (% of GDP) France Netherlands Germany Italy - 10 Portugal - 20 10
Bust Current account deficits = capital inflows. => Capital inflows stop: current account has to adjust (slow inside euro area, quick outside) => demand has to adjust (exports cannot jump). Depth of recession related to size of boom (= current account correc/on needed). Centre for European Policy Studies www.ceps.eu 11
The sacrifice ratio (GIPSY vs. BELL) 5,0 GDP sacrifice for CA adjustment Bulgaria Real GDP Growth in % a^er the crisis Italy 0,0 Ireland - 5 0 Spain 5 10 15 20 25 30 Portugal Change in CA (% of GDP) - 5,0-10,0 Greece Lithuania Estonia - 15,0 Latvia - 20,0 12
Mi/ga/ng the bust Bust = Boom in reverse? Demand down, prices down, current account improves (exports up)? Depends on slope of Philips curve, export supply. Centre for European Policy Studies www.ceps.eu 13
Philips curves differ: Greece as usual a special case Phillips curve Greece 14 12 10 Nominal wage infla/on 8 6 4 2 0-2 - 4-6 - 8 4 9 14 19 24 29 y = - 7,954ln(x) + 22,266 R² = 0,53748 Unemployment rate Centre for European Policy Studies www.ceps.eu 14
Portugal: a standard case? Phillips curve Portugal 7 6 5 Nominal wage infla/on 4 3 2 1 y = - 3,948ln(x) + 11,309 R² = 0,59347 0 3,5 5,5 7,5 9,5 11,5 13,5 15,5 17,5-1 - 2-3 Unemployment rate Centre for European Policy Studies www.ceps.eu 15
Latvia: flexibility or just wild swings? 50 Phillips curve Latvia 40 30 Nominal wage infla/on 20 10 0-10 2 4 6 8 10 12 14 16 18 20 22 y = - 29,23ln(x) + 81,372 R² = 0,5581-20 Unemployment rate Centre for European Policy Studies www.ceps.eu 16
Flexible labour markets are an advantage Slope of Philips curve in Latvia = 5 /mes Portugal or Greece (or Germany). Fall (or dura/on) in unemployment 5 /mes lower to achieve same gain in compe//veness. How important was gain in compe//veness? Openness and nature of export base. Centre for European Policy Studies www.ceps.eu 17
Compe//veness important, but not only factor in external adjustment 15 10 y = - 1,1803x + 1,4328 R² = 0,48568 Change in REER 5 0-8 - 6-4 - 2 0 2 4 6 8 10 12-5 - 10-15 - 20 Change in Cyclically adjusted Trade Balance Centre for European Policy Studies www.ceps.eu 18
The fiscal adjustment: theory and practice (I) Pure Keynesian predicted that Greece would go into depression (large mul/plier and large deficit: 2.5 * 10). Was not taken into account, hence programme off track This also implied unrealis/c projec/ons for tax revenues. Country Keynesian muliplier: 1/(1- c+m)=1/(s+m) Marginal propensity to import (m) Marginal propensity to consume (c) Greece 2.5 0.20 0.92 Ireland 1.3 0.57 0.82 Portugal 1.7 0.60 0.99 Cyprus 1.0 0.82 0.86 Note: The marginal savings rate, s, is computed as the ra/o of the increment in private savings rela/ve to the increment in GDP over the period 2002-07; similarly the marginal propensity to import, m, is computed as the ra/o of the increment in imports rela/ve to the increment in GDP over the same period. Sources: European Commission Services (AMECO database) and authors own calcula/ons. Source: European Commission Services (AMECO), 2013. 19
The fiscal adjustment: theory and practice (II) Fiscal adjustment has been most visible challenge Greece off track because lack of recogni/on of large mul/plier. Revenues planned to increase, but fell by large amount. => need to con/nuously cut expenditure. Other countries mul/plier much less of a problem; hence fiscal plans more realis/c. Note: Cyprus is excluded, as the IMF plan only started in 2013. In the case of Ireland, the year before the start of the adjustment plan was characterised by a large fiscal deficit to bailout the Irish financial sector. Sources: IMF and authors own calcula/ons. 20
The fiscal adjustment: theory and practice (III) Logic says: high fiscal mul/plier means that high deficit at start of programme should have produced boom. Not the case! Why other components of demand down (investment). If one looks at the fiscal adjustment over the en/re cycle (2007-2013) no nega/ve effect for IRL, PT. => Con/nuing output gap due to fall in investment Greece different: fiscal adjustment large (in structural balance terms). Note: Cyprus is excluded, as the IMF plan only started in 2013. In the case of Ireland, the year before the start of the adjustment plan was characterised by a large fiscal deficit to bailout the Irish financial sector. Sources: IMF and authors own calcula/ons. 21
Putting the fiscal adjustment in perspective: the 2007 2013 cycle (I) Ireland, Portugal and Cyprus actually had an expansionary fiscal policy over the en/re period (2007-13) The reduc/on in the deficit for Greece was minor (<3%) Changes in exogenous demand components (07/13) Country Fiscal balance Real GDP Investment Exports Imports Ireland - 7.36-6.99-12.2 15.81 1.25 Greece 2.66* - 23.29-11.91-1.56 13.25 Portugal - 2.70-7.09-8.07 7.18 2.71 Cyprus - 11.78-7.88-8.11-2.34 7.57 Note: *The Greek fiscal balance in 2013 is taken from the Troika s programme review the data of AMECO database, which includes the cost of banks recapitalisa/on. Source: Own calcula/ons based on AMECO, 2013. 22
The key role of exports: PT vs GR (III) Exports of goods and services excluding oil ( bn) 75 65 55 24bn or 13.2% of Greek GDP 45 35 Portugal Greece 25 Source: European Commission Services (AMECO), 2013. 23
The key role of exports: PT vs GR (II) CompeIIveness indicator (ULC) Development in Greek travel services 160 150 140 130 120 110 100 90 80 70 60 50 40 30 2004 2005 2006 2007 2008 2009 2010 2011 2012 12.000 11.500 11.000 10.500 10.000 9.500 9.000 Nights spend by non- residents in Greece, mio, lex axis Source: ECB. GR PT Travel expenditure (mio), right axis Source: Authors calcula/on based on Eurostat data What makes GR special is the lack of growth in exports despite a considerable fall in wages. Explana/on (par/al)? Greek export base in commodi/es + lack of structural reforms plus low elas/city tourism. 24
Little sign of deep reforms anywhere Public Institutions Index, 1-7 (best) 7,0 6,0 5,0 4,0 3,0 2,0 1,0 0,0 2007 2010 2013 Source: World Economic Forum, 2013. Portugal Ireland Greece Cyprus Germany 25
Conclusion What went right: Quick adjustment What went right axer a while: Slow adjustment in euro What went wrong: Greece Why? Excessive concentra/on on fiscal adjustment, special economic structure, lack of structural reforms. Conclusion: Compe//veness as measured by ULC or prices not everything. Note: Cyprus is excluded, as the IMF plan only started in 2013. In the case of Ireland, the year before the start of the adjustment plan was characterised by a large fiscal deficit to bailout the Irish financial sector. Sources: IMF and authors own calcula/ons. 26
APPENDIX 27
Cost-Benefit Analysis: 2009-2014 Country Cumulated unemployment cost, calculated based on: Levels Increase over baseline Cumulated Output gap Over baseline Cumulated current account balances as % of exports Ireland 70.5 47.6-11.3 16.7 Greece 90.6 44.7-45.5-123.4 Cyprus 48.5 24.3-4.9-6.5 Portugal 69.6 25.4-16.1-56.7 GIPSY 78.9 40.6-21.7-98.3 BELL 67.9 31.5-17.8-2.1 Note: The cumulated unemployment rate is calculated as the sum of the unemployment rates between 2009-2014. The average unemployment rate, taken over the calm years of 2005-2007, cons/tutes the baseline of our calcula/on. The cumulated output gap is derived from the sum of annual output gaps over baseline. The output gap is defined as actual GDP less poten/al GDP as percent of poten/al GDP. The cumulated change in current account is calculated as the sum of current account balances (2009-2014) above the baseline (average of 2005-2007).All values are given as an average of the GIIPS and the BELL states and represent net present values, i.e. a 5% discount rate has been applied. Source: Own calcula/ons based on AMECO, and Eurostat 2013. 28