For months now, soaring government debt has shaped public debate over economic policy in the eurozone. One often overlooked aspect is that the deficits of some countries are not only attributable to crisis-related revenue shortfalls and higher spending or poor budget policy. They are partly also due to reduced growth prospects resulting from a country’s lack of competitiveness. The differences in competitiveness are increasingly becoming a problem for EMU, especially since the gaps between the member states have grown over the past few years.

The nominal exchange rates between the EMU member states are fixed. If individual countries want to boost their price competitiveness they cannot do so via a nominal devaluation of the currency. The alternative, at best, is via a reduction of real wages and non-wage labour costs (thereby achieving devaluation in real terms). In terms of (wage) policy, this is not always the easiest task. The elimination of the exchange-rate channel has increased the importance of non-price competitiveness. By strategically promoting technological progress and enhancing economic structures towards the production of knowledge-intensive goods and services it is possible to make export demand in key sectors less sensitive to price movements.

A third way of smoothing out differences in a monetary union is to improve the cross-border use of production factors. Supply, demand and market price could then neutralise the differing levels of competitiveness between the member states. Unfortunately, particularly the cross-border labour market in EMU is still marked by an inadequate degree of flexibility – despite liberalisation. The lack of worker mobility, due not least to language differences, causes considerable inefficiencies.

As a result, macroeconomic tensions remain prominent. As can be seen in the chart, the differences in competitiveness between the EMU states – as measured by their average balance on current account – continued to widen in the first 11 years of the eurozone’s existence. The reason is the differing growth models in the member states which can be classified in three groups.

First of all there are countries with a high degree of competitiveness that went hand in hand in recent years with strong export-driven growth and sizeable current account surpluses. Examples include Germany, the Netherlands and Austria. With the crisis-induced slump in the world markets petering out, the outlook for these countries is positive again.

A second group is composed of countries with robust demand at home but a decline in net exports, examples being Belgium, France and Italy. Growth has been driven mainly by consumption, so the strong internal demand has cushioned the impact of the crisis. However, high wage settlements in the past have limited the ability of these countries to compete on price.

The countries in the third group are under particularly heavy pressure: they initially enjoyed a huge growth boost thanks to their accession to the single European market, but they failed to implement necessary structural reforms with the same gusto. Their growth was primarily nurtured by high capital inflows and low interest rates. However, inward investment was not always channelled into projects with the highest productivity, and high wage settlements led to a decline in competitiveness. Greece, Spain and Portugal are cases in point.

In some cases the different growth models developed over time, in others they are attributable to political errors and omissions of the past few years. These must soon be rectified via structural reforms. However, to do so in EMU requires a coordinated approach which includes the option of imposing sanctions. The reason is that the willingness of member states to launch reforms still varies considerably. Moreover, care must be taken to prevent negative spillovers from one country to the next.

In efforts to achieve a coordinated approach within EMU, EU legislation provides for the following possibilities:

• The Broad Economic Policy Guidelines, established and updated annually by the Commission and Council for a period of three years, set out the priorities of economic policy for the European Union. Besides listing general priorities for the EU-27, they also define country-specific reform priorities. Member states transpose these targets into national reform programmes which they have to report on once a year.
• The Stability and Growth Pact enables economic policy to be coordinated via two mechanisms. First, the multilateral surveillance framework ensures that eurozone countries give an account of their reform projects in national stability programmes (the other EU states table convergence programmes). If an EU member runs up an excessive government deficit it is subjected to an excessive deficit procedure that, for EMU members, may result in the imposition of sanctions. Deficit procedures are currently under way against 12 of the 16 EMU states – in Greece’s case at an advanced stage.
• Furthermore, the Treaty of Lisbon has created the option of tighter, sanctions-linked coordination of the Eurogroup within the framework of the Broad Economic Policy Guidelines. However, this option must still be fleshed out under secondary European law.

In the years ahead the gaps between the EU economies will need to be narrowed. This convergence in competitiveness should naturally be based on the laggards catching up with the leaders. Only then is it likely to be in the interest of all parties involved. The countries in the leading group certainly have an interest in the competitiveness gap closing again. The fear of competition is more than outweighed by the dislike and rejection of permanently higher transfers and aid for the laggards which would loom if no further action were taken. And, for the laggards too, a lack of competitiveness would mean that their growth opportunities would be limited in the long run – and thus their ability to get to grips with the crisis-driven ballooning of government debt.

In the coming weeks, DB Research will devote several commentaries to the causes of differing competitiveness levels and their implications for the fiscal situation of the euro-area members; in addition, we shall outline potential economic policy responses.

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Nicolaus Heinen (+49) 69 910-31713

 

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