Troubled Europe is Quickly Regaining Competitiveness

Readjustment in Europe is underway as Germany, France and U.K. are becoming more expensive

Jan 30, 2013, 09:00 ET from The Conference Board

NEW YORK, Jan. 30, 2013 /PRNewswire/ -- Driven by austerity and massive job cuts, Europe's most troubled economies have dramatically improved their labor competitiveness since Q2 2011, according to a new Executive Action Report from The Conference Board. Labor costs have declined substantially in Greece, Portugal, and Spain, closing competitiveness gaps with Germany, France, and other "core" economies, finds the report, which asks Will the Decline in Unit Labor Cost in Europe's Troubled Economies Help Improve Competitiveness?

"No doubt economies like Greece and Portugal have made huge strides over the last two years in terms of bringing down labor costs in line with output," said Bart van Ark, The Conference Board Chief Economist and a co-author of the report. "But already we're seeing signs that these heroic efforts won't return competitive balance to Europe without financial stabilization and long-term clarity about the policy environment moving forward."

Extremes on the Periphery, Core Losing Edge
During the decade of the 2000s, labor competiveness measured as Unit Labor Costs (ULCs) — that is, compensation per unit of output — diverged noticeably with countries like Ireland, Finland, Germany, and Austria keeping wages under control, while economies in the south saw large increases. The debt crisis has dramatically reversed the trend: Between Q2 2011 and Q2 2012, ULCs for Greece, Portugal, and Spain decreased 9.2, 5.9, and 2.1 percent, respectively.

"Looking at ULCs, the competitive gains are obviously still negative adjustments — output and compensation are both dropping, with the latter faster than the former," said Bert Colijn, labor market economist and co-author of the report. "Moreover, because wages tend to be 'sticky,' the ULC declines in Greece, Portugal, and Spain have been driven less by falling per-hour compensation than large employment cuts still underway. In other words, the least competitive workers — as well as the least productive enterprises — are being 'shaken out' of the economy. The competitive gains will not result in a recovery unless investment returns. Otherwise the countries will get caught in a downward spiral of consumption and employment."

Meanwhile, ULCs have been climbing precipitously in the stronger European economies, signaling potential competitiveness concerns for the future. In Germany, higher wage increases in the manufacturing sector have helped push ULCs up at the quickest pace since the start of the Euro area in 1999. France saw its ULC increase by 3.9 percent since Q2 2011, while Italy is seeing large losses of output in manufacturing, but labor costs are still rising.

Outside the Euro area, the U.K. has resisted massive employment losses, despite having one of Europe's most flexible labor markets. Though a relief to British consumers, the choice of retaining workers over capital investment in uncertain times has pulled down labor competitiveness: Since Q2 2011, U.K. ULCs have increased 4.7 percent, in pounds sterling, one of the three largest increases in the European Union

Competitive Balance Needs European Cooperation
The convergence of ULCs in recent years — with costs rising in countries like Germany, France, and Belgium; and falling in Spain, Portugal, and Greece — offers an encouraging sign that the competitive imbalance within the Euro Area is closing. Since 2008, exports have grown substantially in Spain and Portugal, though Greece continues to trail badly. However, full convergence between the two Europes will require not just lower labor costs but higher labor productivity — improvements which demand a rebound in confidence that encourages smart investment in R&D and human capital.

"The recession-driven improvements in competitiveness are impressive and indicate peripheral Europe might become more attractive as sites of production," said van Ark. "But we need to see some confidence return to the domestic economies of troubled countries as well, if they're to start a recovery from the deep recessions they are in. At this stage, a return of investments is what troubled Europe is longing for, for which the recent upticks in business confidence might be a green shoot."                                       

For complete details:

Will the Decline in Unit Labor Cost in Europe's Troubled Economies Help Improve Competitiveness?
Executive Action Series
By Bert Colijn and Bart van Ark

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