Nomura’s Richard Koo is back to bang the balance-sheet-recession-drum and has taken a look at falling unit labour costs across the eurozone periphery and where they are likely to meet Germany’s as they creep upwards.
(This is the good type of convergence.)
Koo pays particular attention to Greece — as if you take away the benefits of devaluation on competitiveness, you lose a large part of the argument for a Grexit.
He says that although the structural reforms undertaken by Germany between 1999 and 2005 (wage agreements, pension and labour market reforms) are key contributors to the competitiveness gap between Germany and Greece, much of the difference is down to the slump in the German economy and money supply growth (relative to other eurozone nations) after Germany’s IT bubble burst in 2000, ushering in a balance sheet recession.
The Germans paid down their debt post-bubble and their money supply grew by 56 per cent versus a cumulative 108 per cent in the ex-Germany eurozone between 2000 and 2008.
That helped unit labout costs in Germany stay pretty static, rising just 0.6 per cent in the same period. Compare that to Greece where unit labor costs rose 33.7 per cent, as money supply expanded by 101.5 per cent, and you see the point.
Koo estimates the 33.1 percentage point difference between the two countries is down equally to Germany’s structural reforms and its balance sheet recession.
He argues that, if Greek money supply had grown at the same rate as Germany’s than unit labour costs would have grown by 18 per cent:
As German unit labor costs rose by only 0.6% over this period, the 17.4ppt (18.0% – 0.6%) that cannot be explained by differing rates of money supply growth — 52.6% of the 33.1ppt gap — can be attributed to structural reforms.
This means while a microeconomic factor — the structural reforms often touted by Germans—played an important role, accounting for more than half (52.6%) of the competitiveness gap with Greece, the remaining 47.4% is attributable to amacroeconomic factor — a balance sheet recession in Germany at a time when Greece had a robust economy.
And that macroeconomic factor is now working in Greece’s favour:
That trend, says Koo, implies that Greek inflation and unit labor costs will continue to fall, and in fact unit labor costs have already dropped more than 10 per cent since the 2010 peak. Given the time lag between changes in the money supply and their impact on prices and unit labor costs, he anticipates further declines in the latter.
The gap between German and Greek unit labor costs has already dropped to less than half the 2009 peak, and I suspect it is only a matter of time before it disappears altogether.
So, says Koo (as he has said before)
Until now the argument commonly heard in Germany was that peripheral countries were in such deep recessions because their economies were uncompetitive. In effect, they were looking at phenomena caused by a balance sheet recession and trying to attribute them to a lack of competitiveness, when in fact that is only partly responsible.
Hence the German argument that there can be no economic recovery in the periphery without structural reforms. But as noted above, much of the improved competitiveness that structural reforms are supposed to produce has already been achieved by internal deflation.
That these nations’ economies have still not recovered is due to the fact that—with the exception of Greece—they are in balance sheet recessions, and the only way to address those recessions is to administer the fiscal stimulus that Germany so strongly rejects.
Germany may be unable to accept the theory of balance sheet recessions until unit labor costs in the periphery drop to German levels. In other words, the pain in the eurozone is likely to continue until the competitiveness gap disappears and Germans realize the theory of balance sheet recessions is the only way to explain the continued economic slump.
Based on the above, that point is getting closer. The full note is in the usual place.