What’s Stopping Europe?
PITTSBURGH – On a recent visit to Greece, French President François Hollande declared that Europe’s decline was over, and urged French companies to invest in Greece. Bad advice. French production costs are high, but Greek costs are higher. Despite the considerable decline in Greek (and Italian and Spanish) real GDP since 2007, adjustment is far from complete.
In fact, one would be hard pressed to find broad agreement with Hollande’s assessment anywhere in Europe. Before the recent Italian election, financial markets showed signs of optimism, encouraged by the European Central Bank’s policy of guaranteeing eurozone members’ sovereign debt, expanding its balance sheet, and lowering interest rates. Bondholders gain when interest rates fall. But unemployment continues to rise in the heavily indebted southern countries, and output continues to lag behind Germany and other northern European countries.
The main reason for the lag is not simply low demand or large debts. There is a vast difference between unit labor costs – real wages adjusted for productivity – in Germany and in the heavily indebted southern countries. When the crisis began, production costs in Greece were about 30% higher than in Germany, so Greece exported very little and imported very much. Production costs in other heavily indebted countries were 20-25% higher than in Germany.