October 02, 2014
Paul Krugman had a short blogpost in which he criticizes Hans-Werner Sinn, the head of a prominent German think tank, for insisting that the southern European countries have to go through deflation in order to restore competitiveness, rather than Germany having somewhat higher inflation. Sinn effectively says that these countries must do what Germany did in the last decade.
Krugman then links to a post which shows that Germany, along with Japan, were the only countries in the OECD to see declining labor costs in the last decade, meaning that this is not easily accomplished. However there is a further point at issue. Germany had falling labor costs not because wages actually fell, but because they did not rise as fast as productivity growth. Germany could sustain healthy rates of productivity growth because the euro zone economy was growing at a healthy pace, driven by the booms in the peripheral countries.
While this boom both raised relative prices in the rest of the euro zone, thereby increasing Germany’s competitiveness and creating a rapidly growing market, Germany is determined not to repeat the favor. The slow growth and high unemployment environment in which the peripheral countries find themselves is not conducive to investment and productivity growth. Productivity growth has been extremely weak across most of the OECD, in part due to weaker investment and in part due to the fact that many unemployed workers find themselves forced to take jobs in low productivity sectors (e.g. restaurants and retail).
With very low productivity growth, the only way the peripheral countries can gain competitiveness is to have actual wage declines, something that Germany did not do in the last decade. So Krugman is far too generous in implying that Sinn wants the peripheral countries to follow the example of a lone outlier. He is demanding they do something far more difficult and painful than what Germany did in the last decade.
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