What price “success”?

Matt Yglesias has the following take on the “Greek problem”:

Seven of these charts are showing you that the economic situation in Greece is terrible. But the chart in the top right is showing you something else — Greece’s unit labor costs, a key measure of competitiveness, have gone down a considerable amount. This is key because reducing unit labor costs is supposed to be the key to Greece’s recovery.

On blogs, people talk a lot about “austerity” and whether or not it ‘works.’

But the conversation that European Union officials have is much more about competitiveness. Their view is that the continent as a whole (and especially its wayward members like Greece) need to improve competitiveness by increasing productivity and decreasing wages. The scary message of this chart is that Europe’s prescription for Greece is doing something worse than failing — it’s succeeding. Wage cuts really are making Greece more competitive. But while wage cuts have managed to reduce incomes and living standards for the employed, they haven’t succeeded in creating any jobs for jobless or restoring economic growth.

But that “success” could be achieved at a much lower “price”.

The Meade-Swann Internal & External Balance Diagram gives a hint. The Diagram divides the space into four quadrants: Quadrant I depicts a situation of CA deficit and “Overheating” (D,O). Quadrant II depicts a situation of CA surplus and unemployment (S,U) and similarly for quadrants three and four. On the vertical axis we have the exchange rate/ wage ratio (e/w), while the horizontal axis reflects aggregate demand (NGDP).

For simplicity, assume that in 2007 both Germany and Greece were on the Internal Balance line (i.e. unemployment was at the “natural” rate). Germany, however, was running large current account surpluses while Greece was running large current account deficits.


Not being able to raise the e/w ratio by depreciating the exchange rate, Greece has to do it by reducing w (or unit labor costs). Nevertheless, if it had a “helping hand” from Germany it could gain competitiveness at a much lower social (unemployment) cost. Germany would have to adopt expansionary policies, like reducing taxes and raising wages, thus moving to a point like c. Greece would then also go to c.

But Germany has stayed put, maintaining the level of its CA surplus. So Greece is left out to fend by itself (as is Ireland, Portugal and Spain, among others).

Some time ago I wrote a post on the US during the Asia crisis. It could be a paradigm for Germany, always remembering that, unlike Greece, Korea and Co. had, and used, the exchange rate “instrument”.

The real world counterpart of the stylized facts in the Meade-Swann diagram appear in the charts below.


1. Debt/NGDP ballooned because NGDP tanked


2. Unit labor cost in Greece has swerved to the average EZ level (still quite a bit higher than Germany)


3. Unemployment in Greece has “shot to the moon”


The CA deficit in Greece has turned into a small surplus, while in Germany it hasn´t budged.


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