Labour productivity key to sustained growth in Eurozone periphery
Greece, Portugal, Spain and to a lesser extent Italy made significant adjustments to wages and productivity during the euro-crisis to become more competitive. A recent report of ING’s senior economist Bert Colijn examines whether this competitiveness is likely to be maintained now that the economic recovery in most Mediterranean countries has started.
- Although an economic recovery has started for most of the troubled economies, productivity growth is weaker than it was during previous expansions.
- Overall, the current environment suggests that Unit Labour Costs will increase again as the recovery gets underway, making the tough gains of recent years more of a cyclical phenomenon than a structural one.
- In addition, we see the lack of investment and funding thereof are a key hindrance for further structural improvements in productivity and a more sustainable growth path for peripheral Eurozone countries.
Several elements have contributed to making Southern European economies vulnerable and to generating large account deficits. Significant increase of Unit Labour Costs (ULC) and wages, an insignificant rise in workers’ productivity, the role played by internal devaluation in improving the export position of these countries and the hollowing out of the domestic economy have all had impact.
This so-called internal devaluation has helped exports grow strongly in the aftermath of the crisis, but has come at a great cost to employment in the European periphery, resulting in plummeting domestic demand. Moreover, in countries such as Greece and Italy, this has not been enough for a sustained current account balance when domestic demand fully recovers.
Thanks to improvements in ULC, the export performance in recent years across Spain and Portugal has been impressive, with growth outpacing the export-powerhouses of Germany and the Netherlands. Greece has also seen a strong improvement in the export of goods. The question remains whether export recovery has been responsible for reducing current account imbalances, or whether this stems from austerity and declining domestic demand in light of soaring unemployment and wage cuts.
Maintaining productivity growth now that an economic recovery in the Eurozone periphery has started could be more difficult than during crisis times. For a sustainable growth path to be achieved, where the Eurozone periphery maintains its competitiveness, but also recovers domestic demand by improving wages and employment, it is key that labour productivity growth improves substantially. In reality, as businesses have focused on deleveraging in recent years and investment, (especially in R&D), has faltered, it seems unlikely that structural improvements in productivity are around the corner.
As capital is hard to come by and labour is abundant, capital-labour substitution is currently working against improvements in productivity. It is therefore important that regulatory changes focus on enhancing productivity, including continued improvements in labour and product market legislation, while helping investment in the Eurozone periphery.
Bert Colijn, ING Economics Department, email@example.com
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