Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a senior fellow of the Carnegie Endowment for International Peace
Europe is often portrayed as the great underperformer of the global economy, undermined by economic rigidity, high wages and an expansive social welfare system. For years critics have argued that these features must be reversed because they erode Europe’s competitiveness, pushing manufacturing activity towards more “nimble” economies that suppress wages, weaken labour protections, subsidise manufacturing and maintain tight control over their external accounts.
But it is important to distinguish between conditions and policies that make European businesses less efficient and those that make them less competitive globally. These are not the same.
European manufacturing efficiency, for example, has clearly been undermined by red tape, divided national economies, limited labour mobility, poor technology adoption, weak infrastructure investment and slow regulatory approval. These conditions should all be addressed by domestic policy reform.
But high wages and strong social safety nets are a completely different matter. While they may make Europe less competitive in today’s hyperglobalised environment, they are, in fact, beneficial for global growth. Not only do higher wages and strong social safety nets support the household demand that creates the incentives businesses need to expand investment, but they especially encourage the backing of productivity-enhancing technology.
This is particularly relevant in light of a European Central Bank survey this year that shows that it is “a weak demand outlook”, followed closely by “low profitability”, that constrains business investment in the euro area. If weak demand is the problem, policies that boost wages or that reduce precautionary savings should be positive for the economy.
Unfortunately, in an international trading system dominated by economies that intervene to manage their external balances, these same policies put Europe at a competitive disadvantage. We live in a world in which manufacturing competitiveness is a product not so much of greater efficiency but of lower labour costs (relative to productivity). So policies that boost demand by increasing the household income share of total production also undermine manufacturing competitiveness.
The result is an example of what the Polish economist Michał Kalecki described decades ago: a paradox in which a player becomes more competitive and grows faster by suppressing wages even as the overall system suffers from such a strategy. It “wins” by retaining the benefits while exporting the costs to its trade partners.
When a country raises wages and welfare spending, it contributes to global growth by raising total demand. But when its major trade partners boost manufacturing exports through wage suppression and subsidies, including currency devaluations, the country soon finds its manufactures are crowded out by cheaper foreign production. Its trade partners get most of the benefits of its higher wages while retaining none of the costs.
Europe suffers in this setting because of its open external accounts. In a world in which some major economies, like China, have long exerted substantial control over their external accounts, while others, like the US, are regaining control over theirs, those that don’t must inevitably bear the brunt of adjustment. The fact that Europe lacks the political unity needed to act unilaterally leaves it especially vulnerable. Many of its most criticised “weaknesses” are in fact strengths from the perspective of global welfare. But because these policies are not matched by equivalent commitments among the EU’s trading partners, their net effect is to ensure that even when European manufacturing is efficient, it is nonetheless globally uncompetitive.
That is why unless Europe is willing to dismantle its welfare system and force down wages relative to productivity — which would be bad for global growth — it has no choice but to intervene in its external accounts. The purpose of such intervention is not protectionism, but rather to reverse the consequences of trade intervention abroad. Policymakers in the EU must distinguish between domestic conditions that hamper productivity and efficiency and those that undermine global competitiveness. The former can be addressed by the right set of domestic reforms. The latter can only be resolved by policies designed to control external accounts and reverse the consequences of beggar-thy-neighbour policies abroad.
Source link
