This time, Krugman is right. Lowering nominal wages is really, really hard (charts).
from Merijn Knibbe
According to Paul Krugman, in a recent blogpost,
It is really, really hard to cut nominal wages, which is why reliance on “internal devaluation” is a recipe for stagnation and disaster.The crisis really has settled some major issues in economics. Unfortunately, too many people — including many economists — won’t accept the answers
The title of Krugman’s post is ‘Lessons from Europe’. That’s wrong. The title should have been ‘Lessons from Ireland’, as Krugman bases his statement on Irish data only: even very high unemployment combined with policies aimed at lowering nominal wages did not lead to lower nominal wages in manufacturing, in Ireland. The Irish data can however be supplemented with data from comparable countries (high unemployment, policies aimed at lowering wages) like Latvia, Lithuania, Estonia, Greece, Denmark and Spain (for comparison, Germany is added, too). And this shows the same lesson. Surprising, as especially the Baltics are supposed to have very, very ‘flexible’ labor markets. So, Krugman is right. Lowering nominal wages is really ‘really, really hard’. It’s not entirely impossible. Lithuania did manage to decrease wages. But even this success however seems to have been short lived.
Note: the transition countries managed to increase labor productivity with about 10% a year in the 2000-2007 period. The potential for further increases is far from exhausted. Policies aimed at restoring labor productivity growth seem to have a better chance than policies aimed at lower nominal wages.
(all data: Eurostat, average hourly total wage costs in manufacturing. I didn’t include Ireland as Eurostat does not have the Irish data which Krugman shows. Germany, Spain, Ireland, Denmark: 4-quarter moving averages. 2004, 2007 and 2009 were election years in Greece)