Cognitive dissonance at the ECB. High crisis unemployment exists – but it doesn’t
I remember the first time when I saw two men kissing in public. I must have been fifteen or sixteen at the time. I did not shock me, even at that tender age – as I literally did not believe my eyes: “did I really see that?”. And after some seconds looked again (and, to be honest, was shocked after all).
Psychologists call this behaviour: ‘cognitive dissonance’. New information which is at odds with previous experience or knowledge and is either ignored, disbelieved, or rationalized. It happens all the time – also in science. A recent ECB ‘Monthly Bulletin’ article, ‘Country adjustment in the Euro area – where do we stand’ is an example.
The beginning of the article is in fact quite good. It shows that the rapid decline of the current account deficits of the Eurozone periphery countries is not caused by increasing competitiveness but by imploding domestic demand (graph 2 of the article). It also shows the connection between the increase of the current account deficits before 2008 and the increase of private debts (graph 3). And it even states (chapeau), when it comes to deleveraging, ‘However, owing to the sizeable fall in nominal GDP, private sector debt-to-GDP ratios are not yet visibly decreasing’ (see also graph 9). The ECB admitting the possibility of debt deflation…
But the article runs in trouble when it tries to fit these well established facts into the neo-classical austerity-narrative (below I’ll return to the explicit neo-classical side of this):
(A) The graphs show that differences in current account developments before 2008 were not so much related to ‘unit labor costs’ – but plain and simple to inflation differentials (graph 2, 5, 6), the difference between ’unit labor costs’ and the change of the price level to an extent of course being ‘profit inflation’. The text, however, states something else.
(B) Graph 5 clearly shows that there is next to no connection between the development of unit labor costs and exports shares (graph 5). The text states there is.
(C) When it comes to unemployment it becomes groce. Despite the fact that the article clearly establishes that people are trying to deleverage, which contributes to the continuing decline of domestic demand, income, production and employment it also states:
“The continuous increase in the unemployment rate, particularly the notable increase in the long-term unemployment rate (see Chart 8), indicates some persisting rigidities in euro area labour markets”
And it uses a neo-classical macro-model to
explain assume this. This model (see box 2) has, typical for these kinds of models, among other things the next characteristics (emphasis added):
“There is a markup between the marginal cost and output prices, and between the marginal rate of substitution between consumption and leisure, and wages. A reduction of both mark-ups can be obtained by implementing labour and product market reforms which increase flexibility in wage setting and improve responsiveness to productivity and labour market developments, as well as boost competition in product markets“.
Translation: ‘unemployment does not exist, it’s just another kind of leisure, just enhance the power of managers, enable a decrease of wages and people will stop idling around and start to work again’.
And no. That’s an overstatement or a misreading. That’s how these models assume the world works. And how neo-classical macro-economists think. See this article from neo-classical Nobel price winner Edward Prescott about the Great Depression (aptly published together with the notorious ‘The Great Depression in the United States in a neo-classical perspective’ article from ‘Cole and Ohanian’ ) which explicitly states this point of view for the Great Depression. Never mind that production (and employment) in about all developed countries in the thirties only started te grow again when they left gold. And never mind that decades of experience and research have shown over and over again (see this recent IMF study) that growth of employment in modern economies (measured in hours) requires economic growth – that’s just the way it is. More ‘flexible’ labor markets won’t increase employment (if at all) as long as demand and income and production is declining. When wages are lowered – companies still use efficient technologies. And they still increase productivity. And have to shed labor when people do not spend their money on goods and services but on deleveraging.
Dear fellow economists of the ECB – when it comes to unemployment in the Eurozone, please look again. And be shocked.