Inside the neoliberal mind part 1 – the rebranding of failure.
Troika economists have a problem. It’s huge: cutting wages clearly did not work as intended, which goes against their deepest convictions. In such a situation people tend to rationalize. To quote Goethe: “intelligent people are sharpest when they are… wrong“. Some recent publications enable us to investigate the rationalization process of among others ECB economists. One of these is a Voxeu piece by Eric Bartelsman (head of the department of economics of the Vrije Universiteit van Amsterdam), Filippo di Mauro (senior advisor in the research department, ECB) and Ettorre Durucci (head of the convergence and competitiveness division, ECB) which clearly shows that cutting wages did not work as intended (see their figure 1). How did they cope with this?
Figure 1. Relative prices and activity in selected Eurozone countries (change between the year of the ULCT-deflated REER peak and 2014 projected)
Figure 1 shows that
* As a consequence of austerity the ‘Real Effective Exchange Rate (REER)’ of countries like Spain, Ireland, Greece, Latvia and the like declined a lot (i.e.: exports became much cheaper). This was totally intended.
* But this did not lead to the expected increase in net (!) exports, an increase which, implicit in their text, should (together with an export and low wages induced private non-construction investment boom of at least 100%) have been enough to compensate the decline in wage income as well as the building bust and the government spending cuts. Mind that the increase of net exports was generally not caused by an increase of gross exports but to a decline of gross imports.
How do they explain this? Easy: the authors state that austerity damaged the austerity economies to such an extent that they just can’t export anymore, blame this on rigidities and plead for… even more austerity and reforms. A quote (text directly below the graph in the original article):
What happened? Our suggested narrative is that the deterioration of competitiveness during the credit boom left the imbalanced countries, when the financial cycle turned, with no alternative but to pursue internal devaluation. Given labour and product market rigidities, however, the adjustment was initially driven more by compression of demand than by a reduction of costs relative to the other Eurozone countries and the rest of the world. The ensuing shortfall of investment, coupled with labour market hysteresis, produced a significant contraction in potential output.
what’s wrong with this rationalization?
A) In a global perspective all exports boil down to domestic demand
B) A severe decline in investment is a pretty consistent characteristic of the downturn of the business cycle – expecting an increase in such a situation is an idiosyncratic mental attitude.
Ad A) After 2008 a whole lot of neighbouring ‘stressed’ Eurozone countries simultaneously severely restricted domestic demand and/or were coping with the consequences of a severe decline of construction investment. This, of course, led to a decline of imports – and therewith of course to a decline of exports of other countries. At the same time countries like the Netherlands and Germany also restricted demand (government cuts, wage moderation, households which were deleveraging), North African countries were in disarray and other large customers like the UK and the USA had only barely recovered from the 2008 slump. Expecting fast growth in net exports led by double-digit increases in gross exports in such a situation is naïve – not to say superstitious.
Ad B) A strong decline of investment is a pretty universal characteristic of a downswing of the business cycle. Just check the Eurostat data. This is not caused by a ‘lack’ of flexibility but by the combination of a lack of demand, liquidity constraints, lack of confidence etcetera. Expecting an increase of investments during the most severe post WW II business cycle downturn in Europe shows an incomprehensible lack of historical knowledge. Expecting an upswing of private non-construction investment that compensates for the decline in construction investment as well as government investment plus part of the decline of consumption borders on superstition. See also this ECB study published today which shows (according to the abstract, haven’t read the rest) that government consolidation leads to a decline of confidence.
This is not all. The authors also publish figure 2 (their figure 5). According to them, more ‘structural reforms’ are needed to enable larger flows of labour from low productivity companies to high productivity companies to boost growth as well as adaptability of the economy. They are pretty confident this is happening: “Using simple joint distributions between firms’ productivity and selected covariates, we show that for stressed EU countries there is evidence that credit and labour is actually being reallocated towards the most productive use following the crisis. This would be in line with the postulate that the crisis and ensuing structural policies may be generating ‘cleansing effects“. In reality, the graph shows that the crisis – and not structural rigidity – is the real problem. During the upswing ‘rigidities’ did not (NOT) prevent a massive reallocation of labour to more productive companies, especially in the stressed countries. After 2008, ‘following the crisis’, the opposite (!) happened in the non-stressed countries. Also, implicitly calling the increase of unemployment caused by the shedding of labour by productive as well as less productive companies in the stressed countries a ‘reallocation of labour towards the most productive uses’ is pretty shocking. And not really sharp, when I think of it. Structural reforms failed – the wrong cure for the problem, based upon a flawed diagnosis and a severely lacking model of the patient. Calling what happened in the stressed economies ‘cleansing effects’ does not improve this situation.
Figure 2. Percentage change in total labour for firms above/below labour productivity median, for ‘stressed’ (red) and non-stressed (blue) countries. Left: before 2008. Right: after 2008.