Talking point

On prices and costs a number of EMU countries are laggards

February 11, 2010 Even in the twelfth year of EMU there are still differences between the price competitiveness of the euroarea countries. Below is an explanation of how these differences arise, how they can be reduced and the part that the EU can play. Price competitiveness is a key factor in the successful exporting of goods and services. The success of exports to non-EMU countries, which constitute some 50% of all exports, is determined by the external value of the euro, which is derived from the nominal exchange rate . The price competitiveness of individual economies within the eurozone can also be measured. The appropriate indicator is the real effective exchange rate. This represents the tradeweighted, inflation-adjusted exchange value of the euro in the member states and thus reflects the competitiveness of prices and costs in the respective economies. The higher a countrys real effective exchange rate, the lower its price competitiveness. The chart shows that in the last 11 years the decline in price competitiveness has been particularly pronounced in Ireland, Italy, Portugal and Spain. The readings are particularly good for Germany, Austria and France. One important determining factor of the real effective exchange rate is the inflation level. Even though the ECB pursues a single monetary policy for the eurozone, there are some considerable differences between the inflation levels in the member states. There are three main reasons for these differences. Pay settlements: in a number of countries wages have risen faster than productivity. One example is Greece where annual wage increases averaged 4.1% while annual productivity growth was 1.1% between 2005 and 2009. The corresponding figures for Spain show an even greater discrepancy. Germany, Austria and France, by contrast, exercised wage restraint. Differing market rigidities: in certain market segments the competition is still weak at both the national and international levels. Where there is no national or international competition the price level is high. To illustrate this the ECB cites the examples not only of the member states service sectors between which there is no major international crossover but also volatile markets like the energy and food sectors. Differing growth momentum: some EMU economies have grown faster than others. One reason for this is the process of catching-up in the real economy that the two newest eurozone states Slovenia and Slovakia underwent during the last ten years. In other member states low interest rates and strong capital flows over the last five years have led to bubbles forming in financial and real estate markets (in Ireland and Spain, for example). The result was asset price inflation. The causes of differences in national price competitiveness have thus been primarily structural in nature. However, steps certainly can be taken to iron out the differences. Short, medium and long-term measures are conceivable. In the short term unit wage costs can be adjusted to leverage greater price competitiveness. The crisis has not yet had any tangible impact on wage negotiations in the euro area, but this will change. The public sector in Ireland has been setting a good example with wage cuts of up to 15% and has thus sent an important signal to
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Talking Point

the representatives of the employers and employees in the private sector. Collective bargaining decisions do not fall within the competence of the EU and can therefore be influenced solely at member state level. In the medium term increased domestic and international competition within individual market segments can reduce differences in market rigidity. Market rigidity unlike collective bargaining is an area where the EU certainly can take action: the Lisbon treaty cites energy policy as an area of competence for the EU. If the Council of Ministers can be convinced of the vital importance of further liberalisation of the EU service market, this could be promoted more vigorously in the coming years above and beyond the existing Services Directive. In the long term the Commission and the Council should ensure that negative developments such as speculative bubbles are rectified at an early stage via improved monitoring and standards. Nevertheless, this is only a review within the framework of the stability programmes and economic policy principles. It would be wrong to dictate national economic structures via directives and ordinances. The EMU countries are thus not left completely to their own devices in attempting to boost price competitiveness. Rather, they can expect not only political support, but also a strict review of outcomes from the Commission and Council, because the crisis has increased their awareness of negative developments.

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