Wednesday, February 29, 2012

A long, boring post about Greece.

One of Greece' fundamental problems is that the market-clearing wage is too low for most Greeks to accept. As a result, productive citizens are idled and productive work is left undone. To correct this imbalance, the demand for labor has to increase, the supply of labor has to fall, productivity has to increase without wage gains, or the price of labor has to fall.

By far the most popular approach, politically speaking, is to increase the demand for labor (thus the steady drumbeat of "Jobs! Jobs! Jobs!"), often by providing unemployment benefits to keep people spending. Unfortunately, in a global economy in which virtually everyone has idled capacity, increasing the demand for labor is a zero-sum game with correspondingly fierce competition. Consequently, more agile economies will win this competition. Too bad for Greece on this count.

Reducing the supply of labor is also popular, particularly in the form of early retirement schemes. However, this provides only a short-term gain, medium-term losses, and a lot of long-term pain. In the short term, when the demand for labor is zero-sum, reducing the supply *should* help the market clear. In the medium term, the newly retired greatly reduce their spending, making the demand for labor drop. In the long term, removing these individuals from the workforce just reduces the benefits of economic growth. In a globalized economy, all of the costs of reducing the supply of labor are born by the country that does it, but the benefits are spread around the world. The country that seeks to reduce labor supply is capturing all of the negative externalities, whilst the positive externalities are shared. Obviously, that's not optimal. Also, Greece is such a small country that its net impact on the global labor market would be imperceptible.

On the unpopular side, people don't like productivity increases. They would rather that more people did the same work than some people doing more. At any rate, it's a slow process, particularly since the productivity gains will come solely from cost-cutting, since businesses are loathe to invest in light of overcapacity. Greece is particularly hard put in this category, because why would anyone invest in Greece when there are so many, much better opportunities?

The most unpopular, but often the quickest, way to correct the imbalance is to make the price of labor fall. A country with a freely-floating currency has this happen automatically--high labor costs lead to low exports, high imports, and money leaving the country until the value of the currency drops enough that competitiveness is regained. Greece doesn't have this option. A second method to make the price of labor fall is to devalue the currency. It's the same process as above, just performed by fiat rather than by the market. Greece doesn't have this option either.

The final means, short of exiting the Euro, is that Greece will suffer a long, slow slog of reducing wages. The unemployed, and new entrants to the market, play a critical role in this process. The desperation to find work leads them to accept below-market wages (if the market is sufficiently flexible). This, then, puts pressure on the currently employed, as their leverage in demanding higher wages is curtailed. Consequently, productivity gains are reflected in price changes, not wage increases, and the comparative cost of labor falls. The problems with this approach, however, is that it directly conflicts with the first approach. If you provide generous unemployment benefits to keep people spending, you simultaneously reduce the wage pressure on the market. One policy is working against the effectiveness of the other.

Clearly, just because policy A is a good idea and policy B is a good idea, doesn't mean that they're both a good idea at all times in all circumstances regardless of what other policies are in effect. Greece is already doing its darnedest to increase productivity through reform--and I reckon they're at the limits of what is politically possible--they don't have a currency that floats according to their needs, they can't devalue, any increased demand will be swallowed up by others, and they can't meaningfully reduce the supply of labor, reducing their cost of labor is the only option they have left. If you've got one shot, better make it a good one.

As a side note, the United States' currency, thanks to China's peg and the flight to safety, isn't freely floating anymore. We've lost our automatic stabilizer, so we may need to manage our currency for a while.


Blogger Yoel Natan said...

Your post was interesting but unnecessary all the same since the Troika demanded in the last bailout that Greece freeze every wage in the country, and lower minimum wage to the equivalent of something like $8 per hour. That was just last week. (Given Greece's climate, no one will freeze to death at $8 per hour, at least.) The wage freeze is supposed to last until unemployment goes down from 21% to 10%, according to EU demands. However, if things go better than expected, or Greece makes some other concession, they can have that changed in the future, under the same conditions that Ireland renegotiated their bailout.

11:15 PM  
Blogger Yoel Natan said...,1518,814523,00.html

"The EU partners and the Greek government have a baleful fear of the truth. Which is the following: Greece can not actually be saved (with the current approach), not by slashing the minimum wages, and not with cuts in salaries, which are supposed to remain frozen until the country has lowered its unemployment rate from nearly 21 percent to 10 percent.

12:24 AM  
Blogger Octavo Dia said...

Freezing wages is not the same as driving them down. With the particularly low rate of inflation in Europe, a "wage freeze"--which actually only blocked automatic increases and only for unionized employees--will have only a marginal impact. Also, Greece has an unusually high level of self- and family-employment, which the wage freeze would not drive down.

If Greece cannot be saved by those means, they'll have to leave the Euro, which will make the Greek economy a generational problem.

10:42 PM  

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