Krugman on the need for more flexible labor markets in Euro periphery

Krugman:

Perhaps the most startling and frustrating thing about the debate over the fate of the euro is the way almost everyone avoids confronting the core issue — the elephant in the euro. With a unified currency, adjustment to differential shocks requires adjustments in relative wages — and because the nations of the European periphery have gone from boom to bust, their adjustment must be downward. At this point, wages in Greece/Spain/Portugal/Latvia/Estonia etc. need to fall something like 20-30 percent relative to wages in Germany. Let me repeat that:

WAGES IN THE PERIPHERY NEED TO FALL 20-30 PERCENT RELATIVE TO GERMANY.

But nobody is willing to say that outright. Even the ever-pessimistic (and hence realistic) Wolfgang Munchau writes

None of the governance reform proposals that are currently discussed even attempt to answer the questions of how Spain is going to get out of this hole, and how the competitiveness gap between the north and the south of the eurozone is going to be closed … What the eurozone needs is an increase in domestic consumption in the north, particularly in Germany, and labour and product market reforms in the south, most importantly in Spain.

How many readers will get that what he’s really saying is that

WAGES IN THE PERIPHERY NEED TO FALL 20-30 PERCENT RELATIVE TO GERMANY.

How hard will it be to achieve this? Look at Latvia, which has pursued incredibly draconian austerity. Unemployment has risen from 6 percent before the crisis to 22.3 percent now — and wages are, indeed, falling. But even in Latvia labor costs have fallen only 5.4 percent from their peak; so it will take years of suffering to restore competitiveness.

The official answer is that this just shows the need for more flexible labor markets. But this was a subject we all batted back and forth in the initial debate about the euro, circa 1990: nobody has labor markets that flexible. If the euro isn’t workable without highly flexible nominal wages, well, it isn’t workable.

Posted via email from Jim Nichols