Speaking at last month’s European Film Academy awards in Berlin, Spanish film director Pedro Almodóvar complained that Spain had been forced into austerity policies that reflect conditions elsewhere in Europe. “It is difficult to accept,” Almodóvar insisted, “the austerity measures that have been imposed upon us from the outside.”
It is surprising, and a little off-putting, that the movie director understands things about the Spanish economy that many policymakers have failed to grasp. The crisis from which Spain is suffering is an external crisis, not a domestic one.
Of course, Spain does have domestic problems. Its labor markets are inflexible, its tax system is distorted, and its educational system fails to provide young Spaniards with the skills they need. These are all issues that Madrid has failed to resolve, and this failure stretches back many decades.
But this is the point. These problems have existed for decades, during which time Spain managed nonetheless to grow robustly and to keep unemployment low. While no economist doubts that it is important for Spain’s current government to identify and address these domestic issues, they are not the cause of the current unemployment crisis.
So what is at the root of the crisis? It has been said that Spanish workers are too uncompetitive for the global economy. Madrid must drive wages down if Spain is to become competitive, and the best way to drive wages down is to keep unemployment high. Spanish workers must remain unemployed for many more years.
Unfortunately, this solution is not going to work. More than a decade ago, Germany came to the same conclusion. After a decade of slow growth and high unemployment, Berlin urgently needed to generate faster growth. The right way to do so would have been for Berlin to liberalize the economy, improve education, and increase the productivity of German workers.
But it did something else instead. The government, businesses, and the labor unions decided that the best way to increase employment was to reduce workers’ wages and so improve labor costs. They put into place an agreement that resulted in slower wage growth for German workers, so that over the first decade of this century, German wages grew at a fraction of their previous pace. As a result, German businesses did indeed become more competitive, but income inequality in Germany also rose rapidly.
The result was that German businesses regained their international competitiveness largely by forcing down German wages. Yet as German households retained an ever-smaller share of the country’s GDP, their relative consumption also declined, and the national savings rate was forced up. Unsurprisingly, Germany went from running large deficits in the 1990s to running large surpluses after 2001.
These surpluses turned Germany’s problems into the problems of the rest of the world. Lower consumption in Germany had to be met abroad with either higher consumption or higher unemployment. Monetary union had eliminated the traditional ability of countries like Spain to protect themselves by depreciating their currency or raising interest rates. That meant that Germany’s unemployment problems were transferred to countries like Spain that had been forced after monetary union to accommodate “German” monetary policy.
In other words, Spanish unemployment today is largely the result of German policies aimed at supporting domestic employment. These German policies have driven much of Spain’s economic performance since monetary union. Now, Spain is trying to respond to weak German demand by driving down the wages of Spanish workers.
But this is an impossible game to win. If every country drives down its wages to gain competitiveness, global consumption must decline, because rich people consume less of their income than average households. As the rich get richer, and workers get poorer, total consumption must decline relative to total production. Unless global investment rises, lower wages cannot result in lower unemployment overall. On the contrary, they must result in higher unemployment, with those countries that are slowest to cut wages bearing a disproportionate share of the unemployment burden.
Is it really in Spain’s interests to compete with Germany by reducing the wages of Spanish workers? Almost certainly not, but Madrid has few alternatives. It would be far more effective for Spanish policymakers to protect the country from predatory wage policies in Germany while it sends workers back to work. Madrid could then focus on policies that improve productivity over the medium term, without suffering high unemployment.
In the debate about austerity versus fiscal expansion that dominates policymaking in Europe, many analysts seem to confuse austerity with thrift. But austerity is not thrift. Austerity mostly means forcing workers to bear the brunt of adjustment costs.
The problem with this version of austerity is that any temporary benefit one country gets from forcing down wages will be eliminated when its trade partners do the same thing. Ultimately, their actions will only force unemployment even higher. In a world with limited restrictions on trade, policies aimed at reducing domestic demand must have employment consequences abroad. Austerity itself becomes competitive: the employment benefits for one country must come at the expense of employment among its trade partners.
Competitive austerity is simply beggar thy neighbor under a different name. As long as Spain cannot run an independent monetary policy, Madrid’s current economic policies cannot address the root cause of unemployment in Spain, because this unemployment is largely the consequence of austerity measures taken abroad. Until Germany changes its labor policies, or until Spain takes steps to protect itself from low German labor costs, Spain’s unemployment crisis will not be resolved.