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The ‘doomed’ euro
When the euro was introduced about 10 years ago, the pessimists didn’t give the currency much chance of reaching its 10th anniversary. The euro, or so the argument went, was doomed from the outset because of the disparity in economic performance among the member countries of the European Union (EU). In this respect, not much has changed. At one end of the scale, you still have the highly disciplined, but also slow-growing, economies of Germany and the Netherlands; at the other end, you find faster growing but ill-disciplined countries such as Spain and Greece. As icing on the cake, you also have countries that lack in both departments, such as Italy, making it difficult for the union to ‘gel’ — well, according to sceptics.
There is admittedly an embedded weakness in the way that the European currency union is structured. In the US, arguably the largest currency union in the world, fiscal transfers between member states allow for the Federal Government to adjust for variances in economic performance. There is no such mechanism within the eurozone, which explains why the member states are subject to a number of rules.1 These rules require strict fiscal discipline. The problem is that few countries play by the rules.
Unit labour costs out of control
The best example of this variance in economic performance is the huge spread in the rise of unit labour costs over the past few years. Unit labour costs measure labour (wage) costs adjusted for changes in productivity. It is probably the best measure that exists in terms of tracking the changes in competitiveness between nations. The currency union is governed by the so-called Stability and Growth Pact. There is no mention of unit labour costs in the pact which, with the benefit of hindsight, is a major mistake. Even Jean-Claude Trichet, the Head of the European Central Bank (ECB), who rarely admits mistakes, has publicly stated that if he could design the currency union all over again, he would push for a unit labour cost stability pact.
Back to the early sceptics. What they failed to realise was that Europe, together with the rest of the world, was about to enter a period of unprecedented prosperity. The good times would not only gloss over the deeper problems, but the euro would actually go from strength to strength, to a point where it now threatens to unseat the US dollar as the premier reserve currency of the world. It will be a mystery to some of you, then, why one should question the longer term viability of the euro. That is nevertheless what I intend to do.
The PIGS are in trouble
Ever heard of the four PIGS? This less than flattering acronym stands for Portugal, Italy, Greece and Spain, four members of the eurozone which are in much deeper trouble than they are prepared to admit. They are often considered the ‘antidote’ to the BRIC countries, the fast growing emerging market economies of Brazil, Russia, India and China. One of the PIGS’ (many) problems is escalating unit labour costs. Bearing in mind that the Organisation for Economic Co-operation and Development (OECD) numbers for Greece and Portugal do not yet include 2007, the conclusion we can draw from Table 1 is that, since the introduction of the euro, the PIGS have lost competitiveness to Germany at a frightening pace.
Brazil (the only BRIC country on which the OECD reports unit labour costs) scores very well on this account, a fact which is not going to make life any easier for the PIGS.