ECB President Mario Draghi made a presentation to heads of state and government at last week’s European Council on the economic situation in the euro area. His intent was to show the real reasons for the crisis and the counter-measures needed. In this he succeeded – although not in the way he intended.
Draghi presented two graphs that encapsulate his central argument: productivity growth in the surplus countries (Austria, Belgium, Germany, Luxembourg, Netherlands) was higher than in the deficit countries (France, Greece, Ireland, Italy, Portugal, Spain). But wage growth was much faster in the latter group. Structural reforms and wage moderation lead to success. Structural rigidities and greedy trade unions lead to failure.
According to the Frankfurter Allgemeine Zeitung (FAZ), which approvingly reported on the affair, the impact of Draghi’s intervention was devastating. French President Hollande, who had earlier been calling for an end to austerity and for growth impulses, was, according to the FAZ, completely silenced after the ECB President had so clearly demonstrated, with incontrovertible evidence, what is wrong in Europe – or rather certain countries in the Euro area – and what must be done.
Things are not as they seem, however. Draghi’s presentation contains a simple but fatal error – or should that be misrepresentation? As the note to the graphs indicates, the productivity measure is expressed in real terms. In other words it shows how much more output an average worker produced in 2012 compared with 2000. So far so good. However, the wage measure that he uses, compensation per employee, is expressed in nominal terms (even if, interestingly, this is not expressly indicated on the slides).
In other words the productivity measure includes inflation, the wage measure does not. But this is absurd. Real productivity growth sets the benchmark for real wage growth. In a country where real wages increase in line with productivity, the shares of wages and profits in national income will remain constant. By contrast, when nominal wage growth tracks real productivity growth, which is apparently the role model suggested by the ECB President, the share of wage income in national income will permanently decrease. Moreover, real wages will decline continuously, if price inflation is higher than nominal wage growth.
In a country with inflation at the ECB target (1.9%) one would expect a gap to open up between the red and blue line in the ECB president’s charts of 1.9% a year. Cumulated over the 12 years since the start of monetary union, for such a “benchmark country” the nominal wage/real productivity gap would represent almost 28%.
If Francois Hollande had been aware of this, he need not have been silent at all. On the contrary he could have pointed out that his country almost perfectly fits this benchmark: eyeballing Draghi’s chart the gap for France is about 32%. Similarly, the figure of 28% would need to be subtracted from the supposed competitiveness gaps of the other deficit countries, substantially reducing – although not eliminating – them.
Moreover, and this is the key point, using the correct figures transforms Germany from the wage-productivity paragon, as portrayed by the central bank, into what it really is: a country that has systematically undershot the stability norm for balanced growth in a monetary union, and thus been a major contributing factor to the crisis.
A case can be made that the presentation by the ECB president does indeed reveal the true nature of the crisis, albeit unintentionally. Senior economic policy-makers in the European Union are either unaware of basic economic concepts or they are intentionally using misleading – to put it mildly – figures to force policy-makers onto a course that suits their ideological preferences but which is inimical to the stability and recovery of the euro area and, in this particular case, indeed to their constitutional mandate.