Paul Krugman: A Tale of Two Adjustments


 

A commenter on my last euro post asks a good question: didn’t Germany once have a problem of excessive unit labor costs, which it cured with a protracted squeeze? And in that case, why is it so terrible if Spain is asked to do the same thing?

The answer is basically quantitative. I’d make three points:

1. Thanks to the giant housing bubble, Spanish costs got much further out of line than Germany’s ever did, so the required adjustment is much bigger.

2. Germany got to do its adjustment in the face of a relatively strong European economy; Spain is being asked to adjust in the face of a depressed Europe sliding back into recession.

3. In part because of this difference in overall macro conditions, but also because Germany doesn’t have a housing boom and is actually engaging in a bit of austerity on its own, the burden of adjustment this time around is falling much more on deflation by the overvalued country.

Here’s a figure that illustrates that point. According to Eurostat data, German unit labor costs peaked in 2003, Spanish costs in 2009. So here’s what the adjustments looked like in each episode, with blue lines representing the earlier case and red lines the later:

You can see just how much harsher Spain’s adjustment is, and how much less help it’s getting from rising wages in the rest of the eurozone. Basically, Germany is refusing to do for Spain what Spain did for Germany in the past.

And the result of all that is incredibly high unemployment.

A Tale of Two Adjustments – NYTimes.com

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