Paul Krugman: German Wages and Portuguese Competitiveness (A Bit Wonkish)


There’s a three-cornered debate among Ryan Avent, Tyler Cowen, and Karl Smith over the extent to which a more expansionary ECB policy would help the European periphery.

I very much agree with Avent and Smith that Cowen, who worries that such a policy would largely lead to inflation in Germany rather than a boom in Portugal, is completely missing the point; that’s a feature, not a bug.

But what really puzzles me about Cowen’s exposition here is his misplaced focus on the extent to which Portugal and Germany are in direct competition with each other, or to which Germany is Portugal’s main export market. This is very nearly irrelevant — because the point is that Germany and Portugal, for better or (mainly) worse, now share a currency, and what happens in Germany very much affects the value of that currency relative to other currencies.

Cowen writes that rising wages in Germany

solves (at best) only one of the core problems of the eurozone, namely incorrect relative prices between Portugal and Germany. It helps less with the “Portuguese nominal wages are too high” problem …

OK, stop right there. When you say “Portuguese nominal wages are too high”, you have to explain, too high relative to what? As Rudi Dornbusch always used to say, it takes two nominals to make a real.

And the answer, clearly, is “too high relative to German wages”. What else could it be?

But, you say, Portugal doesn’t compete that much with Germany. Ahem. Suppose that I could wave a magic wand (or play a few notes on a a Magic Flute) and suddenly increase all German wages by 20 percent. What do you think would happen to the value of the euro against the dollar and other currencies? It would drop a lot, yes? And Portuguese exports would become a lot more competitive everywhere, including non-German and indeed non-Euro destinations.

I guess I thought this was obvious. Apparently not.

Again, as Ryan says, the crucial difference between German/ Portuguese economic relations and, say, US/ El Salvador relations is that Germany and Portugal share a currency. This creates obligations for Germany, whether it likes them or not.

German Wages and Portuguese Competitiveness (A Bit Wonkish) –

This entry was posted in Euro, Germany, Macroeconomics, Paul Krugman. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s