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Abstract
There are two main political economy explanations of the Eurocrisis. The labor market view regards cross-country differences in wage bargaining institutions as the root cause of the crisis. The finance view, instead, emphasizes cross-border financial flows and downplays labor market institutions. For the first time, we attempt to assess these two explanations jointly. We find that financial flows are better predictors of nominal wage growth than labor market institutions. At the same time, we show that wage moderation matters for bilateral export performance in the important case of Germany, but not for other countries. These results suggest that imposing wage moderation and labor market reforms onto the countries of the European periphery was unlikely to improve their plight. In contrast, stimulating wage growth in Germany might have contributed to rebalancing the Eurozone.
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No potential conflict of interest was reported by the author(s).
Acknowledgements
We thank Aidan Regan, Alison Johnston, Anke Hassel, Charles Wyplosz, Christian Breunig, Erik Jones, Federico Ferrara, Fritz Scharpf, Jason Beckfield, Jonas Pontusson, Klaus Armingeon, Martin Höpner, Thomas Sattler, participants at presentations in Bologna, Cologne, Glasgow, and Konstanz, and two anonymous reviewers at the Review of International Political Economy.
Notes
1 This is a key assumption of both orthodox (New Keynesian) and heterodox models (see Carlin & Soskice, Citation2014; Storm & Naastepad, Citation2012).
2 The real interest rate is the difference between the nominal interest rate and the inflation rate, and is lower (higher) the higher (lower) the inflation rate. The RER is the ratio of domestic and foreign prices multiplied by the nominal exchange rate (quantity of foreign currency per unit of domestic currency) and appreciates (depreciates) when, keeping foreign prices constant, there is domestic inflation. An appreciation (depreciation) of the RERs implies that the country in question loses (gains) competitiveness with respect to trade partners.
3 It should be noted that while the real exchange rate disparity is a necessary consequence of countries having the same currency but different inflation rates, the real interest rate disparity is not. Rather, it is a contingent feature of the particular way international financial markets have responded to the introduction of the euro in the first ten years of the new currency’s life, and specifically of their treating sovereign bonds issued by core and peripheral countries as if they had essentially the same risk profile. This is demonstrated by the generalized decline of interest rates spreads relative to German bonds in the pre-crisis years. It was only after the start of the Eurocrisis that financial markets started differentiating—this time heavily—among bond-issuing countries (Schelkle, Citation2017; Sgherri & Zoli, Citation2009; Sinn, Citation2014).
4 In the explanation centered on domestic credit creation, cross-border flows emerge ex post from southern banks having to borrow reserves from northern banks (see Cesaratto, Citation2017).
5 These are Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal, and Spain.
6 Outliers are those observations that lie outside 1.5 × the ‘inter quartile range’, i.e. the difference between the 75th and 25th quartiles.
7 One reason why we do not find a significant effect of wage coordination may be that our measure of wage coordination is less precise than the economic variables. Yet, we apply the same indicators used by the previous literature, which finds significant results (e.g. Johnston, Citation2012).
8 Our estimated coefficients underestimate (real) GDP-based estimates of the foreign demand elasticity of exports if imports outgrow the rate of GDP, i.e. if the elasticity of imports to GDP is more than 1. In our sample, imports grow considerably faster than GDP. The elasticity is approximately 1.8–1.9, depending on the country (estimates not shown). This implies that in order to derive an estimate of the total demand elasticity from our estimates, one needs to multiply the estimated country-level elasticity of imports by roughly 1.8–1.9. We thank an anonymous reviewer for pointing this out.
9 Nor do they in Belgium, Finland, Greece, and Italy (see Table A6).
10 We performed a number of additional computations to assess the robustness of this finding. When the analysis focuses on the sensitivity of exports to manufacturing wages (Table A9), it finds an insignificant coefficient even for Germany, while the effect of labor productivity remains significant (although smaller). This suggests that the cost advantage of German exports is not so much related to the direct containment of wage costs in the manufacturing sector, but to the indirect and systemic benefits of wage moderation for the German real exchange rate in the economy as a whole, including the non-exposed sectors (see Baccaro & Benassi, Citation2017). Moreover, Table A10 repeats the annual analysis for the pre-crisis period. We fail to reproduce the statistically significant effect of German relative wages in this specification. However, given the results of the quarterly analysis for the pre-crisis period (Table A8), we attribute this null finding to the large drop in the number of observations and the corresponding loss in statistical power. Finally, in Table A11, we add domestic credit as a predictor of trade flows. This variable is always insignificant suggesting that domestic credit has no direct impact on trade performance in any of these countries.
11 These calculations are obtained as follows: (estimated elasticity of the predictor from ) × (compound annual rate of growth of the predictor)/(compound annual rate of growth of German exports).
12 The imports of Germany’s EZ10 partners (excluding German exports) grew at an compound annual rate of 3.3 percent between 1999 and 2014 (6 percent before the crisis). By multiplying the foreign import elasticity of German exports (0.633), EZ10’s imports contributed 64 percent of the total compound annual rate of German exports (54 percent of the total before the crisis). Thus, the imports of trade partners in the Eurozone were the most important determinant of German export growth.
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Notes on contributors
Lucio Baccaro
Lucio Baccaro is Director at the Max Planck Institute for the Study of Societies in Cologne, Germany.
Tobias Tober
Tobias Tober is a postdoctoral researcher at the University of Konstanz, Germany.