The illogical ECB

www.ecb.int/pub/pdf/other/art2_mb201305en_pp85-101en.pdf

The link is to a "monthly bulletin" issued by the ECB. It has the title "Country Adjustment in the Euro Area: where do we stand". It is a little dry for most tastes, perhaps: but I think it is instructive.

It starts by demonstrating the continued lack of impartiality we have come to expect from this body, infected as it is by neoliberal certainties and a political agenda disguised as economics. The loaded language is a give-away, in that sense, though what is truly telling is this:


It seems to me that it is a straightforward admission that the "Maastricht fiscal criteria " are patently irrelevant to economic outcomes. So far so good. Note also that the much vaunted "confidence fairy" is now part of the problem: it used to be part of the solution, so far as I remember. This body still believes that people borrow because they are feeling confident (though that has now morphed into "over optimistic); and not, for example, because they have no choice if they are to put a roof over their heads. In this sense individual borrowing is almost entirely unlike institutional borrowing, and it is a feature of neoclassical/neoliberal analyses that this inconvenient fact is masked, as everyone is reduced to a "representative agent" who makes "rational decisions" defined in a very peculiar way.

According to the paper "excessive demand" led to a credit boom which in turn led to a build up of debt, and in some areas to a a housing/real estate bubble. This was accompanied by inflows of capital directed towards finance and asset accumulation, rather than to the trading sector. If it had gone to the latter the investment would have led to increased production and trade and so the profits generated would have meant the debt could be repaid: as it stood it did not result in increased production and growth: it led to an asset bubble. This, it is said, made the subsequent adjustment more difficult.

What does this mean? First we have to consider what is meant by "excessive demand". Keeping to the housing sector, it means that everyone wants a roof over their head. That is apparently "excessive", in the odd world that economists inhabit. It is true that some people want two houses, and there has been an increase in the "buy to let" market in this country (not relevant for we are not in the eurozone, arguably, but I do not think it is much different in those EZ countries which experienced the housing bubble eg Ireland and Spain). But that brings up the question of the direction of causality: and that is fairly simple to see. To make a housing bubble you have to keep interest rates low, and indeed that is trumpeted as a success by governments here. Low interest rates mean people can borrow more because they can service more debt from their existing income. At the same time any other form of prudence, such as saving, is unattractive because the interest paid on deposits is below the rate of inflation; and house prices are going up by more than the rate of inflation. What will a rational agent do? Here both the economists and I agree about what people will do: but not for the same reasons. Rich people will maximise their gain by buying houses: ordinary people will also buy houses, but not because that gives them the best return: they will do it because they need somewhere to live. I assert that with no more evidence than my opposition has: I don't have a theory, I have my observations. And what I observe is that people do not borrow the most they can get: they borrow the least they can get which will allow them to buy a suitable house. And they worry about the level of their indebtedness (though less than in the past for reasons outlined in the debt thread).

The ECB also notes that this capital investment was itself debt fuelled. Pause for a moment to consider what that means. In the conventional picture investment comes from surplus: that is people who have spare money buy shares in productive industries as a way of getting a return on the money they do not need at present. Or they save that money in a bank or a pension scheme and that money is available for investment. That does not increase the money supply, it directs it. Efficient application of surplus money to production is what the free market is said to be uniquely good at: and we still talk as if that is what happens. It isn't. What happens is that money is created as debt and that non-existent money is what is invested. That does increase the money supply because it is created out of nothing: and it drives up prices. Because it is debt there is a need for big returns (to pay the interest on that debt) and for reduced risk. Investment in productive industry is always going to be riskier than investment in tangible assets which are assumed to have an inherent (and rising) value. That has no relevance for what ordinary people do, but it is important for banks and financial institutions and it informs their decisions. We have seen that many companies which formerly made stuff turned themselves into financial businesses and that is no surprise given the relative returns in the short term. But to suggest that this was a consequence of "excessive demand" seems odd to me: it is a cause. It is obvious that if I have £100 in savings and I invest it, then if I lose it it is sad but it is not catastrophic so long as I still have an income sufficient to my needs. But if I borrow £100 to invest and I lose it I still have to service the debt and I have no more income than before: so that can indeed be disastrous. This is what we have seen. It is interesting how we characterise this sort of thing: when we are looking at government debt and deficit we relate it to the household budget and we condemn any profligacy without much further thought: but applying the same principle to the behaviour of the private financial sector, as I have just done, does not seem to happen much. In that case the debt must be transferred to the public sector through bail outs etc: and that is the government's fault, not the fault of the person who borrowed £100 in order to invest in expectation of a return which failed to materialise. And who contributed to the need for the ordinary person to take on ever higher debt by driving up the price. Curious.

But the bulletin concludes that the problem is structural imbalances, and the solution is to tackle "structural rigidities" and "inefficiencies". There is nothing quite like assuming your conclusion, is there?

In section 2 they give a lot of self serving guff which is deeply unattractive. Apparently they expected increasing convergence because of the benefits of the EMU, and apparently that was reasonable: it just did not happen. Let us think about that. What they are saying is that free movement of capital across europe would lead to investment in those areas which had higher prospects of growth; that is the economies which were "catching up". Poor countries, as we call it. This is based on a sweetly old fashioned (or mindbogglingly dumb, if you prefer) theory that wealthy people would invest in productive industries in poor countries and this would lead to higher growth and therefore to convergence: prosperity for all! In this picture the money would come from the suplus held in other wealthier parts of the eurozone, and thus there would be current account deficits in those countries. But that would be no problem because those countries would grow and produce and so they could repay those debts or provide high returns on the investment. "Inward investment" was a good thing, just as any investment which leads to more productivity is. Unfortunately that is not what the investors did: as just outlined, they put the money into real estate: which does not produce anything at all in the real world. So the deficits turned out to be "unsustainable". Amazing, isn't it? These people, who predicate on the neoliberal theory that everyone maximises his own "utility" did not imagine that people would seek the highest return, or did not notice that the highest return does not come from industry or production. It is not that that is not well known, or that it is a new phenomenon: it has always been true. And, importantly, it is not an act of god. Those with the money can make it happen by the simple expedient of buying all the houses: that puts the price up and if you don't have to live there you then sell at an enormous profit: much higher than you can get by any other form of investment, and it is under your control: until the bubble bursts, of course. But that is the skill. The gamble you take is judging the top of the market: that is fun and profit; what is not to like?

The ECB characterises this as "external imbalance". I love the use of language here: it is nobody's fault, you notice. Nobody did anything improper. "No human beings were damaged in the making of this debacle" cos no human beings are involved in any way: it is all the market. Tell that to the millions whose lives are ruined by "external imbalance"! To illustrate that point of view consider this statement in section 2 of the report:


What that means in english is that people were impoverished. That is what austerity means and it is what they are pleased about. The people can't afford to buy anything. Hurrah! The language of "adjustment" means people are starving and have no medical care or houses or jobs: but we call that a fall in "domestic demand", driving a "correction", and it sounds much nicer.

They note that most of this "adjustment" is a consequence of private sector debt reduction: households and non financial corporations have, it is said, increased their savings rate and those same corporations have reduced their investments as well. The chart they refer to in support of that statement does not seem to demonstrate what they say, though it may be true. What the chart shows is a reduction in net debt for those sectors: which is not the same thing as saving unless you are an economist. Paying off debt is not the same thing as saving, not in my world.

And note that the reduction in debt is in part due to non financial corporations reducing their investment. Wait. Was that not the origin of the problem in the first place according to the first section of this paper? I think it was. There was not enough investment in productive sectors, so there was no growth to reduce the deficit. That was a bad (but wholly unforeseeable) thing: but now it is a good thing! It seems we have given up any idea of growth and prosperity for all. Now we just want to make sure that those irresponsible financial institutions (including the ECB, it must be noted) get paid. And we don't give a tuppeny toss for the people who have to achieve this through their poverty. It is surely unfair to imagine that this was also true when these naive but well meaning people started the liberalisation which dumped us all in this mess in the first place? Surely....

Unfortunately, it seems that this "improvement" in the private debt position was offset by a deterioration in the government debt ratio. Um....that is inevitable. If you put folk out of work they get benefits paid by the state. If you do not allow irresponsible banks to fail you have to bail them out with government money. If businesses fail cos no one is buying you do not get any tax money in. All of this is perfectly obvious. It is well understood, and has been since the 1930's and it does not have any significance at all: the accounts have to balance because that is how accountancy works. It has little to do with the real world.

Nonetheless the ECB is pleased: but not very pleased. There is further to go. And we will go there on the back of gobbledygook, apparently. At leas that is what the next section is full of. let me start with the opening paragraph


Clear as mud. But to be fair they go on to consider each of these three issues in more detail.

i. They say that countries with high external deficits have high costs of servicing the debt, and that is true. So they consider that the debts of those countries have to be reduced: a lot. According to this paper the net external liabilities in those countries which have had to be helped averages 100% of GDP. They aim to reduce that to 35% in 15 years. And to do that they need to generate a current account surplus of 3% every year for 15 years. Wow!

The current account is defined as the balance of trade. It comprises the money you get from exporting more than you import; plus returns you get on foreign investments; and cash transfers (which I take to be foreign aid with no strings attached, so I think we can forget that).

So let us think about the countries which have needed help and which are said to be the problem. We have already seen that imports have collapsed in those countries in the earlier part of the paper. That is the main source of the "improvement" the ECB identifies and they think that is "sustainable" and should continue throughout the period. But it is not enough. So how else can a country improve its export position? Well it can devalue its currency: but that is not possible in the EZ. It can increase its exports: oops, no investment in production, so that is not possible either. It can invest in foreign assets and get a return on those: but there is no money in those countries apparently, so that is not open to them either. It can export its population and rely on remittances from workers abroad: that is happening a lot in all of those countries, but there is a problem: there is increasing resistance to immigration in all the wealthy nations, for the workers there are also subject to austerity and they are blaming the foreigners. I do not think that trend is likely to reverse.

But there is one source of increased exports, nonetheless. You can reduce the costs of production by other means than investment. You can cut wages.

ii. The paper says that it is very difficult to break down the "observed current account adjustment into cyclical and structural component parts" This is because such "adjustments" depend on variables which are not observable, it seems. But they do not let that inconvenient (some might say fatal) flaw detain them: not they! Instead they plough on. "Structural" adjustments are said to be "sustainable". The only thing they talk about is the adjustment which they call "compression of domestic demand" which, as we have seen, means poverty for the population. That is structural, and therefore sustainable, they say. It " reflects the fact that the crisis has resulted in a reduction in the growth rate of potential output and domestic demand, and has triggered a series of structural policies aimed at rebalancing the economy towards the tradable sector". How they square that assertion with reduced investment in the "tradeable sector" they noted above I do not know. But "reduction in the growth rate of "potential output" is nonsense: there is a reduction in the growth rate of actual output cos nobody is working, and I fail to see how that affects "potential" output in any way. Potential output is not easy to measure but I know this: it is related to full utilisation of all of the factors of production and that includes labour. It is, in fact the basis for the original expectation that foreign investment would enhance growth by investment in the productive sector: which they appear to have conveniently forgotten in this section. They are not talking about potential output at all: they are talking about actual and that is adversely affected by the austerity they are seeking to justify.

iii. I confess I do not understand this part of their discussion at all. That is partly due to my problem with graphs because they make assertions which are apparently supported by a graph which seems to me to show the opposite of what they say it shows: and I am perfectly willing to believe that it is my problem, not theirs. I would be grateful if someone else could address this as I am not capable of understanding what they say they demonstrate.

Taking what they say at face value: according to them

I honestly don't see that in the supporting graph, but aside from that I have a problem with this assertion and its implications. The reason is this: what they say they are observing is


.

I am not saying they are not right: but they do not support the implication in any way, and there is no data to show that this is due to an increase in exports rather than an outcome of the collapse in imports which they already identified. These are ratios. If you import less, then the contribution of exports, assuming they stay the same, will necessarily increase, will it not? In fact if they fall it will still increase if imports fall more? Say Scotland produces 100 bottles of whisky every year and sells half of them abroad, and half at home. And say they get £10 a bottle; so the total income of the country from production is £1000. 50% of that income comes from exports, I think. If domestic demand collapses so no bottles are sold at home, and we sell the same 50 bottles abroad 100% of the country's income now comes from export: but it is only half of the income we had before.

According to the IMF,( www.imf.org/external/pubs/ft/scr/2012/cr12202.pdf)in Spain real output was 3% below its peak in 2008, in the first quarter of 2012. Domestic demand was 13% below its 2007 peak in 2011. Wages have fallen, with no commensurate fall in unemployment and that is even in face of net emigration, for the first time since the early 1990's. Poverty and inequality are rising.
Exports did indeed rise in the period under discussion, so the ECB are right about that, if the IMF is to be believed: but they are nowhere near twice the volume of the pre-crisis period, as is implied. Exports fell sharply in Spain between 2008 and 2009, as they did all over europe: and they have recovered better than some other countries, though the shape of the graph is the same. I find it interesting that the ECB paper focuses on the period 2008 to 2012 and particularly on the second half of that period: for Spain's exports are now falling again per the IMF chart, and that started in 2011. As noted, the exports by volume have increased: and the ECB does say that is "partly" the reason for the increased contribution of exports to growth. But they say that contribution has doubled compared to the pre-crisis period. I find it difficult to read charts but the IMF one shows exports by volume at about 115 in 2007, and about 125 at the peak in 2011. (2005 is taken as 100) That is nowhere near double, and I infer that all the rest of the increased contribution of exports is related to the reduction in domestic demand. I may have misunderstood, but my impression is that the ECB is cherry picking to confirm its pre-determined conclusion. I am encouraged in that belief by the fact that they choose only two countries to discuss (Spain and Portugal), and by the way they describe their own correlation between unit labour costs and export performance, though again I am open to correction. What I see when I compare the IMF graph with theirs is this:

Spain's unit labour cost fell by about 5% in the period and exports increased by about 8%. So that is a data point in favour of their theory. But Germany's unit labour costs increased by about 7%, and their exports increased by 5%: not as much, but totally against their thesis, surely? From the IMF graph it appears that Germany was exporting around 128 by volume in the pre-crisis peak: and 138 at the end of the period.

There are 13 countries on the ECB graph. As I read it, 8 are in line with their assertion and 5 are against it: but they say only Greece bucks the trend. I can't understand why they say that, and I am extremely dubious that their conclusion follows from their data. I note they do not give any indication of how this would vary from a chance outcome, either: what statistical test would be appropriate even if you accept that this is a reasonable approach? That it is not is somewhat confirmed by this paper about export performance

http://ec.europa.eu/economy_finance/public...df/qrea2_en.pdf

which comes from the European Commission and points out that export performance is affected by a great deal more than price (the mechanism which relates to unit labour cost). Indeed it says


This is hardly an unbiased paper, given that it is from the EC and tends to support the EU as an institution which benefits its members economically, almost by definition. Yet the simplistic correlation the ECB focuses on is not supported here in full. Indeed the ECB paper does acknowledge that in some detail, so it is a bit of a mystery why they reach the conclusions that they do. They return to the question of cost competitiveness as if the other issues they identify did not really matter.

So back to wages, then. I find it quite instructive to read what they say in this section: in particular this


What that means, in english, is that wages have been falling but prices have not. And this is due to "indirect taxation" ( primarily VAT which, you will note, is a demand of the EU arrangements and not under governmental control to any great extent - http://en.wikipedia.org/wiki/European_Union_value_added_tax), and to the "resilience of profit margins" (or the fact that we are not all in it together, as we say). Apparently the answer is "competition" but I need not go into what I think of that here: I have said it all before. We cannot tax companies to ensure they share the pain; we cannot spend to employ the folk who have been subjected to "labour shedding" in productive work: no, we must rely on that same free market which has served us so well: in particular, we must somehow get that market, which has put firms out of business, as it is supposed to do, to now make more successful firms to compensate for the lack of competition it has inevitably produced. And we are not to connect the "composition effects" which include driving those firms out of business, with the lack of competition they now perceive. This does not make any sense at all.

That a low wage economy is their aim is freely acknowledged: they do not attempt any of the usual guff about temporary adjustment or long run benefits for all: they explicitly deny that would be desirable. They are also very upfront about blaming the unemployed for their situation, as you would expect from neoliberals. They consider that persistent long term unemployment is proof of ongoing "structural rigidities": those "structural rigidities" are in fact the expectation of a living wage. Pesky workers just point blank refuse to work for nothing, and that is the whole problem.

On to debt: this paper is shockingly partisan in its use of evidence and it is clear that they see no need at all to consider their own role, what with them being a central bank, at least in name. In particular I was struck by what we can agree on: for example the paper says

1. Balance sheet problems "migrated" from the private sector to the government sector (once again nobody did this: it just sort of happens, in this language game)
2. Government budgets got worse because of lack of revenue in recession and the automatic stabilisers (for which read benefits etc)
3.The bail outs made debt and deficit worse for governments
4. The private sector then raised the costs of government borrowing by applying a risk premium on the back of worries about default once their liabilities "migrated" to the public sector
5. The cuts were bigger than the "improvements" they produced (which is no surprise at all unless you are a neoliberal - it is an inevitable consequence of cuts in a recession and it will not reverse of itself)


Where we do not agree is in their assertion that there is no alternative: that is nonsense and it is also a lie: there are many alternatives. You might not accept they are desirable, but you cannot deny they exist. Yet they say


Well where is the evidence that this is a "short-run reduction in growth"? Seems to me that the evidence is with me and not with them and every forecast they make about growth is wrong: in spades. They (and the IMF) have been consistently wrong about growth in every country they have made a prediction: and wrong in the same direction.

Then


You don't say! Unfavourable output developments means nobody is working, I think: and rising interest costs are entirely down to the central bank: which is the ECB itself in the eurozone. There is no need at all to pay high private sector interest when they can print money and lend it at low rates to those countries which need it. But perish that very obvious thought.

They then say


Well we all know that is arrant nonsense and the exposure of Rheinhardt and Rogoff's utter incompetence disposes of that argument. No need to say more.

And then we get the true agenda, flimsily disguised. The ECB is wedded to the notion that we need "structural reform" and that it must be achieved no matter what the people want. So they say


Pure ideology based on nothing at all in the real world. That is all that is underpinning the ruining of millions of lives and the dismantling of the welfare state. A "simulation" based on a model which contains its own conclusions: GIGO, as we call it. I adore the word "confirmed" in that quote! And on this basis we hear that some countries have sought to offset the negative effects of this garbage on short term growth by introducing "growth friendly consolidation measures": by which they mean raising the retirement age and cutting pensions. Just when youth unemployment is the biggest problem we have! Sheer genius.

We got into this mess partly because of the deregulation agenda so it is obvious that the solution is to do more of the same: so we need to make sure that professions no longer actually have any professional standards as that is a barrier to competition: and we need to privatise everything as quick as we can and implement more PFI programmes: that will work - see PFI thread. Also we need to make the labour force more flexible: for which read no rights and zero hour contracts. This, according to these clowns, will improve competitiveness and reduce wages: always a good thing. They agree with the neoliberal convention that unemployment does not exist: it is only a preference for leisure on the part of the work force. They call this a neo-keynesian approach, and I am sure they are right: but it needs rebranding for the poor man must be spinning in his grave.

These people are bastards: but worse, they are stupid bastards. Why do we listen to them at all? Seems to me that the very first "labour market reform" we should address is sacking them. I predict that would lead to an improvement in GDP and competitiveness in the short to medium term, and it is quite urgent. Or we could hang them from lamposts.....

Further to this illogical analysis.

Figures out today about the Irish economy, which show that it is again in recession

www.irishtimes.com/business/economy...ssion-1.1444786

Ireland has been the poster child for austerity, having accepted all of the Troika prescriptions since the crisis. It is interesting to note that the ECB paper above focussed on Spain and Portugal only, as I noted when reporting what they said about exports. I suggested they were cherry picking and there is some support for that view in the linked report, because it says:


It may, of course, be a mistake to rely on one quarter's figures: but since the export improvement in Spain was also showing signs of reversal in the second half of 2012, according to the information presented by the ECB itself (and ignored in their crazy paper) I do not think it is illegitimate to note that decline here as well.

In Ireland real wages have fallen about 5% since 2009 according to the ILO, and this is confirmed by this report in the Irish Examiner

www.irishexaminer.com/ireland/publi...ars-223535.html, which is largely about public sector pay but notes that private sector wages increased in the 2012, though not enough to offset the fall over the previous 3 years


Irish unemployment remains high at nearly 14% with some increase in part-time and casual work, as is also seen elsewhere, and which serves to mask underemployment.

www.tradingeconomics.com/ireland/unemployment-rate

The Guardian reported the Irish figures under the headline "Ireland falls back into recession despite multibillion - euro austerity drive". As ever there is no consideration of the proposition that it should read "Ireland falls back into recession because of multi -billion euro austerity drive". It is this lack of objective reporting which is so damaging to any informed debate about what is being done to people in the name of the Troika, and about the status of these policies in theoretical, and even in practical terms. The underlying assumptions are so seldom challenged, and they are smuggled in in headlines like this. It is a drip feed of ideological propaganda, so far as I can see.

I am coming back to this because I have come across another paper which discusses the relationship between price and exports amongst other things. In an earlier post I said that I could not see the relationship which was claimed between the unit cost of labour and good export performance. said to be shown in their graph. It is curious to find that the body set up by the ECB to investigate this very issue can't find it either.

http://www.ecb.int/pub/pdf/other/competiti...lts201306en.pdf


As I noted in the earlier post this was acknowledged there: and then comprehensively ignored as they came to their pre-determined conclusions.

The paper linked here suffers from much the same isolation from the real world we have come to expect from economists: it is all theoretical "models", and when they fail they fall back on vague and ill-defined terms which do nothing at all to increase our understanding; or alternatively suddenly spot things which your granny knew as if they were economic insights. So, for example, they discover a "paradox" which nobody but an idiot could conceive of as a paradox, of any stripe: that is, that the cheapest goods do not always sell best. Then they solve it by suggesting that price is not the sole determinant of market success because both quality and "taste" have a role to play. You astound me, Holmes!


We are employing 150 economists in the body which is undertaking this "research" and I have to presume that every single one of them (on reasonable wages one must assume) always buy the very cheapest soap and the very cheapest meat and the very cheapest car that they can find. If they do not do this there is no possible justification for thinking there is a "paradox" at all: much less one that needs a theoretical resolution which is no resolution at all.

I think we should sack them all on grounds that they are not human beings and they do not live with human beings. Human beings who can afford it buy more expensive soap and cars and meat than poor people do. This appears to have escaped the notice of economists, somehow. But never mind: it has only taken 150 of them to begin to rethink this, and they are going to be employed for ages so they can model it. That a 5 year old faces this fact in a sweet shop need not lead us to the conclusion that these people are completely useless - oh, wait. They are not useless: they are actively damaging, because their fantasies inform policy which reduces real wages and puts people out of work. And this is the level of understanding which leads to those outcomes!

This paper is like a lot of others in that it is full of gobbledygook. For example


Make of that what you will. For me it is merely obfuscation, designed to imply that these people have some special expertise which lends authority to their work. But so far as I can tell they know less than my granny, for reasons already stated.

These folk never give up an idea just because it is wrong, though. They talk about "competitiveness" as still being important: just a little more complicated than their infantile models previously assumed. So we get this little gem


That is brilliant. To translate: "Our model predicts that falling prices will increase export sales. They don't. We have no idea why that might be, but it must be because the price is either too high or too low. Or something"

They call this progress because they think that the "price" now includes some woolly notion like quality or taste: and they are busily developing models to measure quality so that they can do better predictions. So we read:


Well they are right about one thing: it is a simple idea. So simple I knew it at primary school. And so did you. When you went to the sweet shop with your pocket money when you were 5 you probably chose those nasty cheap sweets because you got more for your money. But the time you were 8 you probably realised they were cheap because they were nasty, and settled for less at a higher price. Economists all bought the very cheapest sweets throughout their childhood, apparently. This is because they are morons.

The really wonderful thing about this paper from their point of view is that it changes nothing that is important. You might think that reducing the importance of price in determining competitiveness would lead to a change in the prescriptions about how to go about making things more competitive: and as we have seen the main way of doing this on conventional models is to reduce price by reducing wages. So we might see a different approach. Well no: for we find this


( my bolding)

So flexible labour markets ( read low and insecure employment) are necessary if you focus on the price: and they are necessary if you don't, as well. How "flexible labour markets" are supposed to improve quality is a complete mystery to me. But it is the answer no matter what the question, apparently.

It gets worse.

www.levyinstitute.org/pubs/wp_651.pdf

This is a paper from something called the Levy Institute and it also deals with relationship between "competitiveness" and Unit Labour Costs. It makes some of the same points outlined above, but I learned something more from it, which I had suspected but which is here explained reasonably clearly.

As noted above, the idea behind the austerity agenda insofar as it relates to competitiveness, is that countries will lose their share of export markets if the price of their export goods is too high. Most ways of dealing with this are prohibited, as listed in the first post above: eg those countries cannot devalue as they are part of the eurozone etc. So the only thing left, it is said, is bring down the cost of labour and that means cutting wages. And this is what we are busily pursuing.

Objections to this based on the effects of loss of domestic demand are familiar on this board, and that is not the part of this paper I want to discuss, though it covers it well. What I want to draw your attention to is something much simpler. It relates to the way unit labour cost is calculated.

First you have to think about how a thing is priced. That turns out to be really complicated and there are a lot of theories about price, most of which seem to be twaddle. But at its simplest let us assume for the moment that price is set by a mark up applied to costs.

Imagine that a company makes pencils. It employs two people and they make 50 pencils each in a week. To do that they use a machine which cost £104, and which will last a year. The workers are paid £5 per week each. Energy, and other things such as the cost of premises and materials amount to £1 a week to run the company. So total costs to produce 100 pencils are £13 (including the depreciation of the machine)

Unit labour cost is calculated by dividing the £10 wages by (the number of pencils divided by the number of workers)

So in this case it is 10/ (100/2) = 10/50. That is 20p per pencil.

But firms do not sell their pencils at the unit labour cost. The price has to include it, but it also has to include the other costs, and the profit. In this example we know the other costs. They are the £2 per week depreciation of the machine; and the £1 per week which covers the other expenses. So the cost is 23p per pencil. And then there is profit. I do not think it unreasonable to assume that the owner will want to get more than his workers each week. So let us assume he gets £20 per week (modest enough when you look at remuneration ratios in real world firms). To achieve that he has to sell his pencils at 43p each.

From one point of view the unit labour cost is 20p. But that is only true if you exclude the owner from the calculation, and I see no reason at all to do that. His share is called "capital" because it is not made by his work but by his ownership of the plant. But from another point of view there are three people producing pencils. So far as I can see the sole purpose of not including the owner's remuneration in the ULC calculation is to ensure that only the workers lose money when ULC is reduced. Does that make sense to you?


There is more. This paper reports that


This is described as Kaldor's paradox and it was replicated:


So it seems to be well established that reducing unit labour costs does not increase competitiveness and this is well known in economic circles. Yet that is not discussed when the ECB, IMF old uncle tom cobbley and all prescribe this lunacy as an answer to the economic problems of every country they have power over, no matter what the circumstances. This isn't science: one can only conclude it is faith at best; or dishonesty which has to exclude the evidence from the public debate in order to further the agenda of the very wealthy.

The authors go on to discuss the fact that even with these limitations the calculations used are not applicable for countries. That is because the output for countries is not real in the sense that pencils are. It is an abstraction. Further, the ULC is often compared between countries and that is not appropriate either. As the authors note, it is pointless to compare Germany with, say, Greece. The structure of their exports is very different


This is important because of the element of capital in pricing noted above and elaborated within the paper. The abstraction which takes the place of the pencils when looking at output for countries rather than companies is "value added" and this equals


Total nominal wage bill/labour compensation is the average nominal wage times the number of workers

Total profits are the nominal profit rate times the capital stock

So the measure of output is defined as the total of profit and wages, to put it crudely. It follows that this cannot have anything to do with competitiveness because it is only about share: if one rises the other necessarily falls because of the way it is calculated. This is a very laborious demonstration of a point I have made before in a different context: there is no reason to suppose that prices will fall if wages fall - the cost saving will turn into profit. That would not happen if we were talking about pencils, of course. But we aren't. This seems to be the same kind of error that we see when economies are compared to household budgets: they are not the same and the measure of productivity here is not like pencils either.

These points are elaborated on another board I visit.

http://rwer.wordpress.com/2013/07/21/seven...ompetitiveness/

and that is also worth reading, though it addresses "Real Unit Labour Cost" rather than ULC

Edited by FionaK - 25/7/2013, 18:18

Thanks as always for correcting my sums. I don't think it changes the basic points (at least I hope not)

Turns out it is not my mistake: it is the author's mistake. So now I have to check their arithmetic as well as their logic. I am not equipped to do that I should have known after the Rheinhardt and Rogoff debacle. Is there anything economists can do properly?

Edited by FionaK - 25/7/2013, 20:25