Competition in the Euro Area: The Commission and the ECB Rely on the Wrong Criteria

Press Release March 18, 2011

Competition in the euro area is currently one of the favorite topics of politicians in the EU. Angela Merkel and Nicolas Sarkozy want an EU competitiveness pact to be established, and the European Commission wants sanctions to be applied when particular criteria are not adhered to. Are these criteria, however, appropriate?

Some economists and policymakers have long been of the opinion that it is necessary to increase nominal unit labor costs throughout the euro area to correspond to the ECB’s inflation target of two percent if the European Monetary Union is to function properly.

Dominik Groll and Björn van Roye, both researchers at the Kiel Institute, explain why doing so would be counterproductive in their new Kiel Policy Brief entitled “Price Competitiveness Divergence in the Euro Area: The Level Matters!”. They show that, in order to assess price competitiveness based on nominal unit labor costs, the decisive measure are levels. A simple thought experiment shows that nominal unit labor cost levels that are only minimally different at the beginning of any particular observation period will drift apart over time given the same growth rates.

Further, they show how wrong policy decisions can be made by relying exclusively on indices and growth rates without taking levels into account. This holds true for every price competi­tiveness indicator, not only unit labor costs.

Link to Kiel Policy Brief No. 24

Another Kiel publication, by Dominik Groll, Björn van Roye, Jens Boysen-Hogrefe, and Joachim Scheide, shows that unit labor costs cannot always be used as a suitable indicator, as their differing paths in the euro area countries cannot explain the differences in the export performance of these countries. The export success of a country depends to a much greater extent on the particular mix of goods the country exports and on the rapid pace of economic development in emerging countries which are new demanders especially in investment goods markets as well as competitors on other markets. Long phases of accelerated in­creases in unit labor costs are not only possible but also justifiable in emerging economies that have previously had low unit labor cost levels, such as in Estonia or Slovakia. Thus, unit labor costs benchmarking will not help to bring about better export convergence in the euro area.

Link to Business Cycle Report

Contact: Dominik Groll, Dr. Jens Boysen-Hogrefe und Björn van Roye