Is cutting Greek minimum wage economically relevant?
We would like to react at the agreement given by Greek government & assembly to cut private minimum wage by 22%. It seems an obligation to receive next financial aid from Troika (IMF, ECB and European Union). According with the Greek labor minister, "it's very big" (see previous link to Bloomberg) but it is in return for €130 billion of public aid and €100 billion of debt cut from banks creditors. Now we know the deal, which troikahas not fully approve yet, despite the strong commitment of the Greek side (there was an official vote in the assembly, some deputies lost their seat because they were against this proposal).
Given the terms of the deal, what is the economic purpose of a minimum wage cut? Official documents are missing but it appears as a consensus in officials' statements that to cut minimum wage will improve competitiveness and growth. We are going to check which aspects of Greek economy have justified that kind of "very big" change.
Let's check the current and trade accounts of Greece. We have added some others European countries to make comparison, Portugal would have been relevant too.
Obviously it's hard for the Greek economy to balance exports and imports1. In this way restoring (or developing, because the sold was never positive) price competitiveness of exports by lowering wages may look like a nice –and quick - response. But if we watch besides near the components of the current account, we found a more shaded story.
Both services and goods exports are growing, since end of 90's. In particular, since the entry in the euro (2001), goods exports increased of 48% until 2010 (and even +71,7% to the high point of 2008), services respectively +34,7% and +54,3% (2001/2008). These are nice yearly average growths! Here we have a real "Eurozone" effect; exports are increasing in consequence of the entry in a common monetary zone.
We also note that services represent 62,5% of total Greek total exports, which is not a frequent profile in Europe, except for tiny countries like Luxembourg. Travel services are a proxy of tourism performance and we see that the entry is not so good for the industry, one can easily think the contrary, and perhaps there is a price effect when swapping from drachm to euro.
Although it is always useful to stimulate exports competitiveness, it seems that Greece already achieved a nice performance since its entry in the euro. Yearly average growth rate of exports (goods and services confounded) is of +6,2% until 2008 (before the financial crisis that reduced world trade). One can conclude that imports increased quicker than the exports during the last 10 years and not that exports have made a bad result. It changes nothing about the current account (the deficit is growing faster than GDP) but that puts in perspective the urgent need to lower the minimum wage of 22% to encourage exports.
As we can see it, the imports increase very heavily in GDP terms, but the trend is not linear. Indeed we note that a peak is reached just before the entry in euro and followed by a decrease for 3 years (in fact it is explained by a stable level of imports and a strong economic growth
). It may be interesting to look more closely what's happened in these years to see what can be transposed in the present situation.
To conclude with the competitiveness, a good performance indicator is the market share of exports.
Greece have a steady share of 0,4% of world trade. This stability is a good performance by itself. More open economies have seen reducing their world market share on the same period. Il appears that improving Greek competitiveness will not be so simple that cutting exports prices. This economy achieved honorable performances in this domain during the last 10 years. Greece is selling abroad -as shows the success to maintain its world market share- but trade deficits remains. The question of raising exports volume would be less in the price than in Greece's capacity to produce a larger range of goods and services for exports2.
Therefore the problem rests less on a question of value than on a question of volume. In this way acting against export prices through wages is a wrong policy choice.
But European Union know that well, at least since may 2010, when the report "The economic adjustment programme for Greece" clearly affirm and explain why a cut on minimum wage will have no effect on export competitiveness (p21).
On reason for the wage cut is that Greek labor cost have increased faster than German one, which explain both competitiveness and growth issues of this economy. That's true in nominal terms, but if you look in real terms then you'll see a very different trend (nominal cost deflated by CPI).
What do we learn from these 2 charts?
First, there is a good reason why Greek's labor cost is increasing fast; average inflation in this country Is bigger than those in Germany. So to maintain purchasing power (not succeeded in real terms), labor cost has to follow prices. We have here a traditional problem of non-optimal monetary zone; asymmetric inflation. Of courses if euro monetary authorities didn't find a solution to this problem in the ten previous years, we can't expect more than "cutting wage is the unique solution to the fast relative growth of labor cost". It seems to us that it deserves a bigger monetary policy brain storming than that, at least because it could happen again in this country or another in the monetary zone.
Second, real labor cost decreases(also in Germany) then it should be difficult to maintain domestic consumption with this trend combined to the minimum wage cut. Yes it's a Demand based approach but ceteris paribus inside the economy, if labor cost and prices of goods and services have close trends there is no constraint on Offer, problem is on Offer addressed to the rest of the world. For the moment it seems hard to imagine that a 22% cut on wages leads to a similar cut on domestic prices, at least because it is very likely that a big part of domestic consumption is linked to imports. So cutting minimum wage shouldn't make a positive choc on domestic offer, nor help with the unemployment issue3.
Finally the first thing one should ever do before talking about heavy (or "very big") economic measures is to take time to understand what is the economic model of the target economy. If we do so with Greece, then we can see a very obvious fact, this is not and export based economy.
In Greece, households consumption represents by far the biggest GDP's share of the above panel (76,2% in 2010, according to Eurostat), and even of all European Union. Following countries are Cyprus (71,6%), Malta (69,7%), Latvia (62,3%) and UK (61,2%), the closest country (in all senses) is Turkey (74,2%). So Greek's households consumption represent two third of country's GDP and government and Troika are cutting the minimum wage? How economic growth may be possible at short term?
To solve the debt problem by economic growth and public solvability, what Greece need the most for now is a clever macroeconomic policy which plans and defines countries' development for several years and takes into account all aspects and specificities of a not-really-ready-for-globalization modern economy. Solutions may be a little more complex (and we hope efficient) than a downsizing at a country scale.
You can also find another nice analysis about the unfounded obsession of cutting Greek minimum wage on Rebecca Wilder's blog.
1 Being about the current account, there are some incomes flows, creating an increasing but still small gap these last years with the commercial balance.
2 Exports expressed in percentage of the GDP are indeed among the lowest of the euro zone, around 20% (source eurostat).
3 Again you can refer to the same occasional paper of European Commission stated above for more detailed reasons of wage cut's inefficiency in Greece.