Do European Labor Market Rigidities Cause Global Imbalances?

Steven Dunaway has a report for the CFR called “Global Imbalances and the Financial Crisis” which, as you can tell from the title, makes the case that global imbalances are key to understanding the crisis. He makes the case that these imbalances have been permitted to grow out of a kind of political laziness and that that trend must stop:

The United States has taken advantage of its position as the primary issuer of reserve assets to finance a growing current account deficit
during the 2000s. East Asian emerging market economies in general, and China in particular, have taken advantage of the second feature of the system. They have resisted upward pressure on their currencies and run large current account surpluses. Japan and Europe have made use of the third feature. Weaknesses in the value of the yen and the euro in the late 1990s and early 2000s contributed to the slow pace and inadequacy of structural reforms in labor and product markets, slowing economic growth and contributing to global imbalances.

I want to focus specifically on his claims about Europe. That Europe needs substantial labor market reforms is one of those things that “everyone knows.” Consequently, a tendency develops to say that substantial labor market reforms are the answer to every problem. So you’re worried about global imbalances? As far as the US and China are concerned, the story is pretty clear—unsustainable American consumption and a badly unbalanced Chinese economy. But what about Europe? Labor market reforms! But note right here that the timing is off. If I were to say “I’m thinking of a trend that came into being in the late-1990s and early 2000s but faded by the middle part of the decade” you wouldn’t say “he’s talking about global imbalances!” The growth of global imbalances doesn’t track the fluctuations of the euro at all.

And look at his own chart on page 15 of the report, which shows that current account surpluses in Europe don’t track the deficit in the United States:

I would further note that running a small current account surplus is exactly what you would expect a wealthy and rapidly aging region to do. Europe is both wealthy and rapidly aging. I’m not sure what else they’re supposed to be doing. Yes, yes, they’re supposed to be undertaking structural labor market reform. But what are they supposed to be doing about global imbalances? They seem to have things just right. It’s America and China that are out of whack.

Delving into the text:

Consumption-fueled growth in the United States fostered economic recoveries in Japan and Europe on the back of higher exports. Particularly in Europe, corporate profits rose. But problems in the structures of these countries’ economies—especially rigidities in product and labor markets—limited investment opportunities. The combination of high corporate savings and sluggish investment led to rising national savings and external surpluses (Figure 4)

Figure 4 is the bottom figure I reproduced above and, as I said, I don’t really know why you would characterize that as “rising . . . external surpluses.” I also have to say that I don’t think this “weak currency —> export-led growth —> reduced pressure for labor market reform” holds up very well to country-by-country analysis. It’s true that “Europe” has a current account surplus, but look at individual countries. These are the top ten current account surpluses in Europe:

– Germany: $254.5 billion
– Switzerland: $72.35 billion
– Norway: $64.07 billion
– Netherlands: $47.31 billion
– Sweden: $37.97 billion
– Austria: $12.03 billion
– Finland: $11.4 billion
– Luxembourg: $4.921 billion
– Denmark: $4.28 billion
– Belgium: $3.3 billion

Now note a couple of things about this list. One is that these aren’t just the top ten current account surpluses in Europe, it’s the only ten current account surpluses in Europe. And of them, two (Norway, Switzerland) aren’t in the European Union at all and a third (Sweden) doesn’t use the euro. More to the point, look who’s not on the list: France. The poster boy for European labor market regulations! Also Spain and Italy. Indeed, this list contains some of the countries with the most flexible labor markets in Europe (Netherlands, Denmark) while leaving out some of the most rigid labor markets. It’s true that Germany has inflexible labor markets and a large current account surplus, but there’s no wider pattern to that effect.

Long story short, there’s a case to be made that greater labor market flexibility in continental Europe would boost growth rates in the large continental economies. And that would be good for the world. But I don’t see any compelling reason to think this is particularly related to global imbalances.