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Tuesday, April 08, 2003
Thank You Brad Delong
Just a word of thanks to Brad Delong for his continuing confidence in me: Semi-Daily Journal. The reference to Pygmies in the title is, I think, an allusion to the work of Luigi Cavalli Sforza - who really should be on everyone's list of "must read" - and to my admiration for him as the kind of scientist who gets out of the office to follow-up a long-shot hunch, in this case among the Pygmies of the African tropical rain forest. Anyone looking for more substance behind my arguments about Germany could do worse than check out Euro Watch where I bring-together my euro-related posts. On the Harrod-Balassa-Samuelson effect, I'm afraid you'll just have to check back later this week for a more considered opinion, because I'm still putting my thoughts together about the scandalous way a relatively sound idea is being used to justify extremely preoccupying inflation in Spain, Portugal and Greece.
Meanwhile, and by way of a hint, the core of what's worrying me in the way the argument is being used is this. Brad (and I think in this he is only reflecting what he feels is the Brussels 'conventional view') in an earlier post (here) says: "As time passes, and as the European periphery becomes richer and richer, its real exchange rates vis-a-vis the European industrial core have to rise". Now this idea of the periphery becoming richer and richer (relative to the core) is based on some growth theoretical assumptions which might well be extremely suspect. Rather than the model of all countries converging to a common homogeneous type, what we may have is a centre/periphery dependence based on an inter-relation of economies with different structural characteristics. The Southern Three (Spain, Portugal and Greece) have economies which are driven by construction and tourism, Germany and France have large machinery, equipment and technology components in the traded sector. These economies are not 'converging' in any meaningful sense of the word. A look at the 'Asian' model, Japan, the four 'tigers', and now China, is instructive in this sense. This model exports manufactured products to acquire strategic capacity which is then put to good use. This is not happening with the Southern Three whose structural dependence is inbuilt.
If you look at the tradeable and non-tradeable sectors you will see that, as theory predicts, productivity is higher and inflation lower in the tradable sectors. But it is what is happening in the non-tradeable sectors - low productivity growth and high inflation - that is preoccupying, since these form an important part of the cost structure of the tradeables, and their impact must be felt eventually, as non-tradeable sectors gradually get traded by importing from cheaper sources (look at Spain's ballooning current account deficit for one). Normally this problem would be resolved by a devaluation of the currency, but with EMU.......?
Equally the orginal rich-getting-richer argument could now be displaced to the new 'Eastern' entrants (who remember are not in the euro). The standard use of the H-B-S effect could serve to justify the idea that price deflation should now also take place in the Southern Three as the new entrants close to converge. This argument would have a lot more logic to it as they may well be more direct FDI competitors with the Southern Three. In fact the main impact of the euro in the Mediterranean countries (where, remember, negative real interest rates exist, and the savings accounts are quietly emptying-out as everyone sinks their money - possibly irretrievably - in concrete) is that the central core economies serve as guarantors for debt liabilities on the perifery. If Europe was one state this might work, but in a Europe of rising political tensions and lacklustre economic performance it is hard to see the centre being held fortune to the moral hazard presented by the perifery. One day the markets will wake up to this fact, and the willingness of the core to sacrifice for the periphery will really be put to the test.
And if you still have lingering doubts, remember Japan is a country with high tradeable productivity, low internal productivity with high prices, and ageing population. This will soon also characterise the much poorer Mediterranean three. But look what is happening to Japan. If you still feel I haven't made my case, as I said, check back at the weekend.
Posted by Edward Hugh at 8:08 AM