Analistas 16/06/2015

Euro troubles don’t just affect southern countries

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If you look at the numbers on The Conference Board’s website (bit.ly/1dpcMmr), you’ll find that Finland has indeed seen a rapid rise in unit labor costs, but not because of a wage explosion - it’s all about collapsing manufacturing productivity.

But the broader story here is that we’re increasingly seeing that the problems of the euro extend well beyond the troubles of Southern European debtors. Economic performance has also been very bad in some Northern nations with good credit ratings and low borrowing costs - including Finland, the Netherlands and Denmark (which isn’t on the euro but shadows it).

What’s going on?

Well, in the case of Finland we’re seeing the classic problems of asymmetric shocks in a currency area that isn’t optimal. Finland’s two main export sectors, forest products and Nokia products, have tanked. This creates the need for a sharp fall in relative wages to make up for the lost markets, but because Finland doesn’t have its own currency anymore, this adjustment must take the form of a slow, grinding internal devaluation (which is, by the way, why the garbled discussion of wages turns the F.T. story into nonsense).

The problems of the euro, in other words, weren’t caused by an outbreak of fiscal irresponsibility that won’t recur if the Greeks can be brought to heel.

The problems weren’t even, in a deep sense, the result of big capital flows that won’t come back again. The whole single currency project was flawed from the start, and will keep generating new crises even if Europe somehow gets through this one.

The Finnish Disease

It’s worth emphasizing just how bad Finland’s performance has been. For Finns, the great depression they remember is the slump that happened at the beginning of the 1990s, which was driven by a combination of a bursting housing bubble and the collapse of the Soviet Union next door.

The result was a very nasty slump and a delayed recovery. But this time, although the slump in per capita gross domestic product hasn’t been quite as deep, it has been far more persistent.

Why can’t Finland recover this time? Debt isn’t a problem; the country’s borrowing costs are very low. It’s all about the euro straitjacket. In 1990, the country could and did devalue, achieving a rapid gain in competitiveness. But this time there is no quick way to adjust to adverse shocks.

This shouldn’t come as a surprise - it’s the core of the classic Milton Friedman argument for flexible exchange rates, and in turn for the trade-off at the center of optimum currency area theory. The trouble in Finland is indicative of what everyone expected to go wrong with the euro.

The trouble in Greece, meanwhile, represents a whole additional level of hurt, which nobody saw coming. But it’s important to realize that even countries that didn’t borrow a lot, didn’t experience large capital inflows and basically did nothing wrong by the official criteria, are nonetheless suffering in a major way.

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