Poland
Amid the general Eastern European malaise, Poland’s economy has been a br ight spot. In the first quarter, the economy posted positive real growth of 0.8% y/y, outperforming all other EU economies with the exception of Cyprus.

Why is Poland a stand-out? For starters, Poland’s economy did not boom to the same extent as its regional peers in the Baltics and Balkans, and therefore did not build up the same level of accompanying external imbalances, which helps explain its milder downturn. Second, as Eastern Europe’s biggest economy, Poland has a large domestic market, making it relatively less dependent on exports to ailing Western Europe. Third, the country’s flexible exchange rate and record-low interest rates have helped cushion the slowdown. Finally, Poland proactively distinguished itself from others in the region and boosted investor confidence in May by securing a US$20.5 billion Flexible Credit Line from the IMF – a special facility reserved for emerging markets with strong fundamentals. While Poland’s economy has weathered the global turmoil better than its regional peers, a rapid recovery is unlikely and the outlook is not without risks. In particular, Poland’s fiscal situation is deteriorating, which will likely push back the country’s planned euro adopt ion in 2012.

The principal current economic problem is a significant surplus of labour (world-wide), but there is either a falling or stagnant demand for labour (depends where you live). This is a long-term emerging problem which was disguised for many years - now its out in the open.

We live in an economy which has both extensive and high ‘costs’ - all sorts of things. Our wage and salary levels are necessary to ensure that we can pay for things - not just consumer goods, but mandatory services. Reducing wages and salaries will - with a short lag phase - impact on our ability to pay our mandatory service costs. This is a deflation spiral. Once it starts it is quite difficult to halt. The end result is long-term economic misery.

There are two ways out of this mess. 1. Default the debts (all categories) - and start again. 2. Inflate the money supply. Both of these options bring their own set of special problems, but continue on with the current ’soft-shoe-shuffle’ and you risk increasing, systemic, social unrest as the young have nowhere to ‘escape’ to this time.

Brian P

How can there be “trust in the process” when:

1) most of the “brain trust” (such as it is) of the government proposing “the process” is made up of the very same people who got us into this mess as a matter of explicit policy;

2) their cronies in the banking sector have been protected throughout this debacle;

3) “the process” has been characterised by a concerted effort–no doubt hatched by that very same brain trust and their allies in IBEC–to demonise the public sector (largely through their mouthpiece, the Independent Newspapers)?

Economists here can lament that the political situation is not propitious for the stern medicine that, they say, we all need. But they might have more credibility on this if more of them publicly made note of and denounced the three factors above (and not only NAMA) rather than constantly trying to ingratiate themselves to the government and the media. Twenty of you signed a letter about NAMA that got quite an echo. Where’s the collective letter denouncing the demonisation of the public service and the cronyism of the current government?

An important issue appears to be whether or not an economy wide wage cut would be equivalent to a devaluation.

For instance, would David Begg or Micheal Taft oppose a devaluation if we were not members of the euro? Or is there opposition to wage cuts based on a belief that wage cuts would not have the same or at least very similar effects to a devaluation?

It appears to me there are two arguments taking place

1) If we could, should we devalue? and,

2) Will economy wide wage cuts deliver an effective devaluation?

Would it be useful to not conflate the two questions?

Andrew raised the question of potentially different distributional effects between the two on the previous thread. Is there a reading on that?

However, the public sector contract makes this difficult and reading comments on any blog (not a representative sample admittedly) shows a strong potential for “money-burning” in that people will take enhanced risk of unemployment rather than take a perceived disproportionate pay cut. This, despite all evidence, that unemployment has such a massive effect on welfare independent of income.

Philip talks about the role unions may play in selling a devaluation to their members. Firstly, they would need to accept Philip’s analysis that this is an effective method of recovering the economy and thus accept the idea that the long-run expected value of accepting the cuts was positive. Secondly and as importantly, they would need to convince their members that this is a fairly applied pay cut. Countless studies show that people will reject potentially financially beneficial offers if they perceive unfairness. The clear debate in this literature is how people actually process different offers as being fair or unfair (in experiments its pretty easy as the fair solution is usually to share an amount like 100 euro evenly).

Related to fairness is trust. If people trusted the centralised bargaining decision processes then achieving a high employment, lower nominal wage equilibrium would be easier. Once again, the unrepresentative sample of blog commentators suggests that both trust in the process and perceptions of its fairness will make it difficult for the wage bargaining process to deliver a coordinated nominal wage reduction in current set-up.

http://ideas.repec.org/p/ucb/calbwp/92-199.html (Rabin on fairness)

http://ideas.repec.org/e/pfe29.html (Ernst Fehr’s work covers inequity aversion, bargaining, trust and related topics including the potential causal effect of trust on improving economic outcomes)

But how relevent is that empirical evidence?

We are in unchartered waters. This downturn is unprecidented in size and scope since the Great depression (possibly since the industrial revolution) and the economic controls and leavers (Quantitive easing stimulous packages etc) we are using were not around then. So any evidence from previous times must keep this in mind.

What is a cynic? A man who knows the price of everything and the value of nothing.

Oscar Wilde

Do economists understand the value of production? It seems not. These heated and one-sided discussions of wages and competitiveness are symptomatic of a beancounting exercise, rather than an example of constructive debate on the economy. It is not the price of labour nor the cost of business which determines profitability and, consequently, the creation of added value in society, i.e. economic growth. It is the organic composition of how products and services are produced. Efficiency is not dictated by price, it dictates the cost of production. Infrastructure (transport, energy, etc), regulation, innovation and investment are far more prescient issues to determine productivity.

Economies are not driven by the price of everything, they are driven by our willingness to invest in the hard slog of structural reform and our hunger for broad economic growth. Neither are evident in these discussions of wage cuts or competitveness. There is nothing inspiring in the mantra of cuts, but more importantly there is nothing positive either. The Irish economy and our living standards will only languish longer if we allow economic discussions to be dominated by the cynical imperative of price adjustment.

Imagination, innovation and ambition are missing from the vocabulary of economics. More practically, the Irish economy needs more hard-nosed discussions about the lop-sided structure of the Irish private sector (retail and tourism meh!) and our business elite’s continuing aversion to long-term risk and productive investment. As for the public sector, there is a need for a public discussion to thrash out what role the state should play in the economy. Getting the prices right may suit those with economic minds, but please leave that to sales departments

It’s hard to disagree with your point that nominal wages are often sticky (although we’re still waiting for good private sector data here), or that there is an urgent and important political and economic reform agenda beyond the labour market.

But the question remains: to what extent can wage cuts contribute to the recovery process, and over what time period?

There must be good empirical evidence internationally regarding the slope of the demand curve for labour in the short-, medium, and long-terms, adjusting for different labour market structure and institutions.

It would be very useful if this evidence could be brought to bear on the upcoming debate.

It seems to be that comparing wage and unit costs levels between Ireland and other countries is interesting, but ultimately misses the point. We have a huge surplus of labour, which will likely only be reabsorbed back into employment through an improvement in external competitiveness.

Andrew

Firstly, only around 3% earn the minimum wage though it is obviously a yardstick for setting wages in other areas.

Secondly reducing the minimum wage might be expected to help deliver a recovery, reduce unemployment and reduce distortions in the labour market.

However in this post you state that wage cuts are unlikely to deliver a recovery, that Ireland already has what is considered a free labour market and cutting the minimum wage will have a limited effect on overall employment.

I may be entirely wrong so feel free to correct any misinterpretations.

It is certainly true that the gains from devaluation may be offset by an increase in inflation. This is relevant under several scenarios. First, if all wages and prices are flexible, clearly a nominal exchange rate shift will have no real effect and all wages/prices will adjust to ensure a zero real impact. Second, if there is full employment, adding stimulus via devaluation will be mostly absorbed via an increase in demand-driven inflation (Ireland during 1999-2001 when the euro fell a lot against the dollar). Third, if devaluation is accompanied by a loss of monetary control, then the same regime that devalues may also deliver a higher inflation rate.

For a country with lots of unemployment and that is a member of a monetary union (so that the monetary regime is externally secured), the risk that devaluation will be quickly eliminated via inflation is not too high. This is the European experience in 1993: inflation did not budge for those countries that devalued. It is also the experience of countries such as Argentina that undertook devaluation when unemployment was high (sure inflation rose in Argentina but it was much lower than the scale of the peso devaluation).

Regarding Liam’s point, I discussed this type of evidence in my recent ESR article. It indeed seems to be fairly robust that nominal wage reductions are rarely used to address firm-specific problems. But that is not the current scenario, whereby there is a big macroeconomic problem and the standard prescription is devaluation. The support of the union movement in explaining why wage cuts are helpful would be valuable in convincing workers to overcome resistance to nominal wage reductions.

http://cowles.econ.yale.edu/books/bewley/tfb_wages.htm