Blog Post

On the efficacy of internal devaluations: answers to the questions of Kevin O’Rourke

Kevin O’Rourke kindly drew attention at http://www.irisheconomy.ie/ to my recent Bruegel Policy Contribution titled “Compositional effects on productivity, labour cost and export adjustments” and asked four questions. In my answer I would like to show some charts – but as I cannot post charts at the Irish Economy blog, I post these charts at Bruegel […]

By: Date: June 25, 2012 Topic: European Macroeconomics & Governance

Kevin O’Rourke kindly drew attention at http://www.irisheconomy.ie/ to my recent Bruegel Policy Contribution titled “Compositional effects on productivity, labour cost and export adjustments” and asked four questions. In my answer I would like to show some charts – but as I cannot post charts at the Irish Economy blog, I post these charts at Bruegel Blog.

Question 1: What happens when you calculate a composition-adjusted real exchange rate index for Ireland vis à vis other eurozone members only?

Figure 1 below shows that since 2008Q1, the difference between the developments of the real effective exchange rate (REER) calculated against euro-area partners only and 30 trading partners is not large: the former depreciated by 12 percent, the latter by 14 percent. In both cases the increase in unit labour costs (ULC) of trading partners played a major role, in addition to Irish ULC falls. The nominal effective exchange rate is constant by definition against euro-area partners and had limited role when considering 30 trading partners.

There is a more significant difference between the intra-euro and the total REER when we look at the 2000-2008 period, largely due to the appreciation of the euro from about 2002.

Note that the 30 countries I consider comprise 85 percent of Irish trade. The distribution within these 30 countries is the following: euro-area 39 percent, UK 22 percent, US 23, Japan 7 percent, others 9 percent.

Figure 1: Business sector excluding agriculture, construction and real estate activates: main components of the Irish unit labour costs based real effective exchange rate (using constant weights; 2008Q1=100), 2000Q1-2011Q4


 

Question 2. What happens if you include agriculture in the index? This is an important traded sector in the Irish context.

Question 3. What happens if you do both 1 and 2?

Let me respond to both questions by showing the REER and its components for the agriculture alone (Figure 2). The data looks noisy, yet after a temporary decline in 2008-2009, the REER has appreciated somewhat (just a cumulative 1 percent if we consider 30 trading partners, but 11 percent when considering euro-area partners only). Therefore, for the business sector the cumulative REER depreciation from 2008Q1 to 2011Q4 is somewhat less if agriculture is included, but not much less, because the share of agriculture in the value added of the business sector excluding construction and real estate was only about 2.5 percent.

Figure 2: Agriculture: main components of the Irish unit labour costs based real effective exchange rate (2008Q1=100), 2000Q1-2011Q4

Question 4. One of the most striking graphs in the paper is Figure 2 on p. 6, which shows that while manufacturing value added has risen by 30 percent since the start of 2008 (thanks to what happened in the pharmaceutical sector), gross production has only risen by 5 percent. Can we make further progress in understanding this discrepancy (there are some helpful suggestions in the paper), and what might this tell us about the movement in Irish unit labour costs and real exchange rates since the crisis began?

Unfortunately, I cannot add more observations on the reasons for the discrepancy – and even acknowledge that the four possible explanations listed in my paper were suggested by the Irish economists I thank on the cover page.

But I can highlight that the assessment of this issue is severely hindered by the lack of publicly available data. Ireland is among the few EU countries for which manufacturing sub-sectoral gross value added is available only in current prices, but not in constant prices (I used Eurostat data). Constant price value added data is available only for the total manufacturing industry and therefore one cannot assess the discrepancy between vale added and gross production at the sub-sectoral level.

Deflators may also play a role (the fourth item listed in my paper), which, consequently, also cannot be assessed at the sub-sectoral level. For the total manufacturing Figure 3 compares the deflators of some countries. The deflators of Ireland, Sweden and the UK showed a similar pre-crisis pattern, which very much differed from the euro-area total – but at least Ireland is not unique in this regard (and deflators are certainly impacted by the sub-sectoral composition of manufacturing).

Since 2008Q1 Irish manufacturing prices fell the most and the trend is in line with the pre-crisis trend. In the UK and Sweden the depreciation of the nominal exchange rate may have contributed to the fall in the deflator. And in Sweden the deflator went up recently, in line with the appreciation of the nominal exchange rate.

Understanding the reasons for the developments of the Irish manufacturing deflator – and having data for sub-sectoral deflators – would help a lot in answer Question 4 of Kevin O’Rourke.

Figure 3: Deflator of total manufacturing value added (2008Q1=100), 2000Q1-2011Q4

Finally, since several bloggers commented public sector wages, also asking what happened in southern euro-area members, let me show a chart on this as well. The left-hand panel of Figure 4 suggests that public servants in Ireland are well paid compared to other sectors of the Irish economy, apart from financials. (Btw, Irish real estate agents take home little, at least as reflected in official statistics.) The right hand panel shows that Irish public servants earn much more per hour than their colleagues in southern Europe, yet Ireland has a much higher income per capita as well, which explain at least part of the difference. Public sector wages declined significantly in Greece from the peak in 2009, yet in all four countries public sector wages are broadly at their late 2007 levels.

Figure 4: Hourly labour compensation ( per hour), 2000Q1-2011Q4

Note: hourly labour compensation was calculated as the ratio of total labour compensation to total hours worked, as reported in the national accounts database of Eurostat.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More on this topic More by this author
 

Podcast

Podcast

REOPENING EUROPE - Reopening Common Good?

What should be the ground rules to support more sustainable business in a post-pandemic world?

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: August 12, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

REOPENING EUROPE - Reopening Tourism?

In this episode we unpack some reflections about tourism we have collected during the Reopening Europe journey.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: August 5, 2020
Read about event
 

Upcoming Event

Sep
1-3
09:00

Bruegel Annual Meetings 2020

The Annual Meetings are Bruegel's flagship event which gathers high-level speakers to discuss the economic topics that affect Europe and the world.

Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author
 

Podcast

Podcast

REOPENING EUROPE - Reopening Borders?

In June 2020, as Europe reopened after lockdown, we crossed ten national borders. We listened to diverse citizens, from passers-by to politicians, business people to artists, recording, documenting, and publishing stories.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: July 29, 2020
Read article
 

Blog Post

Is the EU Council agreement aligned with the Green Deal ambitions?

On 21 July, EU leaders agreed on a €1.8 trillion package that should boost the recovery after the COVID-19 crisis, but also contribute to the advancement of key EU societal objectives, starting with the climate transition. In this blog post we assess the green ambitions of the package and evaluate its consistency with the European Green Deal.

By: Grégory Claeys and Simone Tagliapietra Topic: Energy & Climate, European Macroeconomics & Governance Date: July 23, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

REOPENING EUROPE - Reopening Governance?

This is a summer feature of the Sound of Economics in cooperation with the Reopening Europe project.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: July 23, 2020
Read article More on this topic More by this author
 

Blog Post

Having the cake, but slicing it differently: how is the grand EU recovery fund allocated?

The European Commission’s original allocation mechanism really favoured lower-income countries and to a large extent was based on pre-COVID economic data. The modification adopted by the European Council gives more consideration to the country size and the adverse economic impact of COVID-19. As a consequence, by using the Commission’s May 2020 economic forecasts, I estimate that only Germany and France will get more grants from the EU’s recovery fund compared to the Commission’s original proposal, while other countries will get less.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: July 23, 2020
Read article More by this author
 

Opinion

The EU’s Opportunity to Turn Its Markets Toward the Future

Meeting the fiscal demands of COVID-19 will require the European Union to borrow on capital markets more than ever, and for European pension funds and households to look more widely for ways to build their nest eggs safely. The EU should take the challenges of the pandemic and Brexit as a chance to get its financial infrastructure house in order.

By: Rebecca Christie Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 16, 2020
Read article More by this author
 

Podcast

Podcast

The benefits of the single market - the case of last enlargement

As the Brexit negotiations are entering their final straight line, the question of trade agreements is heating up. Economists talk about the “cost of non Europe”. How much each country has gained from belonging to the EU’s single market? How much would it have missed out on if it didn’t belong to the single market? […]

By: The Sound of Economics Topic: European Macroeconomics & Governance, Global Economics & Governance Date: July 15, 2020
Read article More on this topic
 

Blog Post

Ukraine: trade reorientation from Russia to the EU

Over the past five years conflict has led to a deterioration of Russo-Ukrainian economic relations while ties with the EU have been deepened. This shift is evident in trade flows: the European Union has become Ukraine’s biggest trading partner, while China is poised to overtake Russia as its second. Natural gas imports from Russia, Ukraine’s prior Achilles heel, have been partially replaced by reverse deliveries from the EU and reduced as result of reform of the gas sector.

By: Marek Dabrowski, Marta Domínguez-Jiménez and Georg Zachmann Topic: European Macroeconomics & Governance Date: July 13, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

Apps without borders? How COVID-19 apps show the limits of the EU digital single market

In their toolkit against a pandemic that knows no borders, several EU countries have bet on new technology from our era of globalisation: digital contact tracing COVID-19 apps. But the way they've been rolled out illustrate troublesome limits to the EU digital single market.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: July 9, 2020
Read about event More on this topic
 

Past Event

Past Event

An EU budget for Europe's future with Johannes Hahn

How do we make the EU fit for future?

Speakers: Zsolt Darvas, Johannes Hahn and Mehreen Khan Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 7, 2020
Load more posts