Caution: Falling wages

By Nick Malkoutzis

So this is what it?s come down to. The negotiations over wages in Greece due to take place over the next few days will be a defining moment of this crisis, not because a reduction in the minimum wage or cuts to private sector salaries will make a huge difference to the economy but because it is a test of whether those involved in the process ? labor unions, employers, the government and the troika ? are prepared to face the truth. It is test of whether someone is willing or able to step forward with some kind of coherent plan.

It doesn?t take long to think of several good reasons why reducing private sector wages during a deep recession seems a suicidal idea. They include the fact that it would further undermine withering domestic demand and likely precipitate the closure of more businesses on top of the 38,000 that have shut down over the last two years. The more fiscally minded might point out that lower wages means lower tax revenues, which has a heightened relevance at the moment given that recent figures showed Greece raised 50 billion euros in revenues in 2011 compared to 50.8 in 2010 despite imposing a raft of new taxes.

Also, the troika-inspired austerity measures and Greece?s ham-fisted handling of the crisis have done a good job of shrinking the Greek economy over the last couple of years, making the country?s external debt grow in comparison. A wage reduction would perpetuate this cycle.

However, proponents of wage cuts argue that a reduction in labor costs would help make Greek exports more attractive and profitable while helping draw investment to Greece. Through this prism, revenues would flow into the country, production would take off, jobs would be created and the state of public finances would improve.

It sounds idyllic but it?s based on the principle of everything else being equal. In Greece?s case, everything else is very much unequal.

Those who repeat the greater-competitiveness-through-lower-wages mantra focus on the country?s unit labor costs, which is the average cost of labor per unit of output. In its simplest terms, this theory argues that the cheaper your goods and services are to produce, the more competitive you will be. In Greece, unit labor costs rose for most of the previous decade. Although labor productivity grew as well ? often outpacing the eurozone average ? some Greek products and services were priced out of the market.

However, using just unit labor costs (ULCs) as our guide to Greek competitiveness, progress should have been made over the last two years as ULCs have been dropping dramatically ? quarter after quarter ? since the beginning of 2010. This is a reflection, in part, of the wage cuts that have already taken place in the private sector and the downsizing at thousands of businesses.

This suggests that those arguing for wage cuts are either unaware or choose to ignore what is actually going on in Greece?s private sector. They forget, for instance, that the government passed a law last year allowing companies to set aside the collective labor contracts and negotiate with their employees individually or in-house pay deals lasting up to three years. Many companies have availed themselves of this reform to reduce their workers? salaries over the past few months. Wage cuts of 10 to 20 percent in the private sector have been the norm.

The only guide for these companies is that pay should not fall below the minimum wage of 751 euros (gross) per month and that full-time employees should have their wages split into 14 monthly payments. However, both of these rights are now on the chopping block despite Greece?s minimum wage being one of the lowest in the eurozone and its average annual salary (17,500 euros gross) being at the bottom end of the countries in Organization for Economic Cooperation and Development (OECD). The OECD also estimates that social security contributions account for almost 35 percent of the labor cost in Greece. This is roughly double the rate for the UK, three times the Danish percentage and a little higher than in Germany.

That?s why labor unions and some employers have suggested that labor costs should be brought down through a reduction to social security contributions. This is not an ideal solution either as social security funds also have serious financial problems, which will be exacerbated when the Greek bonds they hold suffer the haircut agreed as part of the Private Sector Involvement (PSI) deal needed to secure Greece?s next bailout.

However, unions are adamant that a wage freeze for the next few years and reductions to social security contributions are the only concessions they will make. They argue that even on issues such as the minimum wage, which unions are flatly refusing to negotiate, compromises have been made. Legislation passed last year allows employers to pay workers under 25 years of age 84 percent of the national minimum wage. This means young people can be paid salaries starting at 592 euros a month.

These facts seem to have eluded those who argue that lower wages would act as an incentive to Greek businesses to hire people. Were this the case, surely firms would be snapping up young, able, educated Greeks for the bargain price of less than 600 euros per month. Instead, youth unemployment has passed the 40 percent-mark.

The reason these salary reforms did not have a discernable impact is that Greece will not find the growth, jobs and competitiveness it seeks at the bottom of the wage barrel. Just as proponents of lower wages take little notice of the realities of the Greek private sector, so they disregard the way the Greek economy is structured and what?s really holding competitiveness back.

There is no doubt that Greek wages have risen over the past decade and that this has played a part in eroding competitiveness. In an experience shared by other eurozone periphery countries, euro membership sparked a drive to catch up with salaries and living standards in core members. This meant that between 2001 and 2009, real wages per employee increased by 26 percent whereas labour productivity went up by 22 percent, according to Eurostat figures. As a result, nominal unit labour costs in Greece compared to 35 of its trading partners went up 20 percent.

However, unit labor costs only tell part of the story because comparing Greek ULCs against Germany, for example, serves little purpose given that the two countries are not direct competitors. Germany does not compete with Greece in its major industry ? tourism ? and Greece cannot compete with Germany in, say, car manufacturing. When compared with its direct competitors, Greece?s loss of competitiveness as a result of wage rises is actually fairly low. A study conducted by Eurobank EFG?s research unit in 2010 found that when measured against its six major competitors in tourism, wage competitiveness in Greece?s service sector declined by only 5 percent since 2000, compared to a deterioration of 19 percent when compared against Greece?s 12 major trading partners in manufacturing goods.

The Eurobank team made another interesting discovery, which was that the loss of competitiveness was greatest in industry and agriculture but not solely as a result of wage increases. They found that when the evolution of prices and unit labour costs in the industrial sector were compared, it suggested that Greek industries ? taking advantage of the fact that oligopolies dominate a number of markets ? had increased their profit margins by 4 percent since 2000, as prices of their goods had increase by 24 percent and wages by 20 percent. In the meantime, industrial profit margins in Greece?s main trading partners had fallen by 16 percent.

During the same period, prices for Greece?s agricultural products rose by 30 percent relative to the country?s 12 major trading partners. European Union subsidies and pampering from successive governments fuelled a dramatic drop in productivity and competitiveness in this sector.

It is also worth noting that ? paradoxically ? the crisis has to some extent helped Greek competitiveness. About half of the country?s exports and its tourism services are provided to customers outside the eurozone. The fact that the euro has descended to an 18-month low against the US dollar has helped Greece?s price competitiveness.

When Prime Minister Lucas Papademos broached the subject with unions and employers earlier this month, he was careful to identify wages as just one of several factors that define Greece?s competitiveness. Others included corruption, a fair tax system and the inefficiencies of the country?s public administration and justice system. Even this does not tell the whole story.

It does not begin to explain the insularism and amateurism of much of Greek business and what part this has played in undermining competitiveness. For instance, the European Commission?s 2011 Innovation Union Competitiveness Report found that Greek private sector investment in research and development and innovation was one of the lowest in the eurozone. It also highlighted that despite having a growing number of researchers and doctoral graduates, Greece only employs 4.2 researchers per thousand, compared to the EU average of 6.3.

The areas of the Greek economy that displayed growth over the last decade were services (mainly tourism and shipping) and some low-tech production. Greece is paying the price for failing to organize its production and invest in the future of its economy. Innovation and entrepreneurship were shunned in favor of the fast, or borrowed, buck. Only 22 percent of Greek businesses innovate, while only 45 percent of the country?s largest corporations export, according to the Foundation for Economic and Industrial Research (IOBE), an economic think-tank. Too often, Greek business was unable to envisage tomorrow?s world and discover profitable forms of production or unearth promising synergies with other local producers. It was every man for himself but in the end we all fell down.

But then again, who would be a producer in Greece? Why put up with an obstructive public administration when you can have a much smoother ride elsewhere? No amount of wage cuts can make up for the fact that doing business in Greece is an inexcusably hard task. As long as this remains the case, Greece will not be able to establish a production base or generate the kind of investment that would make it competitive. The World Economic Forum?s 2011-2012 Global Competitiveness Report (which ranks Greece 90th out of 139 countries) found that the biggest obstacle to doing business in Greece is the inefficient government bureaucracy. Just over one in five respondents identified this as the biggest problem, while 11.8 percent cited tax regulations as an obstacle.

In both cases, the state?s failure to address its own weaknesses has acted as a disincentive to business and dealt a blow to the country?s competitiveness. The World Bank?s 2012 Doing Business Report ranks Greece as 100th out of 183 countries in terms of ease of doing business. Despite reforms to speed up the process of starting a business, Greece still performs poorly. It also loses marks for the lengthy and complicated processes involved in getting electricity and registering property. Meanwhile, attempts to open up closed professions, where newcomers face inexplicable barriers to entry, have dragged on interminably. For example, almost two years after the process began, road haulage and taxis, have yet to be fully liberalized. The lack of genuine competition can be nothing but a barrier to greater productivity and competitiveness.

What really lies behind Greece?s lack of competitiveness is partly a failure of its private sector but mostly a dereliction of responsibility on the part of its public sector. So, in effect, what Papademos is proposing is that private sector workers make sacrifices to account for the government?s inability to address public administration shortcomings. This would be galling at the best of times but the fact that it comes on the back of two years during which these same private sector workers have been paying ? either through job losses or higher taxes ? for public sector deficiencies and decision makers? failure to address them is potentially inflammatory.

The government has threatened to pass a law reducing the minimum wage and private sector salaries if the unions and employers fail to reach an agreement or if the deal is not the one policymakers are looking for. This would compound the clumsy handling of the issue and would be a red rag to an already enraged sector of society. In Greece, unions and employers have only had the freedom to negotiate collective contracts since the early 1990s, before which the government set wages. To undermine them now would take Greece much further back than just a couple of decades.

If the government or the troika wants to talk about wages and competitiveness, fine, let?s talk about it. But they?d also better talk about exactly how much they think wages should be reduced to increase competitiveness. And they?d better have a realistic plan for how this will contribute to growth and job creation in Greece. The onus is also on them to define competitiveness ? for example, compared to whom and in which sectors? Also, if we?re going to talk about wages, let?s also talk about production, profit margins, innovation, social security contributions, public administration and economic policy because that is where the key to Greek competitiveness really lies.

If labor rights and wages, which have been repeatedly eroded for the past two years, are to be compromised further then it had better be for something more than a gesture. Anything less than a coherent, substantiated plan will stink of an attempt to disperse the responsibility for failure to tackle this crisis among as many people as possible. Without a clear vision of how lower wages would help Greece and improve the lot of its citizens, this move would simply be collective punishment for an unidentified crime.

[Kathimerini English Edition]