There are several big bubbles driving the global economy and its financial markets. There are the twin bubbles of US household debt and house prices, driven by easy money. And there is the Japanese government bond bubble, fed by excess savings and cheap credit. But the next great bubble in the world is continental European (principally German) labour. This euro wage bubble is sustained by sticky prices and state subsidies.
One by one, these bubbles will eventually burst. Financial asset allocation over the next year or so will depend on how they burst and when.
In Europe, consistent growth of private sector credit above European Central Bank targets tells a hidden tale of EU corporations (which stopped investing aeons ago) financing the high cost of their labour (and the cashflow deficits caused by the labour cost bubble) with bank credit. And Europe’s overpriced labour markets are in some respects similar to the US service sector, which has also managed to overpay its workers and overcharge its clients for very poor productivity, simply because it has not had to compete globally.
Europe’s bubble is different because it is not a balance-sheet bubble but a profit-and-loss item in the greater economic scheme of things. Rigid labour markets created it. These are a part of Europe’s social contract. And the state plays two roles in keeping the bubble pumped up. It ensures that corporations can get back what they overpay workers by enjoying considerable pricing power for their products within small, politically segmented, national markets, where competition is minimized. That’s why, despite all the deflationary forces, EU inflation remained stubbornly higher than ECB targets, until recently.
Despite the slow dawning of single-market competition, European multinationals can still price the same product at vastly different levels in each EU market (as with cars, for example). Also, for those without jobs, the state ensures that living standards stay relatively high, which is why government spending is so big and taxes so burdensome.
The only way that this model can collapse is if the state’s burden of maintaining social peace in a jobless economy becomes too great to tax for. Competition is what will cause this to happen, by depriving the corporate sector of the economic rents needed to finance its share of economic stasis. This would force the corporate sector to fire people wholesale, so transferring the social cost of labour from its profit-and-loss accounts to the government budget.
Instruments of doom My money is on this starting to happen now, with the doomsday instruments being the combined forces of new deflation and the rising euro. New deflation brings the rich (expensive) economies head to head with the new hyper-competitive production platforms of Asia. And they are competing not only in low value-added products, but also increasingly in high added-value products and services, traditionally the province of Europe and the US.
| Multiple of unit labour cost over that of China |
What makes China a killer competitor, for example, is that it increasingly has the means to produce highly skilled (and therefore highly productive) labour that is also very cheap. China’s development model works by redeploying huge numbers of workers from traditionally labour-intensive agriculture into the modern economy at high speed. Such projects as the mega infrastructure development surrounding the Three Gorges Dam are the means of achieving this. The slice of humanity destined for modernization over the next 10 years comprises about 250 million people (the size of the working population of Europe) to be transferred from farm to factory.
As the Chinese masses are moved from unproductive sectors to productive ones, their output per capita will rocket towards European corporate levels (but not their wages), because the factories they work in are pretty much state of the art.
Currently, the productivity level of Chinese industrial workers (including the state enterprises that account for 45% of industrial employment) is only 7% of that of European workers. But with Chinese wages so low, unit labour costs in Europe are five times higher. And if Chinese industrial productivity were to reach 50% of a European factory’s, Europe’s unit costs would be 33 times higher, and China’s share would rise five-fold to one-fifth of total world trade.
The labour forces of rich countries have nowhere to hide from the forces of new deflation, except behind protectionism. No feasible movement of the Chinese renminbi exchange rate (or fall in the dollar or euro) provides any palliative or protection for the overpriced labour forces of Europe, the US or Japan.
The days of Europe’s high wages and substantial benefits are numbered. The cold wind of competition from Asia is set to blow away Europe’s wage bubble.
