Alcidi, Cinzia

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 Cinzia Alcidi is LUISS Research Fellow at CEPS and the co-author, with Daniel Gros, of a related 
study, Fiscal Policy Coordination and Competitiveness Surveillance: What solutions to what 
problems?, CEPS Policy Brief No. 213, September 2010 (http://www.ceps.eu/book/fiscal-policy-
coordination-and-competitiveness-surveillance-what-solutions-what-problems). This commentary 
also appeared in an abridged form in the October issue of CEPS News. 
CEPS Commentaries offer concise, policy-oriented insights into topical issues in European affairs. 
The views expressed are attributable only to the author in a personal capacity and not to any 
institution with which she is associated. 
Available for free downloading from the CEPS website (http://www.ceps.eu) ? © CEPS 2010 
Place du Congrès 1 ▪ B-1000 Brussels ▪ Tel: (32.2) 229.39.11 ▪ Fax: (32.2) 219.41.51 ▪ http://www.ceps.eu 
Competitiveness 
Treat the illness, not the symptoms 
Cinzia Alcidi 
13 October 2010 
n standard textbooks on macroeconomics, the competitiveness of a country is measured by its 
relative prices or relative production costs with respect to those in another country, adjusted by the 
nominal exchange rate. Within a monetary union, the competitiveness measurement takes a 
simplified form. Since all the member countries share the same currency, the nominal exchange rate 
equals one. Moreover, given that financial markets are highly integrated, the cost of capital should be 
the same for everyone, hence the only factor of production that matters is labour. For these reasons, 
the most common competitiveness indicator is simply the labour cost of a country vis-à-vis the rest of 
union. 
Since the start of EMU, this indicator has diverged continuously in the eurozone, with Germany 
having lower unit labour cost increases than most other members and the Southern European 
economies losing competitiveness.  
The sovereign debt crisis of 2010 has now hit the countries with the largest problems in terms of with 
falling competitiveness and growing current account deficits. The solution seems clear: the usual 
suspects need to improve their competitiveness! The official line is that the lesson has been learnt and 
the Union will force them to adopt structural reforms to improve their competitiveness and sanction 
them if they fail to comply. Yet the fundamental problem is that, like fever, a decline in 
competitiveness is just a symptom and not a cause of the true illness (which could be different from 
country to country). 
It is quite surprising that the official diagnosis has been accepted so uncritically because in fact, it 
implicitly maintains two unrealistic hypotheses: 1) that ever since the start of EMU, innovation had 
stopped in the European periphery and 2) in those same countries, trade unions had succeeded better 
than anywhere else at achieving unjustified wage increases. It is a priori unlikely that this disease of 
low productivity and distorted labour markets should have hit only one part of the euro area.  
Our own research suggests a simpler explanation. In several countries on Europe’s periphery, 
domestic demand increased dramatically following the creation of the monetary union, fuelled by the 
availability of easy credit. This resulted in lower employment and thus in higher wages. By contrast, 
other countries like Germany, where demand had been low over the previous decade, experienced 
falling wages.  
I 
 2 | Cinzia Alcidi  
On the one hand, if excess credit and demand were at the root of the problem, then the cure requires 
tight credit conditions and falling demand. While this treatment will be painful, it is already well on its 
way, given that domestic demand is now falling rapidly throughout Europe’s South. Structural reforms 
will of course be useful, but experience suggests that the main way in which the countries in trouble 
regain competitiveness is by keeping their labour markets weak, which will make wage hikes 
impossible. 
On the other hand, now that Germany is making a strong recovery from the crisis, it is also 
experiencing a strong increase in domestic demand, which could lead to substantial wage increases as 
the country is nearing full employment.  
To conclude, if, as argued above, the illness comes from the combination of falling demand in some 
countries and excess demand in others, the ongoing adjustments induced by the crisis may lead 
naturally, though painfully in some cases, to greater and faster convergence than will structural 
reforms.   
 


Competitiveness: treat the illness not the symptoms

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