Friday lay day – the Unit Labour Costs obsession in Finland

Its my Friday lay day but today is going to be anything but. I am in Helsinki at present and it has been a busy few days so far. The concept of Unit Labour Costs (ULCs) is being used by the right-wing government in Finland to bash the population into submission so they can impose the nonsensical austerity. The Finnish government is trying to get rid of some public holidays and reducing wages for sick leave, overtime and working on Sundays. This is the starting point for a broader austerity attack on the public sector and the prosperity of the people. They are calling for a decline in ULCs of at least 5 per cent. The rationale is that with growth flat to negative for five years or so and the massive export surplus they had disappeared the only way to stop unemployment going through the roof is to cut labour costs relative to productivity – that is, cut ULCs. They have been caught up in the ‘dangerous obsession’ that prosperity can only be gained through ‘export competitiveness’ (whatever that actually is) and the domestic economy has to be sacrificed at the net exports altar. International competitiveness is a slippery concept at best but so-called internal devaluation is rarely a successful strategy.

Media coverage of visit to Finland so far

My visit to Finland has so far been interesting and I hope for my sponsors productive. There appears to be a growing resistance to the mindless austerity that the doctrinal government is seeking to inflict on the economy in the name of enhanced competitiveness. There have been some big public protests and there appears to be a committed group of younger activists who are gaining some headway in the public debate.

I did some interviews on Wednesday afternoon when I arrived here with some of the leading newspapers. Finns seem to read a lot of newspapers (per capita) and they still subscribe to home delivery in large proportions.

The leading newspaper is the – Helsingin Sanomat – and it is the largest national daily in Finland and Nordic countries. Its reach in terms of the population makes it “a significant factor in Finnish society and in public opinion”.

It is pro Eurozone. I am reliably told that its editorials are strongly neo-liberal in leaning but that its columnists have somewhat more freedom to develop pluralistic themes.

It also has a very large WWW presence in Finland reaching around 30 per cent of the population.

They published by interview with them (October 8, 2015) – Australialainen taloustutkija: Euroalue on joukkopsykoosissa. It was very cold when they took some photographs!

I won’t translate the article word for word, but my Finnish friends were very happy with the content especially given the right-leaning editorial bias of the newspaper in general.

Another interview was published by the daily business newspaper – Kauppalehti – which “is owned by the Business Information Group” of a major media company and is published out of Helsinki.

It is a major information source for the Finnish business community. Its editorial position is “independent right” although that can be translated to be indistinguishable from ‘neo-liberal’.

The article they published (October 8, 2015) – “Suomen ei kannattaisi olla eurossa – etenkään Saksan kanssa” – was sympathetic and the progressive movement here was really pleased to be getting this sort of coverage of the alternative viewpoint (to the neo-liberal TINA).

The title translates broadly into “Finland should not be in the Eurozone – especially with Germany”.

The third newspaper – Taloussanomat – appears in on-line form only and is owned by the same group that owns the Helsingin Sanomat. Readers in excess of 650,000 per week apparently visit the site.

The article they published (October 8, 2015) was – Professori: Suomi, varo taantuman kulttia – which translates into “Professor: “Finland, beware of the recession cult”.

I have been using the term Recession Cult to describe the elites in the Eurozone. This was also a sympathetic article.

I did some another interview which have not yet been published.

Groupthink in action

An almost immediate reaction to the publication of the article in the Helsingin Sanomat came from the right-wing political machine in Finland that is also embedded in the Brussels recession cult. The newspaper is very influential it seems and needs to know its place! How dare they give the Finnish population a glimpse of a world outside the Recession Cult that promotes the neo-liberal TINA!

One character, Juho Romakkaniemi who is the Head of Cabinet for Jyrki Katainen, the current Vice-President of the European Commission under Jean-Claude Juncker, took to Facebook next morning to intimidate the newspaper for daring to publish the interview its journalist did with me on Wednesday afternoon.

Romakkaniemi is in charge of “Strategy and overall management” of the “cabinet and communications strategy” among other official sounding things that mean ‘spin doctor’ and ‘head kicker’.

He doesn’t sound as if he is a particularly nice chap. He has deep ties to the ruling Conservative Party, which is imposing increased austerity on its own people as the Finnish economy slides deeper into recession. The Party clearly doesn’t understand the most basic fundamentals of macroeconomics – Eurozone or not!

Mr Romakkaniemi wrote on his Facebook page in Finnish:

Olisi ollut kiinnostavaa kuulla kenen kutsumana ja miksi tämä pienen jälkikeynesiläisen talouskultin tutkija oli Suomessa.

Erikoisia ajatuksia hänellä ainakin oli: Isommat palkat eivät ole mikään ongelma yrityksille, vaan niiden etu. Ja valtio voisi vain työllistää kaikki työttömät niin työttömyyttä ei olisi.

Joku sanoi sen täällä eilenkin, mutta onpa erikoisia nykyisin nämä Hesarin juttu-, näkökulma- ja haastatteluvalinnat.

To make sure I understood the actual gist of his message I arranged for a Helsinki local to translate it for me.

This is what he was saying in English:

It would have been nice to know who and why this researcher from a small Post Keynesian economic cult was invited to Finland.

At the very least, he has weird ideas: he thinks that higher wages are not a problem but a benefit for companies.

Somebody said it here already yesterday but the choices that Helsingin Sanomat makes nowadays about its stories, viewpoints and interviewees are strange.

Pressure from the top on the editorial independence of the free press! Groupthink in action. This is what totalitarian states aspire to – the ‘free’ press only being a mouthpiece for the entrenched elites.

The ULC issue

The government, consistent with what Paul Krugman called the “Dangerous Obsession” in a 1994 article ((Source), takes “it for granted that the economic problem facing any modern nation is essentially one of competing on world markets, that the United States and Japan are competitors in the same sense that Coca-Cola competes with Pepsi, and are unaware that anyone might seriously question that proposition”.

This has been the IMF obsession. The EU obsession. But it fails a basic examination.

Krugman argued that:

… the world’s leading nations are to any important degree in economic competition with each other, or that any of their major economic problems can be attributed to failures to compete on world markets. The growing obsession in most advanced nations with international competitiveness should be seen, not as a well-founded concern, but as a view held in the face of overwhelming contrary evidence.

First, the analogy between a private firm that can go bankrupt if it cannot sell enough to cover costs and a nation that cannot “go out of business” is clearly flawed.

Mainstream economists tend to hold out the trade balance as a sign that a nation is competitive or not. This leads to the tendency to consider ever larger trade surpluses are positive and to be pursued.

But giving away ever increasing quantities of real resources to foreigners in return for claims on their financial assets (which is what a growing trade surplus entails) is hardly a sign of strength if the domestic economy is compromised by low real wages growth relative to productivity, for example.

Depressing domestic demand via austerity will reduce imports and eventually push net exports into surplus. Is that a desirable outcome?

The question arises is that if you wanted to try to reduce ULCs how would you go about it? Well first we need to understand what variables are involved.

Employment (L) is a stock and is measured in persons (averaged over some period like a month or a quarter or a year.

Stocks (L) becomes a flow if it is multiplied by a flow variable like wage rate (W). So total wages cost per period is equal to W.L.

Labour productivity (LP) is the units of real GDP per person employed or hour worked per period. That is, LP = GDP/L (if we stick to per person employed).

This tells us what real output (GDP) each labour unit that is added to production produces on average.

Unit labour costs are then (W.L)/GDP. So if the economy produces goods and services worth $1000 and total wages equal $200 over the same period then ULC would be 20 cents. Each unit of production costs the economy 20 cents of labour to produce.

The real equivalent of this term is called Real Unit Labour Costs (RULC) and if the price level that we deflate production with is P then RULC = (W/P)/(GDP/L)

The term (W/P) is just the real wage or the real purchasing power of the nominal wage and GDP/L is labour productivity. So the relationship between movements in the real wage and labour productivity gives us knowledge of how RULCs are moving.

I note that RULC is also equivalent to the wage share in the total national income. Please read my blog – Saturday Quiz – May 15, 2010 – answers and discussion – for more discussion on this point.

So to reduce ULCs, we could cut wages (W) with everything else constant. We could reduce the labour input with everything else constant. If wages (W) were growing and we were able to increase labour productivity (that is, push GDP growth faster than employment growth) then ULCs would also fall.

The problem is that internal devaluation methods focus on cutting wages (W) and assume that the other determinants will remain constaint.

But we know from the extensive research literature that when firms attack the working conditions of their workers morale sags and productivity often drops.

The ULCs may not fall at all and the nation is on the path in a race to the bottom.

Further, there is a fallacy of composition operating at two levels. First, at the international level, if all nations are engaging in austerity and internal devaluation (which is the Eurozone mantra) then they just chase each other down the drain without any relative gains.

This is especially significant given the importance of intra-Eurozone trade. Finland’s case is a bit different because its exports are heavily exposed to some non-Eurozone nations such as Sweden (the top export market) and Russia (third top). Germany is second top export market.

Exports to Russia have slumped (it was previously the second largest market for Finnish exports) because of EU sanctions against Russia over Ukraine. That slump has nothing at all to do with competitiveness considerations.

Further, Finland’s external position would improve if Germany stopped suppressing domestic demand in its economy. There is a strong income effect operating here which has nothing to do with price competitiveness.

Should Germany stimulate its own economy somewhat (and it may have to if the VW saga starts to impact on real GDP growth there), then Finnish GDP growth would improve immediately with no change in its current domestic wages and productivity relationships.

Please read my blog – Fiscal austerity – the newest fallacy of composition – for more discussion on this point.

Second, there is an internal fallacy of composition operating to. A single firm in Finland might take the view that cutting its wage levels would not seriously impact on its sales volumes overall and would therefore increase its profitability. Whether that translates into higher employment and output or just higher profits is moot. Probably the latter.

But if all firms in Finland hacked into wage levels (which is what internal devaluation is about) then there will be a serious negative impact on domestic demand. Wages are a cost (supply-side concept) and an income (demand-side concept). At the aggregate level the collapse in workers’ incomes as the government cut into wages would likely undermine domestic demand.

Then the reduction in costs to firms would be swamped by the reduction in sales and prosperity suffers.

Internal devaluation is really a casino game. The attack on workers’ incomes reduce domestic spending and introduces deflationary forces, not to mention the increase in unemployment.

The population also faces a reduction in its capacity to meet its nominal debt obligations (such as mortgages) and has to reduce spending on other goods and services to ensure they have enough nominal income left over to meet these obligations.

At the margin, some proportion of debtors do not have enough flexibility in their nominal budgets and they default, which causes further problems in the domestic economy.

The casino aspect of the strategy is that the government is really trading off the rate at which the domestic economy contracts against the rate at which exports might grow as a result of the domestic deflation in costs.

Empirical evidence suggests that for most countries the pace of contraction in the domestic economy is greater than any positive growth in exports.

In the Eurozone, it looks like only Spain has defied that usual trend over the last few years.

Further, internal devaluation is relatively indiscriminate in its impact, attacking the wages and conditions of workers in the traded-goods and non-traded goods sector alike.

So the question arises: How does the attack on the wages of teachers, hospital workers, welfare officers, bus drivers etc who all work in the non-traded goods sector feed through to stimulate export competitiveness?

The links would appear to be rather circuitous if at all. Such wage cuts would appear to be more about redistributing national income to business profits generally rather than directly stimulating firms that compete in the exports sector.

There is a strong body of evidence that suggests that the growth in a nation’s living standards is driven by domestic productivity growth rather than how its exports compete in international markets.

Consider the following graph, which shows the movements in monthly – Effective exchange rate indices – (REER) as produced by the Bank of International Settlements (BIS).

You can learn about this data from their publication – The new BIS effective exchange rate indices – which appeared in the BIS Quarterly Review, March 2006.

There was an earlier publication – Measuring international price and cost competitiveness – which appeared in the BIS Economic Papers, No 39, November 1993.

Real effective exchange rates provide a measure on international competitiveness and are based on information pertaining movements in relative prices and costs, expressed in a common currency. Economists started computing effective exchange rates after the Bretton Woods system collapsed in the early 1970s because that ended the “simple bilateral dollar rate” (Source).

The BIS ‘real effective exchange rate indices’ (REER) adjust nominal exchange rates with other data on domestic inflation and production costs.

The BIS say that:

An effective exchange rate (EER) provides a better indicator of the macroeconomic effects of exchange rates than any single bilateral rate. A nominal effective exchange rate (NEER) is an index of some weighted average of bilateral exchange rates. A real effective exchange rate (REER) is the NEER adjusted by some measure of relative prices or costs; changes in the REER thus take into account both nominal exchange rate developments and the inflation differential vis-à-vis trading partners. In both policy and market analysis, EERs serve various purposes: as a measure of international competitiveness …

If the REER rises (falls) then we conclude that the nation is less (more) internationally competitive.

The graph shows the movement in real effective exchange rates from 2005 to August 2015 for Germany (red), Australia (purple), Iceland (green) and Finland (blue).

I included Australia and Finland because they are two small, open economies which float their exchange rate, as distinct from Finland and Germany which do not float as a result of surrendering their currency sovereignty.

Australia is interesting. It experienced major declines in international competitiveness, as the boom in terms of trade pushed the exchange rate up after a temporary lull during the GFC. As the commodity prices boom has tapered the Australian dollar is falling swiftly and competitiveness is rising again.

However, the fluctuations in standards of living in Australia are not particularly driven by these movements.

The Eurozone nations tend to move in lockstep and so gains from measures that might be taken internally are lost

Please read my blog – Eurozone unemployment – little to do with international competitiveness – for more discussion on this point.

But Iceland is the interesting case. It had a huge collapse in 2008-09. But its government did not engage in widespread internal devaluation. Instead, the exchange rate fell sharply which gave the nation instance gains in international competitiveness.

Once the crisis subsided, you can see that the exchange rate increase has seen the REER for Iceland rise again somewhat.

The point is that gains to international competitiveness (if that matters) are much better achieved by allowing the exchange rate to move in response to external imbalances that the markets want to redress than attacking the local wages and conditions.

First, depreciation impacts on all import prices. The nation as a whole has to take a real income loss and then the question is how is that shared.

Notwithstanding the fact that exports then become more attractive to foreigners, the depreciation also gives domestic residents and firms an incentive to substitute away from those goods where possible.

So when the AUD is weaker, we travel less overseas and take holidays within Australia. This boosts domestic demand and sustains employment.

Firms have an incentive to alter production or engage in new product innovations. I have noted before that Greece, for example, exports its world class olives to Germany and Italy for processing into olive oil. If their exchange rate depreciated somewhat, then it would provide incentives to local processors to start up and investment would be attractive in that sector.

There are many examples such as that.

Second, depreciation does not alter nominal incomes within the domestic economy, whereas internal devaluation does. This is quite a significant difference.

Most liabilities are specified in nominal terms (for example, mortgages). If real income levels are being reduced, people who hold nominal liabilities have to reduce expenditure on some items to ensure their nominal incomes can meet their liabilities.

Depreciation of the currency in international markets provides scope for domestic residents to make those sorts of shifts in spending.

But internal devaluation directly reduces nominal incomes and makes it much harder to rearrange household spending patterns to ensure all nominal liabilities can be serviced.

It is therefore a much more damaging path to improving competitiveness.

Finally, it is clear that increasing productivity will also reduce ULCs. The Finnish government is facing an on-going recession which needs more spending to redress.

Private spending (particularly capital formation) is weak. Internal devaluation will suppress domestic consumption growth even further.

The only viable remedy is for the public sector to expand net spending (its deficit). It could increase public investment expenditure, stimulate the research and development sector, improve conditions within its education system (which are undergoing sharp cuts) – all of which would stimulate productivity growth and improve prosperity.

The problem is that it is so caught up in the weird neo-liberal Groupthink that it cannot see past its own blindness.

Please read my blog – Finland – more austerity is not the answer – for more discussion on this point.

Some further points.

Finland has always been a major producer of pulp and paper given its massive forest resources. The forestry industry overall delivers about 15 per cent of Finland’s total exports.

But in recent years the output and exports from those industries have been falling.

Has that been due to competitiveness issues? The decline is more related to structural shifts in end products that rely on paper as input.

Reuters reported (April 9, 2013) – Finnish paper exports to fall on shift to online media -report – that:

Finland’s paper exports are set to fall this year and next as more European consumers and advertisers abandon print and turn to online media due to economic uncertainty

The acceleration in the shift away from paper products has been due to “Europe’s recession”.

What about the failure of Nokia, which is brought out in almost every conversation over here as an example of how uncompetitive Finland has become because of its pay conditions and public holidays.

The reality is that we can trace a lineage of massive corporate failures of companies that were the first-movers and then lost it. Think about Sony Walkman -> Kodak -> Nokia -> Blackberry – which are all similar stories and unrelated to changes in cost competitiveness.

The companies in question failed to anticipate the shifts in consumer sentiment. Nokia was characterised by ‘too many candy bars’ (referring to the shape of their very popular phone handsets) and failed to see that the big market shifts were in favour, first, of flip-top handsets and then the software innovations (touch screen etc) that Apple brought to the market.

They could have cut their wages to the bone and still would have lost their mojo.

Nokia did not lose market share because wage rises undermined its ability to compete.

This article (September 4, 2013) – How bad calls led to Nokia’s demise – is a reasonable depiction of what happened. I have read a lot of articles about the demise of Nokia in recent years. This one is representative of what might be considered a consensus view.

As you will note the demise had little to do with wages.

1. “the Finnish phone giant grew dangerously intoxicated on its own success during the late 1990s and early 2000s. Having ridden so high for so long, it is perhaps no surprise that a degree of complacency and arrogance crept in just as had happened at Kodak and Motorola”.

2. “Such success intoxication left Nokia highly vulnerable to disruption, which soon came in the form of the smartphone.”

3. “Nokia was a company who fell prey to geographic isolation” (wrong location in the US – no synergies etc)

4. “a third causal factor in Nokia’s demise was its stifling levels of bureaucracy” – which saw its management fall behind “the curve”. In particular, it refused to introduce “color touch screens, mapping software and e-commerce functionality” and ignored its technical engineers who had “designed a wireless-enabled tablet computer long before the iPad was even imagined”.

Its research department was “disconnected from the company’s operations departments who were responsible for bringing devices to market”.

5. “Nokia’s example is a case in point of how critical it is to anticipate shifts in the marketplace and adapt before your hand is forced”.

That sounds like a management failure to me – rather than greedy trade unions undermining the competitiveness of an able company.

Various case studies I have read about the demise of Nokia and other large companies reinforce the idea that the management becomes trapped in their own Groupthink which patterns their behaviour and insulates them from reality. They become their own legends.

First Dog on the Moon and the TPP

Here is the FDOM’s take on the TPP. The cartoon is available – HERE.

Music – Reggae meets Jazz

This is what I am listening to this morning as I work. Outside (I am in Helsinki) it is currently -4 degrees and was a little colder an hour ago when I was out running in the streets.

So to warm up my numb brain I put Tommy McCook on the sound system (my iPhone!) and away we went. This is one of my favourite albums – Reggae in Jazz – which came out on vinyl in 1976. My old record was a bit worn out and I was pleased when it was finally re-issued on CD in 2013.

It features – Tommy McCook – on tenor saxophone. He was an original member of the Skatalites and moved on to head up the Supersonics. While he spent most of his life in Jamaica he was actually born in Cuba.

His tenor playing was heavily influenced by an early encounter with John Coltrane’s playing and that bebop and hardbop style was then insinuated over the Jamaican back beat and what a sound it was that emerged.

The entire horn section on this album was the best Jamaica had to offer – Bobby Ellis, Herman Marquis, Roland Alphonso, Tommy McCook, Vin Gordon. World class.

On bass is Aston “Family Man” Barrett, George Fulwood, Robbie Shakespeare. On drums – Carlton “Santa” Davis, Carlton Barrett, Michael Richards, Sly Dunbar.

Guitars are played by Bertram “Ranchie” McLean, Dwight Pinkney, Earl “Chinna” Smith. Keyboards – Ansel Collins, Jackie Mittoo.

It gets one warm just listening to it.

Saturday Quiz

The Saturday Quiz will be back again tomorrow. It will be of an appropriate order of difficulty (-:

That is enough for today!

(c) Copyright 2015 William Mitchell. All Rights Reserved.