January 26, 2010 / 5:48 PM / 10 years ago

Competitiveness gaps could hurt euro -EU exec

BRUSSELS, Jan 26 (Reuters) - A new European Commission report has expressed concern about gaps in competitiveness that could undermine confidence in the euro zone and point to tensions related to wage levels and capital flows in the 16-member club.

Among other things, the report suggests the real effective exchange rate for Greece, Spain and Portugal is overvalued by more than 10 percent — an indication of how much wages in these countries would have to fall, or productivity rise, to make them competitive again, given that they are locked into the euro.

Large and persistent differences in competitiveness across the zone are a serious concern and can undermine confidence in the single currency, the Commission said.

“Competitiveness divergences within the euro area may hamper the functioning of the Economic and Monetary Union, because of large trade and financial spillovers across Member States,” said the note from the European Union’s executive arm, prepared for the last euro zone finance ministers’ meeting on Jan 18.

“In particular, the persistence of large cross-country differences jeopardises confidence in the euro and threatens the cohesiveness of the euro area,” said the note, obtained by Reuters.

It sums up a 172 page Commission report on competitiveness in the 16 countries using the single currency, which was also seen by Reuters.

The differences in competitiveness are reflected for example in current account deficits or surpluses in the eurozone.

The Commission estimates Greece had a current account gap of 8.8 percent of GDP last year, Spain 5.4 and Portugal 10.2 percent. Cyprus had a current account gap of 11.6 percent while Germany had a surplus of 4 percent, Luxembourg 9.4 percent, the Netherlands 3.1 and Finland 1.1 percent.

The note said that the accumulation of large current account deficits could not be sustained forever and that they entailed a build-up of external and private sector debt.

“If they remain unaddressed, the eventual correction can be abrupt and highly disruptive not only for the countries concerned but also for the rest of the euro area,” it said.

“The combination of competitiveness losses and the excessive accumulation of public debt in some Member States are worrying in that context,” the note said.

TENSIONS

Because of rigidities in labour and product markets, regaining lost competitiveness will be long and painful, but the longer the adjustment is postponed the higher the ultimate cost will be, the Commission said.

The Commission said that in the 10 years before the financial crisis, the competitiveness of, for example, Germany and Finland against other euro zone members steadily rose, while competitiveness of Ireland, Greece, Spain or Portugal fell.

“The divergence trend observed in the early years of euro reflects a worrying build-up of a range of domestic imbalances in some Member States,” the Commission said.

While the report suggests the real effective exchange rate for Greece, Spain and Portugal is overvalued, it says Germany’s was 5.1 to 3.1 percent undervalued last year, indicating the slack companies have or the scope for wage increases.

It said that most indicators of price and cost competitiveness pointed to a further divergence in competitiveness in the many euro zone countries during the financial crisis and in the early stages of the recovery.

The only clear signs of rebalancing come from Ireland gaining in competitiveness in 2008 and 2009.

“A smooth adjustment of intra-euro area competitiveness divergence and macroeconomic rebalancing is key for the recovery and, more generally, for the economic resilience and a smooth functioning of EMU in the long term,” the Commission note said.

“It is therefore essential that Member States put in place an ambitious and comprehensive policy response geared at speeding up and improving intra-area adjustment mechanisms.”

It said tackling the differences would have to be tailored to individual countries but that such efforts should be coordinated within the euro zone to make the work easier.

It said fiscal policy should make sure not to hinder adjustments in competitiveness by preventing the necessary relocation of labour and that countries with large current account gaps should swiftly move to consolidate public finances.

“The successful adjustment of intra-euro area competitiveness divergence and macroeconomic imbalances is of vital importance for the long-term functioning of EMU,” the Commission said.

Reporting by Jan Strupczewski, editing by Patrick Graham

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