Improved Structural Competitiveness or Deep Recession?

One of the main problems facing the European Monetary Union is the macroeconomic imbalances between ‘core’ and ‘peripheral’ member states. Though they predated the union’s creation, these problems were highlighted between 1999 and the advent of the international financial crisis. One significant  indicator  of  these  imbalances  is  the  often  divergent  trade  and  current  account  disequilibria of these two groups of countries. With the events of 2007-­‐08 and the subsequent ‘flight  to  quality’  of  financial  capital,  the  current  account  deficits  of  ‘peripheral’  member  states  became unbearable. By the end of 2014, all ‘peripheral’ countries had eliminated or drastically reduced  their  deficits.  We  show  that  this  result  is  more  dependent  on  the  contraction  of  their  GDP and relative reduction in their average real wages than on a productivity increase in their economy.  To  reach  this  conclusion,  the  paper  empirically  describes  the  determinants  of  the  structural  evolution  in  trade  and  current  account  imbalances  and  then  offers  econometric evidence of the impact of different components of unit labor cost on net exports. Based on this evidence,  the  paper  points  out  the  fragility  of  the  European  adjustments  and  suggests  some  policy implications.