Mario Draghi’s Economic Ideology Revealed?

andrew wattECB President Mario Draghi made a presentation to heads of state and government at last week’s European Council on the economic situation in the euro area. His intent was to show the real reasons for the crisis and the counter-measures needed. In this he succeeded – although not in the way he intended.

Draghi presented two graphs that encapsulate his central argument: productivity growth in the surplus countries (Austria, Belgium, Germany, Luxembourg, Netherlands) was higher than in the deficit countries (France, Greece, Ireland, Italy, Portugal, Spain). But wage growth was much faster in the latter group. Structural reforms and wage moderation lead to success. Structural rigidities and greedy trade unions lead to failure.



According to the Frankfurter Allgemeine Zeitung (FAZ), which approvingly reported on the affair, the impact of Draghi’s intervention was devastating. French President Hollande, who had earlier been calling for an end to austerity and for growth impulses, was, according to the FAZ, completely  silenced after the ECB President had so clearly demonstrated, with incontrovertible evidence, what is wrong in Europe – or rather certain countries in the Euro area – and what must be done.

Things are not as they seem, however. Draghi’s presentation contains a simple but fatal error – or should that be misrepresentation? As the note to the graphs indicates, the productivity measure is expressed in real terms. In other words it shows how much more output an average worker produced in 2012 compared with 2000. So far so good. However, the wage measure that he uses, compensation per employee, is expressed in nominal terms (even if, interestingly, this is not expressly indicated on the slides).

In other words the productivity measure includes inflation, the wage measure does not. But this is absurd. Real productivity growth sets the benchmark for real wage growth. In a country where real wages increase in line with productivity, the shares of wages and profits in national income will remain constant. By contrast, when nominal wage growth tracks real productivity growth, which is apparently the role model suggested by the ECB President, the share of wage income in national income will permanently decrease. Moreover, real wages will decline continuously, if price inflation is higher than nominal wage growth.

In a country with inflation at the ECB target (1.9%) one would expect a gap to open up between the red and blue line in the ECB president’s charts of 1.9% a year. Cumulated over the 12 years since the start of monetary union, for such a “benchmark country” the nominal wage/real productivity gap would represent almost 28%.

If Francois Hollande had been aware of this, he need not have been silent at all. On the contrary he could have pointed out that his country almost perfectly fits this benchmark: eyeballing Draghi’s chart the gap for France is about 32%. Similarly, the figure of 28% would need to be subtracted from the supposed competitiveness gaps of the other deficit countries, substantially reducing – although not eliminating – them.

Moreover, and this is the key point, using the correct figures transforms Germany from the wage-productivity paragon, as portrayed by the central bank, into what it really is: a country that has systematically undershot the stability norm for balanced growth in a monetary union, and thus been a major contributing factor to the crisis.

A case can be made that the presentation by the ECB president does indeed reveal the true nature of the crisis, albeit unintentionally. Senior economic policy-makers in the European Union are either unaware of basic economic concepts or they are intentionally using misleading – to put it mildly – figures to force policy-makers onto a course that suits their ideological preferences but which is inimical to the stability and recovery of the euro area and, in this particular case, indeed to their constitutional mandate.


  1. ALB90 says

    Great article… it just goes to show that we always must be careful with figures: one can use numbers to support basically anything, and I just regret that nobody noticed this fact on the presentation made by Mario “Goldman Sachs” Draghi

  2. says

    A worker produces a loaf of bread in year one and then makes two in year 2, all other factors unchanged, his productivity is up 100%. If wages also increase by 100%, there is no net gain or loss in productivity in the world he lives in. However, if his wages go up by 200% when he only produces 2 loaf of bread and not 3, then his net productivity is negative. I believe that’s what Draghi was trying to show.

    The consequence of this gap in net productivity in EuroZone separates the “over valued” region, such as Greece, Italy, France etc. from the “under valued” region such as Germany where net productivity increases are higher.

    That gap over time has had real economic consequences as we have witnessed. The deficit countries require “internal devaluation”, aka recessions as the real economy must adjust since the nominal exchange rate (one to one) is over valued. Draghi did not misrepresent.

    • Peter says

      Sorry but this doesn’t make sense. If a baker increases his output from 1 loaf of bread to 2 loafs of bread using the same amount of time then his productivity goes up by 100% full stop. The question about wages is about the distribution of the gains. What Watt shows is that because of the difference of real and nominal figures the relative share of wages in relation to profits shrinks. If you increase wages with productivity you keep the distribution between wages and profits constant. If you calculate it like Draghi did you increase the profit share at the expense of the wage share. This is how I read it.

    • Andrew Watt says

      Peter’s response is correct.
      @ sing ming shaw. May i suggest that you re-read the article. You will see that I go on a lot about the difference between real (taking out price changes) and nominal (with price changes) variables. If you don’t even consider that in your response (do you mean money wages or real wages?), it is unlikely that you will come up with a cogent criticism.

  3. says

    ‘when nominal wage growth tracks real productivity growth, which is apparently the role model suggested by the ECB President, the share of wage income in national income will permanently decrease. Moreover, real wages will decline continuously, if price inflation is higher than nominal wage growth…’
    Isn’t that exactly what SuperMario wants?
    This is a crackerjack pce vital to all serious students of this hilarious mess. See also:
    Takes a while to get to Draghi, but concurs with yr view.

    • Andrew Watt says

      @ John Ward
      Thanks. I don’t pretend to know what Super Mario wants, but a serious economist should not imply that a correct strategy is to have wages declining towards 0% and profits towards 100% of GDP.

  4. Nardus says

    Good aricle. The sad thing is that the damage has been done and is not likely to be corrected: who is going to point this out to Hollande and his likes? And so the charade will continue, serving the motives of whoever might possibly be behind this misrepresentation.

  5. says

    The economists at Natixis pointed out in a recent note that the problem for the peripheral nations is that wages are flexible and prices sticky, the reverse of what we have been brought up to believe. Nominal wages are sticky, but real wages fall. Prices are sticky. Under austerity policy, which reduces demand and output, sticky prices means that there is no improvement in the competitiveness of export products, so export industries disintegrate. So it is not only wage earners that get hammered. So do the owners.

  6. says

    I suggest to read and look at these charts (see below)

    I agree with the Andrew’s argument, but I suggest also different critics to Draghi’s view,
    Sorry, the text is in Italian language, but charts are clear: “No positive relations between productivity growth and labour market de-regulation policy in oecd countries in the period 1990-2008. If relations exists, it is a negative one: more de-regulation in labour markets, less productivity growth”.

    • says

      @Pini…so, if you are right about the negative correlation between a de-regulated labor market in Europe and productivity growth, then it would seem to me you are not disputing Draghi’s charts showing higher growth in wage rate and slower growth in productivity, no?

      You say you agree with Watt’s argument. His objection to Draghi’s charts was quite specific — wages were in nominal terms and productivity in real terms. He concluded the charts were misleading if not useless to make Draghi’s point. Do you actually agree with that conclusion?

      Actually if you deflate wage growth by a price index, judging by the different slopes, real wages growth would still be higher than productivity growth as shown in Draghi’s charts. Draghi’s point was also specific. There exists divergent growth in wages and productivity and that was one of the main problems of EZone.

      Gini coefficient or K, L shares in GDP is a different issue unrelated to his presentation.

      Nor was Draghi arguing if de-regulation was or was not correlated to productivity growth. I confess I didn’t read his entire presentation, but took note of the charts reproduced by Watt.

      Correlation of lack of between de-regulation and productivity would be an interesting issue by itself. I fail to see why it is so relevant to the North/South surplus/deficit divide in EZone that remains a do or die issue in EZone.

      Given the current monetary/fiscal structure, perhaps you as economists qua economists might agree EZone has real danger of breaking up unless “internal devaluation” — aka austerity measures — rebalances the respective economic structures. And that could mean even much higher unemployment given, yes, the huge gap between wage growth and productivity growth?

      • says

        Hi, I agree with the comment written by Andrew, and I think he is right stressing the role of real and nominal variables. Then Draghi is wrong in his statments, because the analysis is not correct if he compares real productivity and nominal wages.

        But what I would like to stress and discuss is the the policy implications of the Draghi arguments. Draghi declares that barganing on wages should be at the firm level and not at the national level, and supports the view according to which more flexiblity and decentralization in bargainig and labour market functioning increase productivity (growth). Following his presentation it is clear that weak countries, with deficit and debt and rigid labour market, suffer for low productivity; he states that productivity increases if flexibility increases too.

        But the facts (based on Oecd data) do not support this view. No evidence exists of a positive relationship between more labour market flexibility and productivity growth, if we consider Oecd countries, European countries, UE countries, Eurozone countries, for different time periods. If a relations exists, this is negative and no positive, as the charts show (and also empirical analysis using econometrics support this result, quoted in references at the end of my short paper).

        I hope to have made clear my point.
        Yours sincerely

      • says

        “Gini coefficient or K, L shares in GDP is a different issue unrelated to his presentation.”

        @sin-ming shaw

        Is that so? If fewer and fewer make more and more, what is the average supposed to capture?

        In the graph, I can see compensation per employee–isn’t this an average of some type, one that surely includes the workers in financial services and the executives?

      • Yan says

        There is a difference between internal devaluation and rebalancing. As far as I can tell, what Mr. Watts is actually trying to get to, among other things (but I think is quiet important, because it is never mentioned really) is that Germany has been breaking for the past 10 years the reached upon agreement regarding inflation: a 3% target. The importante point is that the target was 3%, not above and certainly not below! but 3%. While most countries have actually followed this to a great extent germany has constantly, and knowingly, undershot the target. This makes “rebalancing” ever more difficult. I cannot find it, but I remember an ex bundesbank official clearly stating this back in the stone age (2009). Also, productivity per se emphatically does not lead to growth!

  7. Kathleen McMullen says

    What about labour that’s not waged, or remunerated in kind. Eh? The wages frozen solid for another year?

  8. says

    It looks as if you are simply saying that wages in countries like France are keeping pace with higher inflation there than in Germany. In a currency union, that is a recipe for France and similar countries to lose out.
    Before the euro, it was widely accepted that countries other than Germany would have higher wage growth, because wages were lower than in Germany. But that was expected to be matched by a productivity catchup.
    Of course Draghi and co have a neo-liberal ideology which wants to drive down the share of national income going to wages, Guaranteed job security themselves, they want to deny it to others.
    But the productivity failure in Italy, France et al is real and cannot be ignored. It would be more useful to focus on the role of tight policies in depressing demand making groiwth harder to achieve.

    • Andrew Watt says

      I largely agree with what you have written. I have written a fair bit (which yoiu can find on the web) about “optimal” wage setting and the link between wages ad prices in the context of EMU. The crucial question is: what is the inflation and nominal unit labour cost benchmark? My argument is that is should be France and not Germany.

  9. lars jørgensen says

    No one can seriously doubt, that Draghi and his clerks made a mistake here… Deliberate manipulation…

    Perhaps Hollande’s silence is most of all expressing relief, that here he (also) has a way out of his political promises against austerity…

  10. BigEd says

    It should be added that these trends of greater productivity in the Euro-North will only continue and possibly accelerate because interest rates (the cost of capital) are much lower and the availability of money is much higher in the creditor North vs the debtor South.

    Adding in the effects of the intra-EZ trade balances (positive in the North, negative in the South) further compounds the imbalances. Germany, etc. can spend even more on new investment (or govt expenditures) without drawing down its consumption.

    • naf says

      Looking at Draghi’s chart it seems that Portugal had a productivity growth of more than 10%, say 12%, higher than Germany growth in the same period. Taking Watt argument into account and subtracting 28% to wages growth one has, instead of th 40% growth of nominal wages, a 12% growth of real wages. Therefore the wages real increase in Portugal was in line with the growth in productivity and aparantely the result seems to have been a higher productivity growth than Germany. Can someone explain me this?

  11. says

    I’d like to see the statistics for Poland. I suspect that they have a large increase in ‘compensation per employee’ too, but also a large productivity growth. And their economy is one of the strongest in Europe.

    So is the lesson not that ‘unions CAN be greedy, as long as they increase production’?

    Don’t forget that a better income for employees also benefits the national treasure chest (income taxes, helping to diminish a deficit) and national consumption (spending).

  12. Joachim Endemann says

    Only one question. Must it not mean: [in the slide] “… the productivity measure excludes inflation …”?

    Sincerely, Joachim Endemann

    • Joachim Endemann says

      Thank you for answering and the link.

      Sincerely, Joachim Endemann

    • says

      This Marga Peeters, Ard den Reije’s comment is bad economics. Prices are not exogenous, but endogenous and depend on market competition. The mainstream view is wrong on this point. What’s matter is real unit labour cost and not just nominal unit labour cost, and productivity is endogenous too; it is just y per hour worked (labour input), and it is not a techinal parameter, it depends on many things, innovation and market demand first …….

  13. says

    Interesting point is in this context that the supporters of the Gold Standard don’t distinguish real from nominal interest rates, because sustained inflation is in their opinion unlikely.

  14. Joachim Endemann says

    Okay. Then one could speculate that the leading persons in the EU have forgotten the rules to measure the units. When the “real term” for the measure of productivity inflation includes but the “real term” for the measure of real wages inflation excludes (of course) then own deception is inevitable if one compares these units without further explication – or does so by using misleading indications. But is this likely? No, it was not a self-deception of Mr Draghi but it was a deception for the attendees.
    That means it is more likely that the Sachsonian employee Mr Draghi had spoken on behalf of the German ideological view (which is really the view of the neo-liberal doctrine in the whole). … And because he spoke, and not the German finance minister or even Mrs. Merkel herself, was a direct contradiction unlikely. (Well, changing the roles may be, but the neo-liberal orientation does not change.)
    This means his speech revealed the future for the majority of Europeans in the Member States of the European Monetary Union. But if they want really to have a future worth living and to avoid social chaos then they should leave the community and establish a real European (Monetary) Union – as soon as possible. Because the hegemonic ambition (dominance) of Germany is only possible because of the design flaws of the Union but it would not be without these errors.
    That means without these design flaws Germany could “only” be a primus inter pares – nothing more and nothing less, but not a state with a hegemonic dominance plus doctrine for its own benefit primarily. That means Germany lacks its own substance, which would show up after a collective withdrawal immediately.
    Incidentally, this means too, that the phenomenon of hegemonic ambition of Germany to dominate Europe and, in the same time, its lack of own substance is not a new one, because it was just present in the period of the so-called Wilhelminism and later on … (The method was amended but not the thinking.) But if there is such a lack of own substance and if there is such a bias to dominate others in the same time, then such dominance is comparable with a finance bubble. And such bubbles are unfertile and futureless. But nothing is done to deflate this bubble – on the contrary as Andrew Watt has shown clearly this further farce. Thank you!

    Sincerely, Joachim Endemann

  15. says

    Comparing the economies of Spain and Germany is like comparing their weather. German GDP comes mostly from exportable goods and services, Spanish GDP from non-exportable ones like construction and tourism. Yes, Spanish overall productivity may be 10% lower than German productivity, but average wages are still at least 20% lower. One of the pillars of European integration was to bring people together – I wonder what happened to that. German productivity by the way is 50% lower than that in Luxembourg – by the way productivity is calculated, bankers are the most productive people of all, which is curious since they don’t actually produce anything…
    If one compares productivity and exchange rates between the EU and the US, while relative productivity has remained more or less the same, the Euro has gained more than 30% against the dollar since 2002. Instead of comparing apples with pears, SuperMario might want to take a look at that.

  16. naf says

    Looking at Draghi’s chart it seems that Portugal had a productivity growth of more than 10%, say 12%, higher than Germany growth in the same period. Taking Watt argument into account and subtracting 28% to wages growth one has, instead of th 40% growth of nominal wages, a 12% growth of real wages. Therefore the wages real increase in Portugal was in line with the growth in productivity and aparantely the result seems to have been a higher productivity growth than Germany. Can someone explain me this?