Competitiveness and the Euro Area Crisis

Many of the peripheral countries experienced a relative appreciation in their real effective exchange rates during the years prior to the crisis in the euro area. Many also experienced widening current account deficits. Commentators have latched on this correlation as causally significant. They argue that the crisis is (at least in part) a result of the loss of competitiveness. This argument is consistent with standard macroeconomic models of relative price movements across countries at different stages of development under fixed exchange rates. That makes it both empirically and theoretically persuasive. But it is right? A closer look at the data suggests significant anomalies both in terms of manufacturing employment and in terms of export market performance - both in terms of market share an in terms of export composition. The movement of component parts of the relative real effective exchange rate indicator is anomalous as well. Yet if relative cost competitiveness is not the problem, then market liberalization is unlikely to prevent a future crisis. The peripheral countries may need market liberalization in any event; but in responding to the crisis, they also need other types of support and reform.