Inflationary Pressure and Labor Conflict

1. Inflationary Pressure and Labor Conflict • Inflation in the 1960s jeopardized the corporatist wage structure of the postwar period • In the late 1960s work stoppages began to occur where workers demanded higher wages

2. Factors Leading to Friction in the Labor Market • Decline of agricultural workers to less than 15% of employment continent-wide • Elastic supplies of labor in underemployed agricultural workers no longer exists • Unemployment as a whole declined leaving the threat of unemployment as a restraint on wage demands as no longer a viable option • Wage and price inflation did not subside even when unemployment rose, which indicated there were other factors at work • Young no longer remembered what it was like to be unemployed • People were no longer willing to sacrifice themselves for postwar reconstruction and preferred immediate gratification instead

3. Factors Leading to Friction in the Labor Market (cont.) • The Soviet threat was seen as less immediate, removing one immediate incentive for labor and capital to pull together • Another important event in this time period was the weakening and final breakdown of the Bretton Woods system in the 1970s • Exchange rates were fixed and then inflation became temporary, with its breakdown, this was no longer the case • Unions started to fear inflation and wanted wage increases

4. Friction in the Labor Market (cont.) • Wages started to grow but production slowed • Profits began to fall right before the 1973-1974 oil price shock • Governments tried to contain inflation with controls (such as a statutory freeze on wages and prices) • These tactics were not very successful

5. Contradictions of Corporatism

6. 1973 OPEC Oil Crisis and the Rise of Oil Prices

7. Contradictions of Corporatism • Countries began to promise workers more benefits in exchange for wage restraint • But, financing these benefits was very expensive • Where the institutions of corporatism were most advanced, their reinforcement limited the rise in labor costs and the rate of unemployment • After the wage explosion of 1974-75, wage increase slowed • Inflation wasgetting worse and making things difficult to handle • Keynesian demand stimulus was used to keep unemployment levels down • However, the golden years of Europe were over

8. Contradictions of Corporatism (cont.) • Recession came about • The 2nd OPEC oil-price shock at the end of the 1970s made things even worse • Unions no longer wanted to practice wage constraint • Public employment (and hiring) had gone up for the last recession and was no longer a viable option to use • Social corporatism began to crumble and by the mid-eighties it was in retreat

9. Retreat Into Regional Integration • European governments tried to create economic stability with the process of European integration • UK, Ireland, and Denmark joined the EEC • A new system needed to be put in place to replace the now defunct Bretton Woods system • European countries did not want uncontrolled exchange rates • Europe's response was “The Snake” - December 1971 • Participating countries held their exchange rates within narrow margins and established financing facilities to extend credits to one another • However, they still lacked a convergence in their monetary and fiscal policies

10. Retreat Into Regional Integration (cont.) • Countries with inflationary policies were driven from the Snake • The UK was the first to withdraw in June 1972 • Denmark withdrew one week later but returned in October • Italy withdrew in 1973 • France was forced to float in January 1974 • Sweden withdrew in 1977 • Norway withdrew in 1978

11. The Snake

12. Retreat Into Regional Integration (cont.) • France and Germany wanted political and monetary integration for exchange rate and inflation stability • A new system came about in 1979 – European Monetary System • A better version of the Snake • Participants had to hold their currencies within 2.25% to fluctuation bands, but countries were allowed to revalue and devalue • 8 out of the 9 EC members joined the EMS at the beginning (except UK) • No one was forced to withdraw in the 1980s although there were realignments • Yet the poor coordination of macroeconomic policies strained the EMS

13. Rising Unemployment and the Integrationist Approach • The 1980s were a decade of dissapointment for growth and productivity for Europe • Unemployment was still high • Causes of the problem • Inadequately flexible wages • Overly rigid work rules • Excessive labor costs

14. Rising Unemployment and the Integrationist Approach (cont.) • Another solution was looked at in integration – deeper integration adding free movement of capital and labor to the existing customs union • The aim was to be like the US so European producers could exploit economies of scale and compete internationally • This came with the Single European Act (SEA) in 1986 – signatories agreed on the creation of a single market free of internal barriers to trade • The Maastrict Treaty (early 1990s) was the next step • There was a commitment to move to a monetary union (a single monetary policy, a European Central Bank and a single currency)

15. Rising Unemployment and the Integrationist Approach (cont.) • Removing capital controls was important for monetary integration • The elimination of controls made the EMS more fragile because countries were now faced with destabilizing capital flows • If investors thought a country was going to realign its exchange rate, there was a massive outflow of funds • There were no more realignments • Fixed Exchange Rates, International Capital Mobility and Monetary Independence are mutually incompatible • Europe had to choose between fixed exchange rates and independent monetary policies • Common currency was the best option

16. Rising Unemployment and the Integrationist Approach (cont.) • For countries other than Germany which had to follow the Bundesbank's policies, now they could have more say in their monetary destinies • They had no representatives on the Bundesbank but would have representatives on the ECB • An alternative to this was to face FX-volatility

17. Rising Unemployment and the Integrationist Approach (cont.) • Guided by the Delors Report, a three-step transition of the Maastricht Treaty to a monetary union: • Stage I (1990-93): countries bring their national economic policies more closely in line, remove remaining capital controls and butress the independence of their central banks • Stage II (1994-1998): further convergence of policies and by creation of a transitional entity, the European Monetary Institute, to plan the move to a monetary union • Stage III (starting in 1999): monetary union itself

18. European Economic and Monetary Union • Stage III: • Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain join the EMU in 1999 • Greece joins in 2001 • Slovenia joins in 2007 • Cyprus and Malta join in 2008 • Slovakia joins in 2009 • Denmark, Sweden and United Kingdom refused to join • Estonia joined in 2011 • Potential new members (no exact date can be given due to the current Eurozone crisis): • Lithuania (previous target 2010) • Poland, Latvia and Czech Republic (previous target 2012) • Hungary (previous target 2013) • Romania (2014) • Bulgaria (2015)

20. The Crucible of Integration • Collapse of centrally-planned system had the biggest impact on Germany where there was immigration from the East • Germany proposed reunification of both Germanys – the Soviet Union was not in a position to object • Eastern Germany came under Western Germany's wing • Living standards were lower in the East, there was outdated infrastructure and equipment • In 1991 the new lander accounted for 20% of Germany's labor force but less than 7% of its GDP • There was still a strong incentive to migrate west • The East was also cheap labor threatening unions

21. Germany's Integration • The Bonn Government responded by giving the same benefits and wages to the East that the West had • This helped to lower migration to West and bring up their productivity • These transfers of money gave Germany deficits • Germans did not want to pay higher taxes and this led to higher interest rates since the Bundesbank did not intervene • Interest rates were hitched due to the pegged exchange rates of the EMS – this affected all of Europe • Unemployment in the whole continent rose • This turned into a crisis that disrupted the progress of Europe's integration

22. Integration in Distress... • Denmark rejected the Maastricht Treaty in a referandum in June of 1992 • This raised the possibility that a monetary union might not happen • Speculators anticipated that the Bank of England and the Bank of Italy would respond by cutting their interest rates and allow their currencies to depreciate (could not be done before because of the prospect of the monetary union) • Speculators pounced on their currencies • This drove Italy and England out of the EMS • Their currencies depreciated by 30%

23. Integration in Distress... • Spain, Ireland and Portugal were also forced to devalue several times • By 1993 the crisis affected France whose currency was one of the center currencies of the EMS • The EMS bands were finally widened from 2.25% to 15% • This allowed speculators to retire to the sidelines and for European financial markets to settle down • Governments again began pursuing the Maastricht Criteria

24. Integration in Distress... • Unemployment though was still high • Corporatism was in decline and this caused high wages and non-wage costs • Europe needed to cut hiring and firing costs • Within all of this the Maastricht Criteria began to mean unemployment for a lot of European countries

25. The Collapse of Central Planning • Centrally planned economies broke down completely at the end of the 1980s • Eastern Europe just could not keep up with the new technology and production of the West • In order to keep going Eastern Europe had borrowed a lot of money from the West and the US in the 1970s (about $70 billion by the end of the 1970s) • This finally led to a debt crisis in 1981-82 • To pay of its debts and keep its economies going, the Eastern European countries began to let market principles creep in • In the end economic freedom and political repression proved incompatible – Central planning collapsed

26. Difficulties of Transition • Eastern Europe had a way difficult transition to the market • Between 1990-1992 output and employment plummetted

27. Difficulties of Transition

28. Difficulties of Transition • These countries needed to reallocate resources from the production of heavy machinery to consumer goods – they needed to go from manufacturing to services • Obviously this would bring down output • Western Europe had the same challenge after WWII • The difference was the Marshall Plan • There was no Marshall Plan for Eastern Europe • Liberalization needed to take place to give managers incentive to make profits and avoid losses

29. Difficulties of Transition

30. Difficulties of Transition • Radical transition happened • The front runners in the transition were Hungary, Poland and Slovenia

31. Europe in the 21st Century • In economic sense Europe in 1948 and Europe today look very different

32. Links between Europe of Yesterday and Today... • Shift to intensive growth • Governments increased spending and hiring to keep labor happy now leading to massive unemployment and higher taxes • Regional integration • Major financial crisis

33. Globalization and Regional Currencies Based on Benjamin Cohen’s article “Monetary Governance in a World of Regional Currencies”

34. Deterritorialization of Money • Circulation of national currencies no longer coincides with territorial boundaries of nation-states • Dollar and Euro used widely outside their origin competing directly with local currency for both transactions and investment purposes • Called currency substitution (effect of globalization) • Before there was a monopoly of currency now there is an oligopoly • Another alternative has been to replace national currency with a regional money

35. Currency Regionalization • Currency Regionalization occurs when two or more states formally share a single money • Currency Unification: Countries merge their separate currencies into a new joint money (ex: EU and the Euro) – ALLIANCE • Dollarization: Any single country can unilaterally or by agreement replace its own currency with an already existing other currency (ex: Monaco, Panama, Ecuador, El Salvador) - FOLLOWERSHIP

36. Darwinian Struggle of Currencies • The number of currencies in the world is declining • Although not all national currencies will dissapear due to national pride • Currency Unification: Monetary Sovereignty is pooled (ex. ECB) • Dollarization: Monetary Sovereignty is surrendered (ex. Countries following the US $)

37. Currency Choices • Traditional Sovereignty • Monetary Alliance • Formal Subordination • Economic globalization is leading nations to reconsider traditional monetary sovereignty

38. Currency Regionalization • 50 years ago, national monetary systems were generally insular and strictly controlled • In the 1950s barriers separating local currencies began gradually to dissolve • This was partly due to increased trade • Facilitated increased flow of funds between states • It was also partly due to increased competition, technology and innovation • Currency substitution began to take hold

39. Currency Regionalization • Capital mobility – another effect of globalization • Led to the integration of financial markets • Money is now being used in many different ways: • Store of value • Investment medium • Medium of exchange

40. Currency Regionalization • Foreign currency notes in the mid-1990s accounted for 20% or more of the local money stock in as many as three dozen (~36) nations inhabited by one-third of the world population • 25% - one-third of the world’s money supply is now located outside its country of issue • Currency substitution is most popular in: • Latin America, Middle East, Former Soviet Union states – favor the US $ • Balkans, East-Central Europe – favored the DM and now the €

41. Currency Substitution • By the mid 1990s there were at least 18 countries that had 30% of their money supply in another currency • Most extreme cases (over 50%): • Azerbaijan, Bolivia, Croatia, Nicaragua, Peru and Uruguay • Another 39 countries were approaching the 30% level indicating “moderate” penetration

42. Currency Substitution • Some economists wonder how this will affect FX rates • Traditionally FX: • Fixed Exchange Rates • Single Currency • Basket of Currencies • Flexible Exchange Rates • Managed • Left to the market of supply and demand • Recently FX: • Contingent Rules • “Corner Solutions” • Free Floating • Monetary Union • Irrevocable (Currency Board) • Target Zone

43. Currency Regionalization • More is at stake than FX rates • The real question is of national monetary sovereignty • Economic actors are no longer restricted to a single currency and this has led to a sort of currency competition

44. Currency Regionalization • 5 main benefits of a strictly territorial currency: • Potential reduction of domestic transactions costs to promote economic growth • A potent political symbol to promote a sense of national identity • A powerful source of revenue (seigniorage) to underwrite public expenditures • A possible instrument to manage the macro-economic performance of the economy • A practical means to insulate the nation from foreign influence or constraint

45. Seigniorage Seigniorage, also spelled seignorage or seigneurage, is the net revenue derived from the issuing of currency. It arises from the difference between the face value of a coin or bank note and the cost of producing, distributing and eventually retiring it from circulation. Seigniorage is an important source of revenue for some national banks.

46. Currency Regionalization • All of these are eroded when a government is no longer able to exert control over the use of its money • So policymakers are forced to compete for the allegiance of markets agents to sustain and cultivate market share for their own brand of currency

47. Currency Regionalization • Four Strategies are Available: • Considerations: • Policy is defensive (preserve market share) • Policy is aggressive (promote share) • Policy is unilateral • Policy is collective • Market Leadership • Aggressive, unilateralist policy intended to maximize the use of national money • Predatory price leadership • Market Preservation • Status-quo policy intended to defend a previously acquired market position for the home country

48. Four Strategies (cont.) • Market Alliance • Collusive policy of sharing monetary sovereignty in a monetary union of some kind • MarketFollowership • Policy of subordinating monetary sovereignty to a stronger foreign currency via a currency board or full dollarization • Passive price followership • Strategy of Market Leadership only available to countries with the most widely circulated currencies ($, €, Yen, ...) • For other currencies only the other three choices remain

49. Currency Regionalization • The question is: What constraints on national policy are states willing to accept? • Market Preservation: Keep their traditional monetary sovereignty • Many states still choose this route regardless of how uncompetitive their currency may be • Monetary Alliance: Join a union and delegate some of that authority • Market Followership: Give up all monetary sovereignty • “Produce their own money or buy it from someone else”

50. Currency Regionalization • Monetary Sovereignty can be defended with tactics of: • Persuasion: trying to sustain demand for a currency by supporting its reputation • Coercion: applying formal regulatory powers of the state to avert any significant shift by users to a more popular foreign money • Ex: laws that dictate what money creditors can accept for debt, limits on foreign currency deposits, exchange restrictions