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Trends in Finance and Accounting – Proceedings of the 17th Annual Conference on Finance and Accounting

Trends in Finance and Accounting - Proceedings of the 17th Annual Conference on Finance and Accounting

1.6 An International Comparison

Will an international comparison lead to similar conclusions? The greatest debts of developed economies arose over three historical periods: the first followed the Napoleonic wars, the second came after World War II—and the third arrived yesterday is with us today and will be around tomorrow too.

A few states can handle this situation. Certainly, this is merely hypothetical, for anyone can still go bankrupt. America now has a public debt somewhere around 100% of its GDP. Eurozone debt is around 88% of GDP. For the sake of comparison, China’s public debt is at 17%, thanks to the strength of its economy, while in Brazil and India, it is at 66%, and in Russia at 11%.

At first sight, the problems that Greece ran into in 2009–2011 were caused by debts. But how about Ireland which also hovered on the brink of bankruptcy? Until then, Ireland had been cited as an example of ‘sound financial management’ (Ireland’s government debt was 24.9% of GDP in 2007 according to Eurostat). Incidentally, fiscal discipline is for this reason a condition, which is necessary but not sufficient for greater competitiveness.

A more detailed analysis of unit labour costs in the manufacturing industry (thanks to international competition, this is a productive sector) and in the construction industry (an example of non-productive sector) during the period of recession time presents a paradox: Although the Irish economy as a whole was on the edge of bankruptcy, Irish industrial enterprises pushed for a growth in productivity even harder than the Germans (thanks to imports of cheap labour too).

The problem was not therefore in the Irish export sector exposed to international competition, but in the bubble in the property market supported by loans from banks owned predominantly by the Irish. For more details, see Appendix Chart 5.

In solving each specific debt problem, one must distinguish between the prob- lems of solvency and the problems of liquidity. When someone has a liquidity problem, he needs a quick loan to tide him over—in the case of a country, loans keep the economy running. Greece, however, is insolvent. Having the country begin to generate its own revenues—simply to earn the money to pay those debts must solve the problem of insolvency.


1.7 Theory and Recommendations for Economic Policymakers

The paradox in the evolution of unit wage costs in view of international competition in different sectors is a challenge for economic policy. It is advisable to concentrate on unbalanced growth in labour productivity. In theory, this can be inferred from the Balassa–Samuelson Theorem or the Baumol Model.

The economy is divided into a productive and a non-productive sector. In the public sphere and services, such as public institutions, state administration, as well as private services, such as restaurants, construction industry or arts, there is as a rule slower labour productivity. By contrast, productivity is higher in industry because firms face direct international competition, there are economies of scale and more use of machines and technologies (although the state can also employ technologies such as e-government).

An improvement in labour productivity is usually followed in the productive sector by an increase in the hourly rate. In this case, unit labour costs will remain constant. But when there are pay rises in the more productive sector, the less performing sector wants to follow suit. This is when what is called in economic terminology wage contagion may occur, when one trade union demands a pay rise at the expense of the others without offering higher productivity or better services.

This is a theoretical explanation why the productive sector is able to keep down unit wage costs, whereas they increase in the non-productive sector. Finally, wages are rising and then building up inflation pressures. However, if productivity increases in the public sector less than in the other sectors and if salaries of employees in the public sector are in line with the salaries in other economic sectors, this has a far-reaching consequence for the economic policy: Public expenditure is on the increase.

The strength of an economic policy with the ambition to boost competitiveness and at the same time to balance the public budgets is in the prevention of wage contagion, pressing for the highest possible labour productivity in the public sphere and services.


1.9 Conclusion

This analysis has shown that appreciation bubbles of the real exchange rate cause a loss of pricing competitiveness in an economy like the Czech Republic. There may be two types of these:

(a) Appreciation bubbles of the nominal rate of the Czech currency; and

(b) Growth in labour costs surpassing growth in productivity.

The best defence of a politician against the two variants is to focus on unbalanced growth in labour productivity. A policymaker should differentiate between productive sectors facing international competition (e.g. the manufacturing indus- try) and less-productive sectors (public services, the construction sector). Industry sectors and firms facing international competition should be allowed by the government to get on with their work.

In the productive sectors of the economy, pressures on labour productivity are not brought to bear by an official but by international competition. On the contrary, the government should press for the highest labour productivity in the public sphere and services to prevent wage contagion.

These are the reasons why the Czech Republic loses competitiveness (and this is also the way to a balanced state budget). The author would therefore advise the government to monitor and transparently publish unit labour costs for the whole economy and the different sectors. Their growth may signal the government a loss of price/cost competitiveness, especially if a dwindling market share of the Czech Republic in world exports accompanies this.

Hand in hand with this, the government should focus on non-price competitiveness, i.e. institutional economics, quality of laws, transparent public procure- ment and smarter rather than bigger regulation, creation of conditions for spontaneous optimisation of the position of enterprises on the value chain towards higher value-added products.

In order to do so and in order to assess the advantages of joining a monetary union (like the EMU), it is recommended to analyse, instead of the Maastricht criteria, five criteria which reflect the change in the competitiveness of a given country:

  1. How do import prices respond to a weaker exchange rate?
  2. How do export prices respond to a weaker exchange rate?
  3. How does domestic inflation respond to a weaker exchange rate?
  4. How do wage costs in firms respond to a weaker exchange rate? and
  5. How do GDP and employment respond to a weaker exchange rate?

Only when the exchange rate balancing mechanism ceases to bear fruit, only when a weakening/devaluation of the currency is not beneficial to competitiveness, only then can a country consider (and the Czech Republic is taken as an example here, but this refers to other countries as well) an entry into a monetary union (like the EMU).

Chapter 3
Does Strong Employment Support Strong National Currency? An Empirical Analysis for the US Economy


3.1 Introduction

The banknotes which are in use in present time are called fiat money, and they take credit from the economic power of the country it represents. When the employment and production is high and economic stability is good, the reliability and recognition of national currency in international markets increase; otherwise, international liquidity of the currency declines. For instance, today, 1 Kuwaiti Dinar corresponds to 3.14 US dollars nearly, and it is globally accepted.

On the other hand, 1 Iraqi Dinar corresponds to 0.0009 US dollars, but it is not convertible in the most of the world. Similarly, there is no need to compare the Zimbabwe Dollar and US Dollar and to discuss the validity of them in the world. The reason is the stability and power of the economy behind currencies.

Developments in the US can bring about important consequences not only for itself, but also for the other economies of the world. Non-farm payrolls data in the USA is announced on first Friday of every month, and closely monitored by the whole world market.

An increase in this data is perceived as an indicator of the fact that things are getting better in the US economy, and dollar becomes stronger against the other currencies among the world. This case also expands to all of the world economy with domino effect. When the non-farm payrolls data comes lower than expected, the opposite happens.

Citigroup, which is the largest foreign exchange trader in terms of transaction volume, has stated that the weak employ- ment in the US economy means a decline in dollar (Bloomberg 2015).

In this context, this study investigates the relationship between non-farm payroll employment and dollar index data of the US by econometric methods for the period of 1995:M01-2016:M01.

The remainder of this paper is organized as follows: Sect. 3.2 gives a brief theoretical framework of the issue and Sect. 3.3 focuses on previous literature. Section 3.4 presents the results of the empirical analysis. The final section gives conclusions and some policy implications. It is evaluated that the study will help both developed and developing countries on managing exchange rate policies by considering employment data and general economic conditions.


3.2 Framework

The exchange rate shows the value of national currency in terms of foreign currencies, and it is an important parameter because of its influence on many variables in the economy. Changes in exchange rate leads to changes in relative domestic/external price structure by changing the relative value of national currency.

On the other hand, exchange rate policies are effective not only on cross-country goods, services, and capital flows. The basic reason for the economic crises in recent years is seemed to be largely the exchange rate policy that is applied (Bilgin 2004). The crisis emerged in certain regions can also affect the relationship between the other countries’ exchange rates. Although the reasons are different, all financial crises, Mexico in 1994, Asia in 1997, Brazil in 1998, Argentina in 2000, and Turkey in 2001, have resulted with serious movements in exchange rates.

The real exchange rate is one of the most important determinants of foreign trade in open economies. The fact that domestic and external demand is directed by real exchange rate has an impact on employment levels at the same time (Balaylar 2011). If the real exchange rate falls (national currency loses value), imported goods become more expensive.

This leads consumers to substitute domestic goods for imported goods. The employment undoubtedly increase when the demand for domestic goods increase. When the imports become more expensive, the cost of labor becomes relatively cheaper in the sector that used imported inputs. In theory, it leads to increase in employment. However, when the imported inputs become more expensive or devaluation occurs, it could lead to inflation causing a decline in employment by decreasing aggregate demand.

It can be said that, under the assumption of prices are not flexible downward, real exchange rate is negatively related with production and employment and positively related with unemployment. On the other hand, an external impact such as a decline in commodity prices in trading countries can increase unemployment rate under the assumption of wages and prices are not flexible in short term (Carr and Floyd 2001).

Fluctuations in exchange rate increase costs and cause uncertainty in short term. Especially in micro level, it makes difficult for businesses to predict future. This situation naturally makes difficult to have right decisions for economic agents, especially businesses. Therefore, eliminating the fluctuations (uncertainty) in exchange rate positively reflects on the decisions of economic agents.

This affects the exports, production, and employment in a positive way. It is clear that employment increase would be more effective in a case that export growth is supported by new investments. Thus, it can be said that there is a linear relationship between exchange rate stability and foreign and between fluctuations in exchange rate and unemployment (Buscher and Mueller 1999).

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