Going beyond the mystery of Italy’s price-competitiveness indicators _ vox

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Going beyond the mystery ofItalys price-

competitiveness indicatorsClaire Giordano, Francesco Zollino, 18 July 2013

Since the mid-2000s competitiveness indicators for Italy have been providing conflicting signals. This column

argues that producer prices and labour costs have actually moved hand in hand since 1992, and that the rise in

the real effective exchange rate based on labour costs can be attributed to price-cost divergences in its main

trading partners. Due to the internationalisation of production processes and fading share of labour in overall

costs, price-based indicators may be more appropriate to assess external competitiveness.

Assessing Italys price competitiveness is becoming a puzzling challenge. Among others, Paul

Krugman (2012) has questioned the reliability of the Italian cost-based indicators pinpointing their links

with the [countrys] mysterious productivity collapse. Bayoumi et al. (2011) also claimed that [w]hile

Italys competitiveness does appear to have eroded [since 1995], the size of this effect is, frankly,

anyones guess. Indeed, since the inception of the European Monetary Union and until the end of 2012,

Italy had lost as much as 33.5 percentage points in competitiveness on the basis of its real effective

exchange rate, built upon unit labour costs in manufacturing, while a moderate gain of nearly three

percentage points is revealed by the indicator based on producer prices and minor changes in the

other frequently used measures (Figure 1). The contrasting evidence across indicators proves more

pronounced for Italy than for other main economies in the Eurozone (Fig. 2); if due to diverging

domestic labour costs and prices, it may signal a worrying buildup of cost pressures on Italian firms,

which would be forced to progressively squeeze their profit margins in order to keep up with their

competitors in a strive to stay on the market. If that were the case, absent a swift change in labour-cost

trends, the process would risk to be unsustainable in the medium term (see, for instance, Levy 2012 on

this site).

Figure 1. Alternative price-competitiveness indicators for Italy

Note: Average quarterly data; 1999Q1=100.

Figure 2. The dispersion of price-competitiveness indicators within the Eurozone

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Claire Giordano

Economist in the Economic

Outlook Division, Research

Department, Bank of Italy

Francesco Zollino

Economist in the Research

Department, Bank of Italy

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Note: Standard deviations across indicators in Figure 1.

Source: Bank of Italy and ECB. (1) PPI stands for producer price index in manufacturing, CPI for consumer price index,

ULCT (ULCM) for unit labour costs in total economy (manufacturing) and GDP for GDP deflator.

In this column we review the main drivers of different competitiveness indicators in order to assess

whether the alarming reading of their discrepancy in Italy is warranted, and to shed light on their varying

power to predict the ability of domestic exporters to thrive in a changing environment.

First, a visual inspection of the trends of manufacturing producer prices and unit labour costs within

countries suggests that in Italy the two series move together over time, whereas a significant

divergence is detected in Germany and France (Figure 3). In order to validate these indications, we

pursued a formal cointegration analysis in the period 1992Q1-2012Q4 (Giordano and Zollino 2013).

Our empirical findings confirm the lack of significant misalignment between unit labour costs and

producer prices in the Italian manufacturing sector in the long run, thus dismissing the haunt of non-

viable restraints on profit margins due to excessive labour costs. A glance at institutional sector

accounts confirms that in the years 2003-07, in which the real effective exchange rate, based on unitlabour costs in manufacturing, sky-rocketed, the profit rate of non-financial corporations in Italy marked

only a moderate decrease, of around two percentage points in the overall period. At the same time we

find that a long-run co-movement between unit labour costs and producer prices in the industrial sector

is rejected for both Germany and France. This would suggest that the discrepancy between real

effective exchange rates based on unit labour costs in manufacturing and producer prices observed in

Italy is more correctly due to price-cost developments in its main trading partners.

Figure 3. Trends in manufacturing producer prices and unit labour costs

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Note: Average quarterly data; logarithms of indices 1992Q1=100. Source: Eurostat.

Although a full explanation of the long-run behaviour of deflators across countries goes beyond the

scope of this article, we believe that a key factor is the internationalisation of domestic production

processes. Less pronounced offshoring in Italian manufacturing, and therefore less sizeable changes in

the shares of wages and intermediate inputs on gross output, can explain the broad stability found in

the long-run relation between its prices and labour costs. This is confirmed by the observation that the

use of material intermediate goods has been relatively stable in Italy between 1995 and 2005 (based

on EU-Klems data), while it has significantly increased in countries such as Germany (see also Sinn

2005 and, on this site, Marin 2010).

Secondly, we run a simulation in order to better illustrate why Italys real effective exchange rates

diverge so significantly although the underlying domestic deflators co-move in the long run. In particular

we build artificial competitiveness indicators for a limited number of trading partners, namely country A,B and the Rest of the World, under the following assumptions: i) country B is a major partner of country

A, whereas the relevance of country A for country B is much smaller, e.g. as is the case of Italy (country

A) and Germany (country B); ii) trends in producer prices and unit labour costs in manufacturing are

similar in country A, whilst they are higher in both country B and in the Rest of the World.

In this simplified setup it clearly turns out that the basic arithmetic of real effective exchange rates plays

a pivotal role. Focusing on a comparison between country A and B, we find that i) the discrepancy in

the producer prices-based real effective exchange rates of the two countries is limited, but ii) the ones

based on unit labour cost in manufacturing would signal a larger loss of competitiveness in the former

than in the second country (Figure 4). Indeed firms in country A suffer from lower labour-cost than

producer-price growth in both their partners, while country B exporters on the one side face only one

partner (Rest of the World) in this condition, on the other they directly gain from their domestic labour-

cost growth being lower than their producer-price growth.

Figure 4. Producer-price- and labour-cost-based indicators in an artificial world


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Note: Average yearly data; 2000=100.

Italys price competitiveness : Mystery or mirage?

Is the 'mystery' of Italys price competitiveness real or is it a mirage emanating from flawed indicators?

Traditionally relative labour costs are a good proxy of a countrys competitiveness in the medium term,

beyond the short-term adjustments in profit margins. However, in a context of intense globalisation and

of restructuring of global value chains, the share of domestically employed labour on total production

costs is decreasing, to different extents across countries. Wage shares in the manufacturing sectorhave actually fallen in most European countries, but to a changing degree generally depending on initial

conditions. For instance, between 1998 and 2007 wage shares of gross output plummeted in Germany

(from 27.4% to 20.7%), whereas they only marginally diminished in Italy (from 20.6% to 18.2%).

Given the fading representativeness of labour costs in the manufacturing sectors of advanced

economies, relying solely on labour-cost-based indicators may provide a biased assessment of price

competitiveness. Price-based indicators seem to convey more reliable signals, and in our analysis this

proves a convincing argument for Italy.

To conclude, we do not intend to downplay the competitiveness strains incurred by Italian exporters, as

indirectly revealed by the progressive erosion of their world market shares (European Commission

2013), somewhat more pronounced than in the case of their main partners. We do however point out

that the drag on Italy price competitiveness of increasing labour costs is much less relevant, in currenttimes, than the sluggish restructuring of its firms production processes, including their pattern of

participation in increasingly pervasive global value chains.

References

Bayoumi, Tamim, Richard Harmsen and Jarkko Turunen (2011), Euro Area Export Performance and

Competitiveness, IMF Working Paper, n. 140.

European Commission (2013) In-depth review for Italy, Staff Working Document, n. 118.

Giordano, Claire and Francesco Zollino (2013) The Divergent Behaviour of Different Competitiveness

Indicators for Italy: An Assessment, Bank of Italy, mimeo.

Krugman, Paul (2012), More about Italy, The New York Times, 28 November.

Levy, Mickey (2012), Diverging competitiveness among EU nations: Constraining wages is the key,

VoxEU.org, 19 January.

Marin, Dalia (2010), Germanys super competitiveness: A helping hand from Eastern Europe,

VoxEU.org, 20 June.

Sinn, Hans-Werner (2005), Bazaar economy, IFO policy issues.

Topics:Exchange rates, International tradeTags:competitiveness, economic indicators, Italy

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