25 Feb 2013

It’s Monday, So Krugman Thinks Labor Costs Hurt Employment

Economics, Krugman 30 Comments

Commenter “Xan” draws our attention to today’s post from Krugman, in which he writes:

A commenter on my last euro post asks a good question: didn’t Germany once have a problem of excessive unit labor costs, which it cured with a protracted squeeze? And in that case, why is it so terrible if Spain is asked to do the same thing?

The answer is basically quantitative. I’d make three points:

1. Thanks to the giant housing bubble, Spanish costs got much further out of line than Germany’s ever did, so the required adjustment is much bigger.

Here’s a figure that illustrates that point. According to Eurostat data, German unit labor costs peaked in 2003, Spanish costs in 2009. So here’s what the adjustments looked like in each episode, with blue lines representing the earlier case and red lines the later:

You can see just how much harsher Spain’s adjustment is, and how much less help it’s getting from rising wages in the rest of the eurozone. Basically, Germany is refusing to do for Spain what Spain did for Germany in the past.

And the result of all that is incredibly high unemployment.

Now it sure sounds like Krugman is saying that high labor costs make employers less likely to hire workers. Quantitatively, from that chart it looks like having labor costs that are 14% too high, is a problem that will lead to “incredibly high unemployment.”

But when it came to discussing President Obama’s call to make low-skilled American workers have 24% higher labor costs, here’s what Krugman said:

[W]hile there are dissenters, as there always are, the great preponderance of the evidence from these natural experiments points to little if any negative effect of minimum wage increases on employment.

Why is this true? That’s a subject of continuing research, but one theme in all the explanations is that workers aren’t bushels of wheat or even Manhattan apartments; they’re human beings, and the human relationships involved in hiring and firing are inevitably more complex than markets for mere commodities. And one byproduct of this human complexity seems to be that modest increases in wages for the least-paid don’t necessarily reduce the number of jobs.

So what’s the story? Aren’t there human beings in Spain? Do workers there act like bushels of wheat? Won’t it hurt worker morale to see the prices of food and energy go through the roof, while their nominal wages stay flat (Krugman’s preferred solution to the Eurozone problems)? Is there monopsony in the US, but not in Europe?

You almost get the sense that Krugman grabs whatever argument he needs, to justify his preferred policies–a minimum wage hike for the US, more monetary inflation for the ECB. But that’s what the guys at right-wing think tanks do, not Krugman!

30 Responses to “It’s Monday, So Krugman Thinks Labor Costs Hurt Employment”

  1. Jonathan Finegold says:

    At the most basic, I think a defense of Krugman would have to be to interpret him as assuming an equilibrium wage for low-skilled labor in the U.S., while in Spain wages are so obviously greater than they should be (largely, probably, as a result of contract costs). This would still make him wrong, but it explains why he approaches each question differently.

  2. Daniel Kuehn says:

    Seems like a pretty clear general vs. partial equilibrium question and the options that Spain has for re-balancing. It’s one thing if low skill workers eat up some margins of employers. To the extent that high labor costs in Europe are due to monopoly power on the part of workers I’d imagine the situation could be explained by appealing to reducing that market power (and people tie European labor institutions to structural unemployment over there all the time). But presumably a lot of this imbalance is unrelated to the monopoly power or bargaining issues that are the feature of other discussions.

    • Bob Murphy says:

      DK wrote:

      Seems like a pretty clear general vs. partial equilibrium question…

      OK, let’s switch to soda. If the price of just Pepsi goes up by 24%, what will be the effect on quantity demanded of Pepsi?

      Now, the prices of Pepsi, Coke, Mountain Dew, Sprite, Dr. Pepper, and all other cola products go up by 24%. What will be the effect on the quantity demanded of Pepsi? Will it be higher or lower than in the first case?

      • Joseph Fetz says:


      • Yancey Ward says:

        Damn, you are evil!

      • Daniel Kuehn says:

        Could you say it again differently?

        I know where you’re going with this but what does this have to do with the price level re-balancing that Krugman is referencing here?

        Your peanut gallery can chime in too if they want, although I doubt they’ve gotten something I’ve missed.

        • Yancey Ward says:

          It depends, DK, what is your answer to Murphy’s question?

          • Typical Keynesian Answer says:

            “Pepsi, Coke, Mountain Dew, Sprite, Dr. Pepper [sic] , and all other cola products”

            MD, Sprite, and Dr Pepper aren’t colas. Dr Pepper, not Dr. Pepper. There are other non-colas and sodas that aren’t Sprite, MD, or DP. In conclusion, Murphy’s question is invalidated.

      • Andrew Keen says:

        I think what Krugman is trying to say here is that Pepsi SHOULD raise its prices 24% in order to improve demand for Coca-Cola. If Pepsi weren’t so damn selfish Coca-Cola would be more successful. At this point, Coca-Cola has screwed up so bad that no amount of cost cutting will make their product more desirable than Pepsi.

        But what you’re really missing here Bob is that people NEED soft drinks. It’s not like people can simply buy less soft drinks because they become more expensive. The only reason people aren’t spending more on soft drinks is because some soft drinks are just way too cheap right now.

  3. Razer says:

    Defending Krugman is an exercise is credibility suicide, though do any Keynesians have any credibility anyway?

  4. Ken B says:

    I don’t see PK’s argument even on its own terms. He argues essentially that raising the minimumum wage a small amount might not immediately lead to firings and layoffs, due to interpersonal effects etc. A workplace is a complex thing. OK, let’s grant that and see what it gets us. Doesn’t it get us to more business failures becasue they didn’t cut costs, fewer expansion projects bewcause they can’t get enoguh return on new investment, fewer new jobs because there is no firing aversion and layoffs by attrition? I have a collander at home. If I plug one hole it still drains.

  5. Christopher says:

    Is anyone else having trouble understanding the figure?

    • Bob Murphy says:

      Christopher I don’t get it either, but the highest thing was 14% which is still lower than 24%.

    • Anonymous says:

      I interpret the figure as following: The highest line is Spain’s unit labor costs from ’03-’07. Spain’s current adjustment is the lowest red line. Krugman is saying Spain’s housing boom increased unit labor costs much more than in the German example that his commenter brings up. Also, the adjustment is much more severe so far for Spain than in the German case.

      The inbetween lines, therefore, are Germany. The blue line is Germany’s adjustment from high unit labor costs after labor costs peaked in ’03, according to PK. The red line just above it is labor costs in Germany coming out of the recent recession.

      I read it as PK making the point that spiking unit labor costs in Spain (and presumably other housing bubble afflicted economies), helped Germany adjust from its own above trend labor costs prior to 2003. In the current case however, Spain’s adjustment is much sharper due to the severity of the housing bubble, yet Germany labor costs have barely increased.

      He should have used four different colors and explained why he chose those dates.

      In any regard, PK is definitely saying that Germany’s unit labor costs haven’t “helped” Spain that much BECAUSE THEY HAVEN’T GONE UP THAT MUCH. Germany’s adjustment was easier because other eurozone countries were seeing spiking costs. While PK argues for solution via the monetary channel he is admitting that much higher labor costs in Germany would make Spain better off.

      BTW, awesome title

      • Jordan says:

        The above is mine. Forgot to plug my name in.

      • Jonathan Finegold says:

        I think it has more to do with the fact that Germany’s export industry assuaged high labor costs — much of the demand for German products came from booming countries, such as Spain and Greece.

        • Adrian Gabriel says:

          Jonathan, great point. Taking a look at various factors we do see that Germany has a more favorable environment to business than does Spain. In Economic freedom, Germany ranks the 19th most free, while Spain is in a dismal 46th place. See Here:


          The tax policies are pretty bad in both countries, so I’m not sure we can point to that as any consolation for seeing Germany be more productive, enough to have the government expropriate it’s productive sector. Germany still is a little better than Spain in these regards:


          Finally, and to one the most dismal points in regards to nation-states, is the fact that Germany does a better job exporting military goods than Spain. Yes perhaps Germany’s more favorable business environment allows for more free trade than in Spain, but Germany (like all powerful nation-states) exports more military goods alone than Spain does export anything. See these links:




          It’s quite amazing that this occurs, especially since the US saw a drop in its GDP in the Q4 2012 because of a drop in military expenditures. This whole Keynesian economics stuff is starting to really be a game of getting numbers up in any category of the variables of GDP. Germany is basically doing what the US is doing, growing it’s welfare-warfare state, at the expense of the ignorance of the populous. Governments love to distort and play with the numbers. If they see a contraction in GDP or exports, they’re going to intervene and boost government spending to get that figure looking better. They need more blood by which to live off of when they’re sucking the other victims dry of theirs.

  6. JSR08 says:

    It is very frustrating that Krugman gets away with this noodle-arm crap like this: “And one byproduct of this human complexity seems to be that modest increases in wages for the least-paid don’t necessarily reduce the number of jobs.”

    “human complexity”
    “seems to be”
    “don’t necessarily”

    Could he even be more vague and noncommittal? It’s almost like he’s setting himself up to be able to worm his way out of this nonsense later on, if need be.

  7. Major_Freedom says:

    In Germany, Schroeder enacted more laissez-faire labor reforms in the 2000s. Wages can fall there as there is no minimum wage law, and Germany went from high unemployment to something like 5.4% today.

  8. Lord Keynes says:

    In Germany, Schroeder enacted more laissez-faire labor reforms in the 2000s. Wages can fall there as there is no minimum wage law,

    No statutory minimum wage, except for construction workers, electrical workers, janitors, roofers, painters, and letter carriers. Minimum wage is often set by collective bargaining agreements in other sectors of the economy and enforceable by law


    Given Germany’s highly export-led economy, the labour market deregulation was able to cut wage costs in some industries, proving some export-led growth, but the reason unemployment did not explode from 2008-2010 was strong fiscal stimulus and highly interventionist “Kurzarbeit” (“short work”) program: this involved government subsidies to German industries to keep people employed by working shorter hours.

    The measure supported aggregate demand, which in turn prevented a large fall in consumption and production. The measure also stopped unemployment from rising significantly. You could not have a more obvious instance of state intervention and distortion of the free market than this program, but it was clearly highly successful:


    • Christopher says:

      LK, that doesn’t seem to make sense.

      1. Kurzarbeit is a temporary replacement for unemployment benefits. Instead of having someone laid of and paying him the full unemployment benefit, you only have him half laid of and pay him a lower subsidy compared to the regular unemployment benefits. In many cases, this may very well reduce expenditures that the gov would have incurred otherwise. Ever if there is an overall expandory effect on the budget, it is much too small to qualify as strong fiscal stimulus.

      2. Kurzarbeit was introduced in Germany in 1957 under the 2nd Adenauer government. A time also know as the great time of German ordo-liberalism which kind of is the German version of the Austrian school. German policies at that time were all but Keynesian.

      3. Even if Kurzarbeit helped prevent a bigger increase in German unemployment figures in 2009, it does not explain Germany’s position today. After all, Kurzarbeit has been existing for decades and we experiences periods of high unemployment more than once since then.

      4. The one thing that really changed is Schroeder’s deregulation of the labor market. Pretty much everyone in Germany agrees with that.

      5. So to summarize: In my opinion Kurzarbeit does not qualify as fiscal stimulus and it’s not the reason for Germany’s success today either.

      • Lord Keynes says:

        (1) you have ignored my first point: that Germany introduced strong fiscal stimulus 2008-2010.

        (2) Kurzarbeit was massively expanded in 2009, and that year marked an unprecedented expansion of the program: one of largest in post-WWII German history (Bent Greve, The Times They Are Changing: Crisis and the Welfare State, p. 152).

        • Lord Keynes says:

          Also, the labour market deregulation may have lowered German real wages in export led sectors, but demand for German exports collapsed in 2009, both internationally and amongst Germany’s largest trading partners in the EU.

          Export led growth did not explain the containment of unemployment in 2009.

          • Christopher says:

            By massively expanded you mean an expansion from 12 to 15 month, correct?

            I agree that Kurzarbeit is the reason that Germany’s labor market didn’t collapse in 2009. But your post was a response to MF who said something about today’s unemployment rate. And that, in my opinion, has nothing to do with Kurzarbeit.

          • Christopher says:

            BTW, the strong fiscal stimulus, as you call it, in Germany amounted to around 1.6 % of GDP in 2009. I wouldn’t call that strong at all.

            Not that I think it has anything to do with the 2013 unemployment figures, though.

    • Major_Freedom says:


      Haha, “yet.”

      Everything that follows are all red herrings.

      Fact: Germany does not have minimum wage laws. Wages can be $1.00 an hour and the state won’t stop them.

      Your standard for what constitutes “success” is vicious and absurd. By your logic, if the state taxed everyone’s incomes 100%, and hired everyone in a grand socialist experiment, then you would call that a “success” because you’re only looking at unemployment numbers, and ignoring sovereign consumer driven needs for employment.

      It is a failure if consumer preference driven needs for labor are overruled by force. Not only are resources wasted, but people are deprived of their liberty.

  9. Tel says:

    You can see just how much harsher Spain’s adjustment is, and how much less help it’s getting from rising wages in the rest of the eurozone. Basically, Germany is refusing to do for Spain what Spain did for Germany in the past.

    This seems like an argument that in order for one country to become more productive, someone else must necessarily become less productive. The implication being that killing pigs will end the Great Depression, because one thing government is really clever at, is finding ways to make people less productive.

  10. Christopher says:

    I just realized some mistakes. Obviously it has to read “laid off” and instead of “all but Keynesian” I meant “everything but”. Sorry.

  11. Gamble says:

    Good article Bob. Here is another great one, http://lewrockwell.com/anderson/anderson359.html

    I hope Krugman reads it.

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