Hindering growth from within: Start-up costs

I'm sure you've all heard of it. It's been around the news for so long we do not even pay attention to it any more. It has become the favourite catchphrase of politicians and policymakers when they want to show they are sympathetic towards the perils of the populace. But it is often vague, it appears rather cold and insensitive and it lacks application. The word we are looking for here is growth.

It's all we've been hearing for the past couple of years. First came Ireland during the sub-prime lending crisis, then Greece, with each subsequent Prime Minister promising policies to rejuvenate growth, then Spain, then Italy, then Cyprus and even Germany. But most promises were nothing but thin air. The more we talk about growth, the more "emphasis" placed on the problem of youth unemployment, the more youngsters stayed out of the job market and the more GDP contracted. The latest (seasonally adjusted) data show that the trend is still on the rise:

Who's to blame for this? Some point at the ECB who has done very little  in order for the euro to survive (as they claim). I beg to differ. As already said the ECB's "whatever it takes" declaration was interpreted as a positive sign by the markets (although we usually forget this, markets are nothing but the collective wisdom of many humans). Then who might the reader ask? The EU? It's policies? No, not really. The simple answer is the Member-States themselves.

What follows is graph of the start-up costs per country, as obtained by the EU website, adjusted by the effective exchange rate. Note that the official EU "encourages" countries to allow for a set-up of under 3 days, at a cost of less than 100 euros. 

Of the 5 countries who required assistance or were in trouble during the crisis, Italy has the highest cost at €2046, followed by Greece at €1007, Portugal at €360, Cyprus at €265 and Spain at €120. Ireland is the only country which abides by the EU standards at €56. Things don't fare better when it comes to days of required to set-up a new business: 5 for Greece and Cyprus, 2-5 for Ireland, a surprising 1 for Portugal and Italy and a whooping 17.5 for Spain. Multiply the cost with the days required to set up a business and a rather different setting occurs:

While the multiplication may appear to be rather arbitrarily chosen (although the idea resembles the Misery Index) it shows the relative cost per country better than just the cost of setting up a business. For example, even though it just costs €120 to set up a business in Spain, the 17-day delay will mean that the cost rises; and note that the official amount of days is most likely the best case scenario where the application is perfectly completed with no mistakes at all, from either side. In this new setting, Greece dominates. It takes more than 1000 euros and 5 days  to set-up business there, in the best case scenario, at a total "cost" of €5036. Not that Northern countries would fare better: Germany would get 1445 in the above index, with Sweden at an even worse 2933. From what it appears, most Member-States need more than "encouragement" to do things like they should.

This unwillingness, nevertheless makes things tougher for their citizens. Think about it for second: what do start-ups have in abundance and what do they mostly lack? The answers are willingness and money respectively. Why should one bother with high costs and a mountain of bureaucratic obstacles (such as most periphery countries) and not set up a business elsewhere? That is why there has been a flight of the periphery's brightest to the North. As the Wall Street Journal notes, Ireland is ranked the most entrepreneurial country in the EU (the cost in the above index is a very low €196) followed by Sweden, the UK, Finland and Denmark. Not surprisingly, there were no periphery countries in the top 10 list. In fact, Europe actually lacks start-ups as The Verge points out. 

In order for unemployment to fall, we need new job openings. In order to get more job openings we need more investment. (Don't take my word that start-up costs hinder growth. Nobel laureate Christopher Pissarides and his colleagues showed evidence about this argument more than 10 years ago.) For investment we need two things: sufficient current demand or high potential demand and institutional support. Even if the periphery has the former it certainly lacks the latter. Why does this occur though? In a discussion with an MEP, she noted that there is a built-in resistance to changing these issues; perceived voter pressure is what holds them back. 

The magic word here is perceived. I doubt that any citizen would object to doing things faster than at the moment and I can really find no sane argument against that. If we all want more jobs and more investment in our countries then why should we object to this from within (and blame the EU about it) when we can do something to overcome these issues? It's rather odd to act like a victim when you are the culprit. So please, next time a politician speaks of growth and policies, just point the start-up costs and time needed to form a business.

P.S. There are more than one ways to build a better structure for start-up support. One of these ways has been online by fellow bloggers Horatiu Ferchiu, Alex Ghita and yours truly since 2012. Here are the links:

1. A skeleton-scheme for funding innovation

2. A Detailed Scheme for Funding Innovation in the EU

3. Funding Innovation in the EU – A governance perspective

4. Detailed Scheme for Funding Innovation: Part II

Are labour costs all that matters in reducing prices?

A month ago, Eurostat published the 2012 data concerning labour costs in the EU. Attention should be drawn to the following graph:

(Click to Enlarge)

As the reader may observe, of the crisis-ridden countries, only Ireland is (barely) over the EA-17 average, while the rest of the countries, although they have been accused of high labour costs and the need for a more competitive economy are facing much lower costs than the "stronger" economies of Europe. Then, in the following chart we can see the change in labour costs compared to the change in real GDP for 2012.

Although not many data can be seen above, it is the case that a decrease in labour costs and a decrease in GDP go hand in hand, although labour costs appear to be lagging with respect to GDP change (see Italy or Cyprus). Economic theory states that for a nation to become more competitive, it either has to decrease its costs of production or depreciate its currency. In the Euro Area case, the second option is unavailable, thus the "need" for the first. Nevertheless, too much emphasis on the reduction of labour costs does not yield good results. 

It is doubtful that anyone would dare state that Greece or Portugal or Spain are more competitive than Germany. Yet, German labour costs were €30.4 per hour compared to €14.2, €12.2 and €21 respectively. If a person knowing just the economic theory described above and the labour costs per nation was told that Germany was the leading exporter in the EU then he would be rightly confused. It is not that Germany has a weaker currency either. In theory, a euro is a euro anywhere in Europe (well, other than Cyprus, that is).

Thus, since Germany is the leading exporter of goods it does either of three things:

1. Buys raw material at cheaper prices

2. Has a better reputation and creates better goods

3. Sells with less profit

Better reputation and quality of goods is not a thing that can be attributed to labour costs. On the contrary, when workers are paid better, it is to their best interest to create better goods. Thus, decreasing labour costs would not assist in neither better reputation nor better quality. Selling with less profit may be an issue, yet it is one we will never find out, as finding out what the profit margin of every company in Greece or Germany is, appears impossible. Then, all we are left with is producer prices. According to Eurostat, Germany's industrial producer price index (which indicates changes in the ex-works sale prices of all products sold on the domestic markets of the various countries, excluding imports) stood at 108.4 compared to 112.9 for Greece, 111.8 for Spain and 111.1 for Portugal. 

The producer index signifies that the German producer is able to purchase goods at lower prices than his Spanish or Portuguese counterpart. Rising prices do not have to do just with labour costs though. If we assume that raw materials are bought at the same prices (i.e. oil, ferrous and non-ferrous metals, etc) given a world-wide market, then all we have left are procedures, costs and productivity. Thus, of the constituents of prices, the only one which is influenced by the state of the economy is costs; which at the end does not even matter that much. 

Productivity is wholly different subject though. Eurostat calculates labour productivity per hour worked per year and the results are impressive. Germany's stands at 42.3, while Portugal's at 16.8, Italy's at 32.5, Spain's at 31.3 and Greece's at 20.3. This means that a German worker actually produces more than double of what a Greek or a Portuguese one does. As a result, the labour cost of a worker in Germany is approximately the same as for a Greek worker if we account for the fact that the former produces more (with the added advantage that the German firm produces more). 

Thus, the issue is not how to decrease wages, but how to to make workers produce more. This is not an easy subject. The main issue here is what makes a worker produce less. Is it because he is just lazy or because the whole system does not allow for more production? If obsolete equipment and stagnant procedures are to be blamed for this (again, as economic theory states), then a renewal of equipment and less bureaucracy would benefit the economy more than any reduction in labour costs would. If all workers in a country were lazy then we would not have any production at all, thus, although it is true that some people are lazier than others, the case is that if you have to work, you will eventually become as productive as your job requires you to be or as productive as it allows you to be.

We can all agree that a contraction in GDP leads to lower labour costs. Yet, we should not forget that it also leads to lower demand and thus less income for any firm. In addition, increasing productivity is a much better way to lower labour costs, increase production and subsequently income. Thus, although the current focus is on decreasing everything that may be decreased, the state of events indicates that this approach has been on the wrong: if productivity is increased then any periphery country may be able to sell more goods, both in the domestic as well as the international market, at a much lower price with much greater profit.

The quick lesson is this: if productivity is increased via increased investment in new and better equipment, then both effective labour costs will be lowered and the country's output as well as the firm's profitability will be increased.