. it isn ’ t that long ago that germany was called the sick man of europe. partly due to the ample supply of low - paid workers from east germany, the labour market institutions in germany were no longer sustainable. this led to the so - called harz reforms, which made the german labour market more flexible and tempered unit labour costs and inflation. turning back to the euro area, before emu came into being, its current member countries followed different economic strategies. between 1970 and 1999, unit labour costs in germany, the netherlands and austria grew by a factor of 2. 5 to 3. during these 28 years prior to emu, unit labour costs grew by a factor of 12 in italy, 14 in spain, 35 in portugal and 55 in greece. by regularly devaluing their currencies, these countries were able to restore competitiveness. but after the launch of emu, this policy option was no longer available, of course. the hope was that these countries would adapt to this new reality and unit labour costs growth would slow down. but is this what happened? bis central bankers ’ speeches this chart shows the cumulative growth of unit labour costs relative to the euro area average from the start of emu. while countries like germany, austria and finland continued their modest wage policies, unit labour costs in southern european countries went up at a much higher pace, undermining their competitiveness. this proved unsustainable. the countries that found themselves in the top of the chart when the sovereign debt tensions started in 2009 – that is greece, spain, ireland, portugal and italy – all ran into trouble one after the other. this is no coincidence. currently, adjustments are hard - handedly being enforced by the markets. in the said countries, probably with the exception of ireland, product and labour markets didn ’ t function properly and they still don ’ t. markets are overregulated and labour markets are highly inflexible. by addressing these problems, labour productivity can increase, thereby lowering unit labour costs. i am not saying this will be easy, but i ’ m convinced that such steps are absolutely necessary for emu to function properly. as the chart also shows, in the netherlands unit labour cost growth was also relatively high during the first years of emu. this, however, wasn ’ t caused by the high inflation rates and low flexibility of the labour market, but reflected the low unemployment rate in the netherlands in that period. for many years, the

severely affected jobs are typically those requiring the least education, our efforts must be directed to improve education and to offer training for those affected. i am often asked whether dutch wages are too high in the face of competition from low - wage countries. i believe that the gap in wages will fall, but there are two sides to that issues : ( 1 ) what will happen in china, and ( 2 ) what will happen in europe. a consequence of china ’ s rapid productivity growth will be that real wages in china will rise. economic history offers no example of a country that experienced long - term productivity growth without a roughly equal rise in real wages. the idea that somehow the old rules no longer apply and that china will always pay low wages, despite rising productivity, has no basis in actual experience. the second issue is what will happen in europe. here my approach is a pragmatic one : we should not a priori exclude the possibility that part of the adjustment could occur via wages. i would like to remind you that we are dealing with a world labour - supply shock of unprecedented magnitude. we simply do not know what the exact effects on european wages will be, but one thing is clear : if real adjustment is needed, we cannot prevent it from happening. the more restrictions we impose on the adjustment process the worse off europe will be in the end. restricting wage adjustment could result in adjustment occurring via a lower exchange rate. but with one important downside : wage adjustment can allow for sectoral differences, while adjustment via the exchange rate hits the entire economy. this is most likely not an optimal solution. conclusion the world economy is increasingly integrated. therefore, china ’ s rise transmits shock waves to western economies as that country continues to develop and prosper. europe will face tough competition. new possibilities will open up for european firms, but europe ’ s production of labourintensive goods is likely to come under pressure. china offers tremendous opportunities for western consumers and firms, and there is little reason to be scared of china ’ s rapid development. to fully reap the benefits of china ’ s rise, european policymakers must not hesitate to reform our economies. in particular, our labour markets need to become more flexible, as the pace of change is likely to increase. changes imply that in the short run, there will be winners and losers. overall, however, welfare will rise, as was the case when we moved from the horse to the car. changes in the european production structure towards