Over the last week or so I have been in Europe and talking to all sorts of people. In the streets the decay is clear and I am in a relatively rich part of Europe (Maastricht). Unsold properties are multiplying and the there are lots of shopping space vacant in the main centres. It is very apparent to me but when I ask people about this some express surprise – not having noticed it themselves. I concede that when you come here once a year you note the changes but the reality is fairly stark. If we put this anecdotal evidence together with the way in which the Euro bosses are behaving and the overall quality of the policy debate in Europe at present it is clear to me that there is a great sense of denial in Europe. Nowhere is this more apparent than in Germany. Their growth model has failed and must change. But it will be very difficult to achieve the sort of national awareness that will render that change possible. The Eurozone was always going to fall apart as a result of its basic design flaws from its inception. But the German strategy – which they consider to be a source of national pride – actually ensured that once the basic design flaws were exposed by the collapse of aggregate demand, things would be much worse than otherwise.
There are so many narratives going on in Europe at the moment that it is taking time to keep track of all of them. Each day a new development seems to drown the controversy of yesterday. So today as I type (Friday, European time) the headlines are all about the ECB defiance of its German critics. This morning (September 16, 2011) the German “mass-market” Magazine – Bild – carried the article – What the hell happened to the guardians of the euro? – with this picture.
The red sub-title translates to “This ruin was once the proud European Central Bank.”
The story is about the new US dollar swap lines that the US Federal Reserve has set up to provide the European banks to quell any shortage of US dollars in the commercial banking system here. I will consider that development in a separate blog because it raises all sorts of questions – such as, why the hell is the ECB prepared to bail out banks but not countries – with what are effectively unlimited low-cost loans? Similarly, why is the US Federal Reserve prepared to proved unlimited US dollar credit lines to Europe with no firm collateral? The words “appease elites” creep in when I wonder about those questions and “damn the unemployed”.
Anyway, the topic for another blog.
The following Essay from the Centre for European Reform (published October 2010) – Why Germany is not a model for the eurozone – is interesting because it addresses the myths surrounding the German position in the current debate.
The Paper outlines a coherent case why the German model should be avoided. Recently, German Jürgen Stark resigned from the ECB executive board in a move that has been hailed as a German protest of the errant ways of the ECB. Stark is now touting his conservative ideas around Europe in a hope to undermine the central bank’s current interventions. If he succeeded and the ECB followed his advice then the Eurozone would collapse fairly quickly.
The Financial Times (September 16, 2011) – carried an article – ECB fires salvo at German critics – which argues that the ECB “has again shown its boldness as a crisis manager – just when German criticism of its unorthodox interventions has intensified”. The Bild picture above highlights the sentiment in Germany at present.
The dual moves by the ECB – “its unlimited provision of euro and dollar liquidity to eurozone banks” and the “ramped up its purchases of eurozone government bonds” have inflamed the German commentators.
Stark keeps making comments in the press since his departure about the need for fiscal discipline throughout the Eurozone and that “All measures that we take to end the financial and debt crisis in Europe should be orientated towards principles that ensure the long term economic stability of the eurozone.” The mainstream macroeconomic theory considers short-term fluctuations to be of no real importance because in the long-run as long as inflation is controlled, real GDP growth will be optimised and unemployment rate be at its natural rate. This is the neo-liberal fantasy.
The FT also quotes the Italian ECB executive board member, Lorenzo Bini Smaghi who has been critical of the German view. He is quoted as saying:
… we cannot hide behind principles and rules designed for a theoretical situation which no longer corresponds to the reality … [much of the German criticism is] … the result of inadequate economic analysis, of insufficient knowledge of the crisis in which we find ourselves and of anxiety resulting from experiences in the distant past that are not relevant to the current situation.
Bini Smaghi is no lover of government intervention. Please read my blog – Default is the way forward – for a critical analysis of his position in the current debate.
But his point is valid – the deficit terrorists have no grounding in reality. They apply ideologically-tainted models of La-La land which shares no characteristics with the monetary systems operating in the real world and come up with conclusions that are not even remotely applicable or of benefit to anyone but their elite mates. Further, they misrepresent actual trends and outcomes to suit their biased perspective.
The amount of misinformation that it circulating in the public debate about Germany and the other Euro nations beggars belief. We are led to believe that Germany alone has been hard working and frugal and have created a highly innovative and productive economy which underpins its trading superiority. We are also told that Greece is profligate, lazy and overpaid.
The Centre for European Reform (CER) paper provides some insights into these “myths”. It says that:
Since the onset of the global financial crisis in late 2007, previously much-vaunted economies – Ireland, Spain, the US and the UK among them – have been exposed as fools’ paradises built on reckless piles of private-sector debt. Germany, by contrast, looks to many observers to have been the very model of economic virtue.
The financial crisis has impacted badly on nations where the private sector carried huge debt burdens. Germany escaped the worst – or did it?
The CER paper certainly doesn’t think this image is correct and concludes that “an unreformed Germany would be a poor model for the eurozone as a whole. Germany is not the ‘world-beating’ economy of current legend”.
What is a more accurate story of Germany in the Eurozone?
The CER paper says that Germany’s “massive external surpluses … are not evidence of ‘competitiveness’, but symptoms of structural weaknesses”. How do they come up with that? The point is related to the current policy direction in the EMU where the external deficit member states (the southerners) are being pushed into a structural adjustment akin to what Germany imposed on itself in the early years of the Eurozone. The bias is towards Greece, Spain, Italy etc making huge adjustments to be more like Germany.
They are attempting to achieve this transition by savagely deflating these economies (wage cuts, demolishing working conditions, abandoning job security etc). The theory is that with the nominal exchange rate fixed, the only way that these nations can become export competitive is if they domestically-deflate, however painful that is proving to be.
Quite apart from the erroneous logic which is based on a fallacy of composition – that if all deflate they will export more – the policy push ignores the main culprit in the Eurozone disaster – Germany. The arrogance of the German politicians and press knows no bounds but a careful examination of the data reveals that Germany’s policy stance is one of the contributing factors in extending the crisis. This is not to say that the basic design flaws in the EMU are ultimately to blame and that the system is – in its current form – unworkable and unsustainable.
But within that basic design flaw, the conduct of the German leaders before the crisis set up the conditions where one the basic flaw was tested the resulting collapse would be worse than otherwise.
The reality of Germany is more like this:
1. Over the past decade there have been “extraordinary sacrifices” made by the German workers to ensure that the traded-goods sector would out-compete its EMU neighbours. Please read my blog – Doomed from the start – for more discussion on this point.
2. The “domestic economy remains chronically weak and in urgent need of reform”.
3. Germany is “structurally reliant on dis-saving abroad to grow at all”. The Greek current account deficits are required for German growth. It is the height of hypocrasy for Germans to berate the southern states for over-spending when that spending is the only thing that has allowed Germany’s economy to grow. It is also mindless for Germans to be advocating harsh austerity for the south states and hacking into their spending potential and not to think that it won’t reverberate back onto Germany.
In the blog – Doomed from the start – I discussed the Hartz reforms which were imposed on the German workers in the early years after the Euro was introduced. Germany pursued an aggressive low-wage strategy which hammered their workers to ensure that their export prices relative to the other EMU nations would be attractive.
The Germans have always been obsessed with its export competitiveness and in the period before the common currency they would let the Deutschmark do the adjustment for them. With that capacity gone in the EMU arrangement, they pursued another strategy which was to deflate labour costs not via high productivity growth but rather by punitive labour market deregulation.
But the Germans were aggressive in implementing their so-called “Hartz package of welfare reforms”. A few years ago we did a detailed study of the so-called Hartz reforms in the German labour market. One publicly available Working Paper is available describing some of that research.
The Hartz reforms were the exemplar of the neo-liberal approach to labour market deregulation. They were an integral part of the German government’s “Agenda 2010?. They are a set of recommendations into the German labour market resulting from a 2002 commission, presided by and named after Peter Hartz, a key executive from German car manufacturer Volkswagen.
The recommendations were fully endorsed by the Schroeder government and introduced in four trenches: Hartz I to IV. The reforms of Hartz I to Hartz III, took place in January 2003-2004, while Hartz IV began in January 2005. The reforms represent extremely far reaching in terms of the labour market policy that had been stable for several decades.
The Hartz process was broadly inline with reforms that have been pursued in other industrialised countries, following the OECD’s Job Study in 1994; a focus on supply side measures and privatisation of public employment agencies to reduce unemployment. The underlying claim was that unemployment was a supply-side problem rather than a systemic failure of the economy to produce enough jobs.
The reforms accelerated the casualisation of the labour market (so-called mini/midi jobs) and there was a sharp fall in regular employment after the introduction of the Hartz reforms.
The German approach had overtones of the old canard of a federal system – “smokestack chasing”. One of the problems that federal systems can encounter is disparate regional development (in states or sub-state regions). A typical issue that arose as countries engaged in the strong growth period after World War 2 was the tax and other concession that states in various countries offered business firms in return for location.
There is a large literature which shows how this practice not only undermines the welfare of other regions in the federal system but also compromise the position of the state doing the “chasing”.
In the current context, the way in which the Germans pursued the Hartz reforms not only meant that they were undermining the welfare of the other EMU nations but also drove the living standards of German workers down.
It was a vicious circle – they damaged their own workers standards of living and then relied on the spending of others (Greece etc) but were at the same time undermining the viability of the economies they were reliant on. Juxtapose that madness with the time-bomb that was ticking (the design flaw) and waiting for the first large negative aggregate demand shock to set it off, and you have the current situation in the EMU.
But we can dig deeper than this. The CER paper poses the question “Is Germany a ‘competitive’ economy?” and notes that “(o)ver the past decade, it is one of the rare members of the eurozone to have increased its share of world exports. It has also been running vast trade and current-account surpluses. Its current-account surplus, for example, peaked at a staggering 8 per cent of GDP in 2008 … it is the second largest surplus in the world after China’s”.
The issue is whether this performance reflects strength (as is the popular perception) or weakness.
First, the size of the external balance is not an indicator of productivity. The CER paper notes that relative to Germany, “labour productivity per hour worked is … higher in France – and it runs a current-account deficit”.
Second, German productivity growth is not out of kilter with general Eurozone otucomes over the last decade (it “has been around the eurozone average”.
The CER paper concludes that “Germany does not run external surpluses because it is a more efficient and dynamic economy than others”.
This research paper (published 2009) – Real Wages in Germany: Numerous Years of Decline – provides a good introduction to wage movements in Germany over the several decades.
The following graph is a reproduction of their Figure 9 and shows the percentage change in real compensation of employees in the EU between 2000 and 2008. It is interesting that Spain, Portugal and Italy were also real wage cutters over this period.
The CER paper says that:
If German competitiveness reflects anything, it is the heroic discipline of the country’s workers, not the world-beating efficiency of its economy … With pay settlements systematically undershooting the rate of productivity growth, real unit labour costs (wages adjusted for productivity) fell consistently between 2001 and 2007.
Germany was one of the leaders in the rush to redistribute national income to profits and away from wages. Please read my blog – The origins of the economic crisis – for a general discussion on this point.
As I have noted regularly, one of the hallmark of the neo-liberal period has been the fall in the wage share in national income in most nations. I am working on a paper with Joan Muysken at present on this topic and tracing the redistributed income to the finance industry (we will unveil the research at the – 13th Path to Full Employment Conference/18th National Unemployment Conference (aka the CofFEE conference) – which will be held between December 7 and December 8. The Conference also serves as an annual Australian gathering of the Modern Monetary Theory (MMT) clan.
The systematic redistribution of income – aided and abetted by governments in a number of ways: privatisation; outsourcing; pernicious welfare-to-work and industrial relations legislation; etc to name just a few of the ways. – was been one of the building blocks of the crisis.
The problem that arises is if the output per unit of labour input (labour productivity) is rising so strongly yet the capacity to purchase (the real wage) is lagging badly behind – how does economic growth which relies on growth in spending sustain itself? This is especially significant in the context of the increasing fiscal drag coming from the public surpluses or stifled deficits which squeezed purchasing power in the private sector since over the last few decades.
In the past, the dilemma of capitalism was that the firms had to keep real wages growing in line with productivity to ensure that the consumption goods produced were sold. But in the lead up to the crisis, capital found a new way to accomplish this which allowed them to suppress real wages growth and pocket increasing shares of the national income produced as profits. Along the way, this munificence also manifested as the ridiculous executive pay deals and Wall Street gambling that we read about constantly over the last decade or so and ultimately blew up in our faces.
The trick was found in the rise of “financial engineering” which pushed ever increasing debt onto the household sector. The capitalists found that they could sustain purchasing power and receive a bonus along the way in the form of interest payments. This seemed to be a much better strategy than paying higher real wages.
The household sector, already squeezed for liquidity by the move to build increasing federal surpluses were enticed by the lower interest rates and the vehement marketing strategies of the financial engineers.
The financial planning industry fell prey to the urgency of capital to push as much debt as possible to as many people as possible to ensure the “profit gap” grew and the output was sold. And greed got the better of the industry as they sought to broaden the debt base. Riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit. This is the origins of the sub-prime crisis.
So the dynamic that got us into the crisis is present again and with fiscal austerity emerging as the key policy direction the welfare of our economies is severely threatened. This is a dramatic failure of government oversight.
In Germany’s case, they suppressed domestic spending and relied on the increasing indebtedness of other nations to keep their “export miracle” going.
The CER Paper notes that the punitive real wage cuts and redistribution of income to profits has led to a “marked decline in Germany’s real effective exchange rate” which:
… has been a central factor behind Germany’s rising share of world exports … Germany is not ‘supercompetitive’ because it is uniquely productive or dynamic. In some respects, the reverse is true. Germany, which accounts for over a quarter of eurozone GDP, has contributed only modestly to the region’s economic growth since 1999. For most of the period since the euro was launched, it is Germany that has slowed European growth – not the other way round.
To see this point more adequately, an examination of the sectoral balances for the EMU is helpful. The CER paper seeks to understand the “causes of Germany’s current-account” and notes that:
Germany has been running a current-account surplus because it has been saving more than it has been investing (or, which amounts to the same thing, because it has been spending less than it earns). The difference between Germany’s domestic rate of savings and investment (or income and expenditure) has flowed abroad as capital to fund countries that have been running current-account deficits (that is, where spending has exceeded income).
Regular readers will immediately relate this to the sectoral balances which tell us that: (a) a government deficit (surplus) equals a non-government surplus (deficit); and (b) an external surplus (deficit) equals a domestic deficit (surplus). Surpluses mean the relevant sector is spending less than they are earning and vice versa.
One of the tasks we are undertaking in the paper I mentioned above on wage share movements is to refute the claim that the rising profit share provided more real income for productive investment and this spawned stronger growth. The reality is that the investment ratios did not go up much (if at all) in nations with large redistributions from wages to profits.
The CER paper specifically notes that the “out-sized external surpluses that Germany has generated since 2000″ were the result of both sharp rises in domestic savings and been the product of a sharply rising saving rate and weak business investment spending at home”. In Germany, the investment ratio fell “from 21.5 per cent og GDP in 2000 to 17.4 per cent in 2005”.
They also note – in orthodox mode I should add – that the rise in the domestic saving had nothing to do with government “saving”:
… was not because the German government was being more fiscally virtuous than its EU counterparts. Between 2002 and 2005, in fact, the German government consistently posted budget deficits in excess of the 3 per cent limit laid down by the EU’s Stability and Growth Pact (during the same period, Spain was running largely balanced budgets).
In other words, most of the large external surpluses generated by Germany since 2000 was because of strong private domestic saving and low business investment (at home). There are various reasons for the strong private domestic saving but as the Hartz reforms started to undermine real pay and job security “uncertainty about future income and job prospects” grew which pushed up precautionary savings.
The upshot is that it “is deeply misleading, therefore, to look at Germany’s external surpluses through the prism of the country’s ‘competitiveness’”.
The CER Paper argues that with German households saving more each year because they are in fear of their future, and firms finding it “more attractive to invest abroad than at home” there is a drastic need for reform:
… a conclusion that is radically at odds with the now common view that improving ‘competitiveness’ in peripheral countries is all that is needed to reduce imbalances within the eurozone.
With the Germans are in denial about the way their government is ripping them off by (a) suppressing their real wages; and (b) exporting their real resources to other nations without commensurate return via imports, the national psyche is resistant to any talk of domestic reform.
But they appear to think that if all countries “live within their means” then there will be no problems. The problem is that Germans do not live within their means. They rely on other nations living (in their accounting logic) “beyond their means” for what little growth they achieve.
Germany’s mercantilist mind-set is characteristic of the surplus nations under the Bretton Woods system. Within that system, all the adjustment required to maintain exchange rate parities was forced on the external deficit nations in the form of domestic deflation and persistent unemployment. The fact that the surplus nations were deliberately suppressing the real standard of living of their own citizens was not as greater political issue as the unemployment and stagnation in the deficit nations.
The end result was that the political pressures in the deficit nations led to strategies (competitive devaluations etc) which ultimately brought the fixed exchange rate system down because it was unworkable.
Given the high containment of trading within the Eurozone, the same sort of pressures are clearly destroying the monetary union.
According to World Trade Organisation data, 72.1 per cent of European exports are intra. The share of European exports in world trade has been falling since the Eurozone began.
You have to go to the German Federal Statistical Office to get detailed export data. For my own purposes I did some analysis of the changing composition of German exports since the inception of the Eurozone and came up with this summary Table.
Exports to the Eurozone dominate the total – 78.1 per cent in 2000, 76.2 in 2005, falling to 69.9 by 2010 courtesy of the crisis as German exporters more than doubled their total value of exports to China between 2005 and 2010.
The point is clear – Germany might export high-quality manufactures which the rest of the world (particularly its Eurozone partners) enjoy and that is not the issue. The issue is that they have only been able to do that because other nations (especially the Eurozone nations) have been running current account deficits. It is thus odd that the popular German rhetoric is to kill the goose that laid the golden egg.
But moreover, what Europe (and the World) needs now – desperately – is increased aggregate demand. Greece needs it as much as Germany needs it. It is a falsehood to think the problem is that the Germans have their house in order and Greece needs to behave more like them. If that logic was carried through then German exports would fall as well.
If Greece left the Eurozone, then its “new” currency would clearly depreciate. How much is impossible to tell although the hysterical claims by the conservatives that it would drop to 1/6 of a 1:1 with the Euro is nonsensical. The German tourists would make sure that its downward spiral was resolved relatively quickly. I intend to write a blog about the implications of a Euro-exit sometime in the future.
But the point is relevant to the current blog. If the Germans paid their workers more appropriately – at least allowing real wages to track productivity growth – then the demand dynamics in the Eurozone would change dramatically. Germans would spend more on holidays and Greece is a desirable tourist destination. The impacts would be broader than this. As the CER Paper notes “stronger German demand would also have indirect effects (since a rise in German demand for, say, Dutch goods might later result in more visits by Dutch tourists to Greece)”.
The other reality that hasn’t sunk into the German brain is that as they try to shunt ever-increasing volumes of their real resources out of their country the rise in their real living standards has been very partial. The growth in income per capita has been modest over the last decade and towards the bottom of the EU nations. In other words, the export-led growth model hasn’t produced much economic growth per se, hasn’t done much for income per capita and has been associated with virtually zero growth in real wages for workers.
Who is benefiting? In each of the nations which have engineered a major redistribution of national income away from wages towards profits, it is the elites who have usurped what growth has been achieved.
The CER Paper notes another anomaly. The domestic savings in Germany have been pushed into foreign investments – in Greece, etc – and “supplied a sizeable share of the capital that funded housing booms and reckless spending binges” abroad. The speculative investments in failed real estate and construction in Ireland, Spain etc – do not look like very good uses of German savings. The on-going demolition of the southern economies, where a lot of German investment is at stake, will further undermine German returns.
Further, it is the German banks that have “huge exposures” to “poor quality foreign assets like US sub-prime securities or Greek government bonds are a result of the sheer volume of capital that Germany has been exporting”.
All of these impacts are intrinsic to the export-led growth model which is now unsustainable.
This BBC article (September 8, 2011) – German exports fall sharply in July – outlines the future for German if their insistence that the deficit nations pursue fiscal austerity is realised.
There are more aspects to this issue that I will deal with in future blogs. But the only way forward for the world economy is to stimulate aggregate demand. The high savings of Germans (and the Dutch for example) which then rely on the dis-saving of other nations to maintain some semblance of growth is not consistent with the way in which the Euro bosses are handling this crisis.
There is a great sense of denial here in Europe which I have picked up strongly over the last week. The dots are not being connected. Somehow analysts think that killing off Greece will help Germany maintain its export-led growth strategy.
That is enough for today!