Wrong Models

Sebastian Dullien has a very interesting Policy Brief on the “German Model”, that is worth reading. Analyzing the Schroeder reforms of 2003-2005, it shows that it fundamentally boiled down to encouraging part-time contracts, but it did not touch the core of German labour market regulation:

Note, however, what the Schröder reforms did not do. They did not touch the German system of collective wage bargaining. They did not change the rules on working time. They did not make hiring and firing fundamentally easier. They also did not introduce the famous working-time accounts and the compensation for short working hours, which helped Germany through the crisis of 2008–9.

Thus, Dullien concludes, the standard Berlin View narrative, i.e. the success of the German Economy is due to fiscal consolidation and structural reforms in particular in labour markets, needs to be reassessed to say the very least. But there is more than this.

The standard metric of German success, its current account surplus (that resisted even during the crisis), is due to wage restraints and to weak domestic demand much more than to increased productivity. Dullien shows that Germany productivity growth in the past decade was only slightly better than the EU average, and was outperformed by countries like France Portugal or Ireland. A similar picture emerges looking at all the indicators of viable long run growth: Investment (public and private), R&D expenditure (public and private), Education (public and private).  These indicators were actually made worse by the reforms of 2003-2005, that exacerbated the dualism of labour markets and helped create a serious problem of working poors, that will eventually worsen the dynamism of the German economy.

Dullien’s conclusion is unambiguous. Wage restraint and austerity only worked because applied in one country. The deflationary effects of domestic demand compression, and the potentially pernicious long-term effects of investment reduction, could be offset by exports. Clear and extremely convincing.

The way I see it, Dullien’s analysis can be complemented by a couple of remarks. The first is that the current account surplus should not be seen as a mark of success. Rather, it was a precondition for it. Without excess spending in other economies (most notably peripheral eurozone countries), the excess savings of Germany would have resulted in a slump. Germany embarked, the facto, in a beggar-thy-neighbour policy that only succeeded because the other eurozone countries did not retaliate. This is why I pointed, a number of times already, that the German model cannot be exported. And it is a very strange model indeed, one that would crumble if generalized…

The second remark concerns an observation that is marginal in Dullien’s argument (but shouldn’t, in my opinion). He argues that labour market reforms had nothing to do with another major factor of Germany’s success, namely its industrial specialization in high value added sectors (machinery, tools) that benefited of robust demand coming from emerging economies. I would argue that this is the major mark of German success: an institutional system (firms, government, unions) that, as a whole, has designed and implemented a successful industrial policy capable of anticipating and taking advantage of future trends in the global economy. The very same industrial policy that Europe as a whole refuses to put in place, or even to discuss; and that Treaties forbid individual countries to pursue, because it would hamper the free development of market forces. Its peculiar institutions allowed Germany, probably unintentionally, to circumvent the rules. For this not to remain an exception, it would be about time that Europe joined the other major world economies in using industrial policy as a tool to boost growth and unemployment.

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  1. Benoit Essiambre
    July 2, 2013 at 3:35 pm | #1

    This is simple arithmetics. The amount of account surpluses have to be equal to the amount of account deficits in other countries. Any policy that implies a reduction of deficits everywhere will hit hard mathematical limits, create economic gridlock, destroy wealth and overall make people poor and miserable.

  2. Gianluca Cerritelli
    July 3, 2013 at 2:13 pm | #2

    For what it’s worth (I’m not an economist) I totally agree. I suspect though that all this won’t change the fact that the unemployed and one or two of the next generations will still have to be sacrificed to the deities of new religion the West adopted: neo-liberism.

  3. Giovanni Marini
    September 12, 2013 at 7:02 pm | #3

    “Dullien shows that Germany productivity growth in the past decade was only slightly better than the EU average, and was outperformed by countries like France Portugal or Ireland. A similar picture emerges looking at all the indicators of viable long run growth: Investment (public and private), R&D expenditure (public and private), Education (public and private).”

    I wonder if the weak data on German productivity comes from the difficulty of detecting in national accounts the productivity that is realized by product innovation and better quality (higher value perceived by clients).

    Perhaps, qualitative innovation (considered in a post-keynesian framework) is the most powerful tool for a “mercantilist” policy aimed to boost current account surpluses, because you really don’t ever need to decrease prices and trigger a retaliation in a oligopolistic market or cheating in the UE “policy market”.

    You also don’t need to increase the market share in terms of quantity sold to counterbalance a diminished unit price (as states marshall-lerner condition), every gain in market share is a prompt gain in revenue.

    This kind of innovation – if pursued at constant prices – doesn’t bear the risk of an increase of the degree of monopoly (increase of the polarization of incomes) that arises when firms had the opportunity to boost the profit rate not fully distributing the quantitative productivity gains. It doesn’t entails the risk of a downsizing of the labour force, when a lower amount of labour input is requested for a unit of product and sources of additional demand are not immediately disposable (by external demand, autonomous investment or public spending). A fear common to many heterodox economists.

    I fear that, for a country of the perifery, fighting core competitiveness gains based on qualitative innovation with quantitative innovation (incremental process innovation aimed at reducing costs) – or more worse with a devaluation of currency (if still available a sovereign currency – and in the EMU is NOT) – could involve some unpleasant consequences, as, for example, specializing even more in low cost / less differentiated products (less market power and fidelization of demand), worsening terms of trade with the impoverishment of the working class – this is not only determined by the weight of imported inputs on the industrial costs of globalized value chains but by the need of compress internal demand to assure, on the long term, the balance of current account by giving away an higher share of internal product and so not distributing fully the productivity gains to the workers.

    Starting from a “theoretical” situation (not obviously present) of full employment, to mantain full employment and the balance of trade after a qualitative competitiveness gain of the core, a peripheral country acting quantitative innovation has to devolve an higher share of utilization of capacity for external demand, and this could be obtained by an higher degree of monopoly as the higher saving to finance export is possible with an increase of the average propensity of saving.

    If this line of thought is correct, it would be desirable for a country to attain a qualitative innovation model based on technology, R&D, etc.

    Why only a few countries succeed to attain a qualitative innovation model in a relevant share of domestic industry? The question is open to various possible answers:

    the internal organization of the national system of innovation, infrastructure, the quality of the economic and political ruling class, the selection process of the latter … ? If quality matters is the quality of talking heads also important to take the relevant decisions?

    Perhaps, this latter issue is interesting either for an heterodox thinker or for a liberal or quasi liberal
    policy maker (as in the italian PD?) who wants to regain growth and employment by structural reforms aimed to reshaping the domestic productive system …

    Obviously, is quality innovation is not attainable, perhaps quantitative innovation flexibility of exchange rates is better than nothing.

  1. September 17, 2013 at 11:08 pm | #1
  2. October 28, 2013 at 2:57 pm | #2

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