I just read, a few days late, a very instructive Op-Ed by Otmar Issing for the Financial Times. The zest of the argument is in the first few lines, that are worth quoting:
Imagine you are asked to give advice to a country on its economic policy. The country enjoys near-full employment; its growth is above, or at least at full potential. There is no under-usage of resources – what economists call an output gap – and the government’s budget is balanced, but the debt level is far above target. To top it all monetary policy is extremely loose.
This is exactly the situation in Germany. Recently forecasts for growth have been revised downwards, but so far the overall assessment is unchanged. At present there is no indication of the country heading towards recession. Inflation is low but there is no risk of deflation. From a purely national point of view Germany needs a much less expansionary monetary policy than it is getting from the European Central Bank. This is a strong argument why fiscal policy should not be expansionary, too.
Where is the economic textbook that argues that such a country should run a deficit to stimulate the economy? There is hardly a convincing argument for such advice.
The quote is a perfect example of what is wrong with mainstream thinking in German academic and policy circles. First, the incapacity to fully appreciate to what extent the German national interest is linked to the wider fate of the eurozone. From a purely national point of view, Germany needs stronger growth in the eurozone, its main trading partner. And it needs higher inflation at home and abroad. Which means that no, monetary policy is not too expansionary for Germany, as Issing claims.
But there is a more important issue: Issing seems not to grasp that the problem with the German economy is that it is unbalanced. True, it is near full employment (even if much could be said about the quality of that employment), but it relies too much on exports and too little on domestic demand, with the result that it runs, since 2001, increasing current account deficits. To say it bluntly, Germany has been sitting on the shoulders of the rest of the world economy, and since 2010 it has been followed by the rest of the eurozone that is globally running trade surpluses. I have already said many times that this is a bad (and dangerous) strategy.
I do not know what textbooks Issing reads. Germany’s intellectual tradition must include OrdoTextBooks. The ones I know say that expansionary fiscal policy, at full employment, crowds out private expenditure and exports. And guess what? This is exactly what Germany should do, for its own and its neighbours’ welfare. And if at the same time private expenditure was also boosted, with wage increases (hey, don’t listen to me; listen to the Bundesbank!) and incentives for investment, crowding out could be limited to foreign demand.
So, I read textbooks and I conclude that Otmar Issing is dead wrong. Germany should boldly expand domestic demand (public and private), thus overheating its economy, crowing out exports, and increasing inflation. The effect would be rebalancing of the German economy, growth in the rest of the eurozone, and relief in the rest of the world, for which we would stop being a drag.
Unfortunately this is not bound to happen anytime soon.
Yesterday’s headlines were all for Germany’s poor performance in the second quarter of 2014 (GDP shrank of 0.2%, worse than expected). That was certainly bad news, even if in my opinion the real bad news are hidden in the latest ECB bulletin, also released yesterday (but this will be the subject of another post).
Not surprisingly, the German slowdown stirred heated discussion. In particular Sigmar Gabriel, Germany’s vice-chancellor, blamed the slowdown on geopolitical risks in eastern Europe and the Near East. Maybe he meant to be reassuring, but in fact his statement should make us all worry even more. Let me quote myself (ach!), from last November:
Even abstracting from the harmful effects of austerity (more here), the German model cannot work for two reasons: The first is the many times recalled fallacy of composition): Not everybody can export at the same time. The second, more political, is that by betting on an export-led growth model Germany and Europe will be forced to rely on somebody else’s growth to ensure their prosperity. It is now U.S. imports; it may be China’s tomorrow, and who know who the day after tomorrow. This is of course a source of economic fragility, but also of irrelevance on the political arena, where influence goes hand in hand with economic power. Choosing the German economic model Europe would condemn itself to a secondary role.
I have emphasized the point I want to stress, once again, here: adopting an export-led model structurally weakens a country, that becomes unable to find, domestically, the resources for sustainable and robust growth. And here we are, the rest of the world sneezes, and Germany catches a cold. The problem is that we are catching it together with Germany:
The ratio of German GDP over domestic demand has been growing steadily since 1999 (only in 19 quarters out of 72, barely a third, domestic demand grew faster than GDP). And what is more bothersome is that since 2010 the same model has been
adopted by imposed to the rest of the eurozone. The red line shows the same ratio for the remaining 11 original members of the EMU, that was at around one for most of the period, and turned frankly positive with the crisis and implementation of austerity.It is the Berlin View at work, brilliantly and scaringly exposed by Bundesbank President Jens Weidmann just a couple of days ago. We are therefore increasingly dependent on the rest of the world for our (scarce) growth (the difference between the ratio and 1 is the current account balance).
It is easy today to blame Putin, or China, or tapering, or alien invasions, for our woes. Easy but wrong. Our pain is self-inflicted. Time to change.
Mario Draghi, in an interview to the Journal du Dimanche, offers an interesting snapshot of his mindset. He (correctly in my opinion) dismisses euro exit and competitive devaluations as a viable policy choices:
The populist argument that, by leaving the euro, a national economy will instantly benefit from a competitive devaluation, as it did in the good old days, does not hold water. If everybody tries to devalue their currency, nobody benefits.
But in the same (short) interview, he also argues that
We remain just as determined today to ensure price stability and safeguard the integrity of the euro. But the ECB cannot do it all alone. We will not do governments’ work for them. It is up to them to undertake fundamental reforms, support innovation and manage public spending – in short, to come up with new models for growth. [...] Taking the example of German growth, that has not come from the reduction of our interest rates (although that will have helped), but rather from the reforms of previous years.
I find it fascinating: Draghi manages to omit that German increased competitiveness mostly came from wage restraint and domestic demand compression, as showed by a current account that went from a deficit to a large surplus over the past decade. Compression of domestic demand and export-led growth, in the current non-cooperative framework, would mean taking market shares from EMU partners. This is in fact what Germany did so far, and is precisely the same mechanism we saw at work in the 1930s. Wages and prices would today take the place of exchange rates then, but the mechanism, and the likely outcome are the same. Unless…
Draghi probably has in mind a process by which all EMU countries embrace the German export-led model, and export towards the rest of the world. I have already said (here, here, and here) what I think of that. We are not a small open economy. If we depress our economy there is only so much the rest of the world can do to lift it through exports. And it remains that the second largest economy in the world deserves better than being a parasite on the shoulders of others…
As long as German economists are like the guy I met on TV last week, there is little to be optimist about…
Olli Rehn wrote a balanced piece on Germany’s current account surplus. To sum it up:
- He acknowledges that Germany’s surplus is a problem.
- He acknowledges (albeit indirectly) that the initial source of the problem were capital flows from Germany and the core to the periphery; flows that did not go into productive investment but fueled bubbles.
- He (correctly) argues that over the long run some excess savings from Germany is justified by the need to provide for an ageing population.
- He points out that investment has been too low and needs to increase (possible within the framework of an energy transition).
- He also mentions, without mentioning it, the problem of excessively low wages and pauperisation of the labour force, calling for increases in wages and reduction in taxes to boost domestic demand.
This seems to me a reasonable analysis, and I would welcome an official position of the Commission along these lines. Yet, I think that what is missing in Rehn’s piece, and in most of the current debate, is a clear articulation of between the long and the short run.
I would not object on the need for Germany to run modes surpluses on average over the next years, to pay for future pensions and welfare. It is after all a mature and ageing country. Even more, I would agree with the argument that low wages need to increase, and that bottlenecks that prevent domestic demand expansion should be removed. In other words, I would most likely agree on the Commission’s prescriptions for the medium-to-long run.
Nevertheless, there is a huge hole in Olli Rehn’s analysis, that worries me a bit. Rehn seems to overlook the need to do something here and now. Today, with the periphery of the eurozone stuck in recession, emerging economies sputtering, and continuing jobless growth in the US, the world desperately needs a boost from countries that can afford it. And unfortunately there are not many of these.
Germany is instead siphoning off global demand, making the rest of the world carry its economy when it should do the opposite. As a quick reversal of private demand is unlikely, (this, I repeat should be a medium run target), I see no other option in hte very short run than a substantial fiscal expansion.
A cooperative Germany should implement short run expansionary policies (the need for public investment is undeniable), while working to rebalance consumption, investment and savings in the medium run, with the objective of a small current account surplus in the medium run.
That, incidentally, would not make them Good Samaritans. Ending this endless recession in the eurozone (yes I know, it is technically over; but how happy can we be with growth rates in the zero-point range?) is in the best interest of Germany as much as of the rest of the eurozone (and of the world).
A clear articulation between the different priorities in the short and in the medium-long run would benefit the debate. The problem is that then Olli Rehn should acknowledge that in the short run there is no alternative to expansionary fiscal policies in the eurozone core. That would be asking too much…
Germany rejected the US Treasury’s criticism of the country’s export-focused economic policies as “incomprehensible”. Much has been said about that. Let me just add some pieces of evidence, just to gather them all in the same place.
Exhibit #1: Net Lending Evolution
Note#1 : I took net lending because because net income flows from residents to non residents (not captured by the current account) may be an important part of a country’s net position (most notably in Ireland). Note #2: I took away France and Italy from the two groups called “Core” and “Periphery”, because their net position was relatively small as percentage of GDP in 2008, and changed relatively little.
Following the widely discussed U.S. Treasury report on foreign economic and currency policies, that for the first time blames Germany explicitly for its record trade surpluses, I published an op-ed on the Italian daily Il Sole 24 Ore (in Italian), comparing Germany with China. My argument there is the following:
- Before the crisis the excess savings of China and Germany, the two largest world exporters, contributed to the growing global imbalances by absorbing the excess demand of the U.S. and of other economies (e.g., the Eurozone periphery) that made the world economy fragile. (more here)
- In the past decade, China seems to have grasped the problems yielded by an export-led growth model, and tried to rebalance away from exports (and lately investment) towards consumption (more here). The adjustment is slow, sometimes incoherent, but it is happening.
- Germany walked a different path, proudly claiming that the compression of domestic demand and increased exports were the correct way out of the crisis (as well as the correct model for long-term growth)
- Germany’s economic size, its position of creditor, and its relatively better performance following the sovereign debt crisis, (together with a certain ideological complicity from EC institutions) allowed Germany to impose the model based on austerity and deflation to peripheral eurozone countries in crisis.
- Even abstracting from the harmful effects of austerity (more here), I then pointed out that the German model cannot work for two reasons: The first is the many times recalled fallacy of composition): Not everybody can export at the same time. The second, more political, is that by betting on an export-led growth model Germany and Europe will be forced to rely on somebody else’s growth to ensure their prosperity. It is now U.S. imports; it may be China’s tomorrow, and who know who the day after tomorrow. This is of course a source of economic fragility, but also of irrelevance on the political arena, where influence goes hand in hand with economic power. Choosing the German economic model Europe would condemn itself to a secondary role.
I would add that the generalization of the German model to the whole eurozone is leading to increasing current account surpluses. Therefore, this is not simply a European problem anymore. By running excess savings as a whole, we are collectively refusing to chip in the ongoing fragile recovery. The rest of the world is right to be annoyed at Germany’s surpluses. We continue to behave like Lilliput, refusing to play our role of large economy.
Let me conclude by noticing that today in his blog Krugman shows that sometimes a chart is worth a thousand (actually 748) words:
Wolfgang Munchau has an excellent piece on today’s Financial Times, where he challenges the increasingly widespread (and unjustified) optimism about the end of the EMU crisis. The premise of the piece is that for the end of the crisis to be durable, it must pass through adjustment between core and periphery. He cites similar statements made in the latest IMF World Economic Outlook. This is good news per se, because nowadays, with the exception of Germany it became common knowledge that the EMU imbalances are structural and not simply the product of late night parties in the periphery. But what are Munchau’s reasons for pessimism? Read More