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
George Soros writes a piece on Project Syndicate, that is both pedagogical and very clear in outlining a possible answer to the current EMU crisis. He starts with a diagnosis of the EMU imbalances that rejects the “Berlin View”, and argues for the existence of structural imbalances
Normally, developed countries never default, because they can always print money. But, by ceding that authority to an independent central bank, the eurozone’s members put themselves in the position of a developing country that has borrowed in foreign currency. Neither the authorities nor the markets recognized this prior to the crisis, attesting to the fallibility of both. Read more
So, on today’s FT the German finance minister Wolfgang Schauble forcefully argued that Europe is on the right track, that austerity is paying off, and that “Despite what the critics of the European crisis management would have us believe, we live in the real world, not in a parallel universe where well-established economic principles no longer apply.“
He then proceeds listing all the benefits that austerity and “well-established economic principles” brought to Germany, and to other countries that followed them. Today, he claims, Germany has strong growth, fueled by domestic demand, and grounded on robust investment and innovation.
Ok, let’s see who lives in a parallel world. Read More
Just a quick note on yesterday’s announcement by the Commission that virtuous countries will be able, in 2013 and 2014, to run deficits and to implement public investment projects.
Faced with an excessive enthusiasm, Commissioner Rehn quickly framed this new approach within very precise limits, that are worth transcribing:
The Commission will consider allowing temporary deviations from the structural deficit path towards the Medium-Term Objective (MTO) set in the country specific recommendations, or the MTO for Member States that have reached it, provided that:
(1) the economic growth of the Member State remains negative or well below its potential
(2) the deviation does not lead to a breach of the 3% of GDP deficit ceiling, and the public debt rule is respected; and
(3) the deviation is linked to the national expenditure on projects co-funded by the EU under the Structural and Cohesion policy, Trans-European Networks (TEN) and Connecting Europe Facility (CEF) with positive, direct and verifiable long-term budgetary effect.
This application of the provisions of the SGP concerning temporary deviations from the MTO or the adjustment path towards it is related to the current economic conditions of large negative output gap. Once these temporary conditions are no longer in place and the Member State is forecast to return to positive growth, thus approaching its potential, any deviation as the above must be compensated so that the time path towards the MTO is not affected.
For once, the Commission is not vague about what is allowed and what is not, and the result is that this announcement will turn out to be nothing more than a well conceived Public Relations operation. Allow me to attach some numbers to the Commission proposal.
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.
In the past weeks I have argued at length that the eurozone is in recession because of a strong contraction of aggregate demand; and that in spite of this fact the overall fiscal stance is restrictive.
I also argued that in the current situation the best that can be hoped for peripheral countries is a more gradual consolidation (ideally a neutral stance, but this is too much to ask). I do believe that a fiscal expansion, even in the periphery, would be sustainable and growth-enhancing. But at this stage this is just daydreaming. It won’t happen.
The fiscal stance of the eurozone will not become expansionary (as is sorely needed), if the core (and in particular Germany) does not implement robustly expansionary fiscal policies.
If their fiscal space is limited or non-existent, what can peripheral countries do, besides waiting for an improbable fiscal stimulus in Germany? A lot, actually. If public demand cannot be significantly increased (and will actually be further compressed, albeit at a slower pace), it is all the more important that the governments of Italy, Greece, Spain and so on, find ways to restart private demand.
There is a lot of discussion about structural reforms. They are not the answer. First, because they have an impact mostly on supply (and the problem, let me repeat it, is demand); second, because their benefits, if any, won’t materialize before a few years. And there is no time. The cumulate effect of five years of crisis is now threatening social cohesion in most peripheral countries.
A more straightforward policy, that could be implemented in the next few months with immediate effects, is a strong redistribution of the tax burden towards higher incomes. The increasing inequality of income of the past three decades is in my opinion one of the deep causes of the crisis; inequality has further increased since 2008. The squeeze of revenues for low incomes, coming from the combination of high unemployment and fiscal adjustment, is depressing both the capacity to spend and the morale of households. Increased inequality contributed to global imbalances in the past, and is recessionary in the current crisis.
In September, when the season of budget laws begins, governments in the periphery should propose to their parliaments revenue-neutral tax adjustments, lowering taxes on low income households and increasing them on the rich and very rich. This would be fair, and more importantly, effective to boost morale and consumption. I am talking about a substantial shift of the burden, large enough for its macroeconomic impact to be significant. This is all the more necessary if standard Keynesian deficit spending can not be implemented.
Just a quick note. The two largest surplus economies have lately decided to take radically different paths. China expressed concern for the imbalances lying behind its large current account surplus, and pledged since at least 2009 to re-balance its growth model towards higher domestic demand. I had already discussed that a little more than one year ago, noticing how the challenge for China was to steer away not only from exports, but also from excessive investment. In the same piece I had argued that while China seemed fully conscious of its contribution to the global imbalances that had led to the crisis, Germany had decided to walk the opposite path.
And here we are. With timely synchronization, we learn that wages in Bavaria will increase by 5.6% over the next two years, maybe triggering a more generalized increase. Or maybe not. While in China they increased 17% in the year 2012.
Even taking into account differences in inflation and in growth, the difference is revealing. China is actually playing the game it committed to. Not only it tries to reduce its dependence on foreign demand; but, domestically, it is trying to boost consumption and to curb investment.
In the meantime Germany is stuck with its small-country syndrome: export-led growth and restraints to domestic demand (both public and private). In spite of recent troubles, austerity remains the course Europe is following (with disastrous results). It is telling that even when partially acknowledging that austerity did not bring the fruits she hoped for, Angela Merkel can only suggest, as an alternative, structural reforms to boost competitiveness. Expanding domestic demand has not, is not, and will not be an option for the German government.
The Berlin View is alive and kicking.