Archive

Archive for the ‘Germany’ Category

Public Debt. I can’t Believe we are Still There

January 25, 2018 3 comments

The crisis is supposedly over, as the European economy started growing again. There will be time to assess whether we are really out of the wood, or whether there is still some slack. But this matters little to those who, as soon as things got slightly better, turned to their old obsession: DEBT! Bear in mind, not private debt, that seems to have disappeared from the radars. No, what seems to keep policy makers and pundits awake at night is ugly public debt, the source of all troubles (past, present and future).

Take my country, Italy. A few days ago this tweet showing the difference between the Italian and the German debt made a few headlines:

 

The ratio increased, so DEBT is the Italian most pressing problem. Not the slack in the labour market. Not the differentials in productivity. I can’t stop asking: why aren’t Italians desperately tweeting this figure?

2018_01_25_Public_Debt1

This shows the relative performance of Italy and Germany along two very common measures of productivity, Multifactor productivity and GDP per capita. I took these variables (quick and dirt from the OECD site), but any other measure of real performance would have depicted a similar picture.

So what? The public debt crusaders will argue that precisely because of debt, Italy has poor real performance. The profligate public sector prevented virtuous market adjustments, and hampered real convergence.  The causality goes from high debt to poor real performance, they will argue. Reduce debt!

Well, think again. Research is much more nuanced on this. A paper by Pescatori and coauthors shows for example that countries with high public debt exhibit high GDP volatility, but not necessarily lower growth rates. High but stable levels of debt are less harmful than low but increasing ones. In a recent Fiscal Monitor the IMF has shifted the focus back to private debt (which, it is worth remembering is the root cause of the crisis), arguing that the deleveraging that will necessarily continue in the next few years will require accompanying measures from the public sector: on one side, renewed attention to the financial sector, to make sure that liquidity problems of firms, but also of financial institutions) do not degenerate into solvency problems. On the other side, the macroeconomic consequences of deleveraging, most notably the increase of savings and the reduction of private expenditure, may need to be compensated by Keynesian support to aggregate demand, thus implying that public debt may temporarily increase in order to sustain growth (self promotion: the preceding paragraph is taken from my book on the relevance of the history of thought to understand current controversies. French version available, Italian version coming out in March, English version coming out eventually).

In just a sentence, the causal link between high debt and low growth is far from being uncontroversial.

Last, but not least, it is worth remembering that Italy was not profligate during the crisis; unfortunately, I would add.  Let’s look at structural deficit (since 2010; ask the Commission why we don’t have the data for earlier years), which as we know washes away the impact of cyclical factors on public finances.

2018_01_25_Public_Debt2

The Italian figures were slightly worse than the German ones, but not dramatically so. And if we take interest expenditure away, so that we have a measure of what the Italian government could actually control, then Italy was more rigorous (Debt obsessive pundits would use the term “virtuous”) than Germany.

The thing is that the Italian debt ratio is more or less stable, in spite of sluggish growth (current and potential) and low inflation. It is not an issue that should worry our policy makers, who should instead really try to boost productivity and growth. Said it differently, it is more urgent for Italy to work on increasing the denominator of the ratio between debt and GDP than to focus on the numerator. And I think this may actually require more public expenditure and a temporary increase in debt (some help from the rest of the EMU, starting from Germany, would not hurt). It is a pity that the “Italian debt problem” is all over the place.

Advertisements

A German Model?

September 23, 2017 1 comment

Tomorrow Germany votes, and there is little suspense, besides the highly symbolic question of whether the far right will make it into the Bundestag.

Angela Merkel will be Chancellor for the fourth time, marking a long period of political and policy stability. In the past fifteen years Germany emerged as the model to follow for the other large economies. For since its economy has performed better, in terms of growth and unemployment, than France or Italy.

I have at discussed at length, here and elsewhere, the costs of the German success in terms of global imbalances and uncooperative behaviours. Last week I wrote a piece for the newly born magazine LuissOpen (Ad: Follow it on twitter! There is plenty of interesting content well beyond economics! End of Ad).

The piece lists, in a non exhaustive way, a number of weaknesses that can be spotted behind the shining macroeconomic results, and also argues that there is much more than labour market liberalization behind a successful economic model (including in Germany).

The original piece can be found here (and here in Italian). I copy and paste it below

Three months after his commencement, Emmanuel Macron delivered last week one of the most important, and controversial, promises of his agenda. The loi travail that will become operational in the next few weeks mostly deals employment protection, which is weakened especially for small and medium enterprises. The aim is to lift constraints for firms hiring, and thus increase employment. This first set of norms should be followed in the next weeks or months by norms aimed at improving training and employability of unemployed workers. Once completed, the package would be the French version of the flexicurity that Scandinavian countries put in place in the past, with different degrees of success.

Without entering into the details of the law, the set of norms approved by the French government, just as the Italian Jobs Act voted in 2014, is a bold step towards the flexibilization of  labour market relations that Germany has in place since the early years 2000, with the so-called “Hartz Reforms”. The German experience, and to a minor extent the first few years of application of the Job Act, can help understand how the French labour market could evolve in the next few years.

Germany in fact sets itself as an example. The argument goes that the reforms it implemented in 2003-2005, did liberalize labour markets, and since then, with the exception of the first years of the crisis, unemployment has been steadily decreasing. But in fact, this is a misleading example, because the Hartz reforms were embedded in a complex institutional setting, which goes well beyond labour market flexibility.

First, an important segment of the German labour market, the one linked to manufacturing and business services, has always been ruled by long-term agreements between employers, workers, and local work councils. For these insider workers a system of work relations was in place, in which highly paid workers acquired skills through vocational training (within or outside the firm), and were protected by an all-encompassing welfare system. Vocational training created robust bonds between the firms, that had often invested substantial resources in the training, and the workers, whose specific skills could not easily be transferred to other sectors or even to other firms.

At the turn of the century, globalized markets coupled with the aftermath of the reunification, exerted a serious pressure for a restructuring  of labour relations.  This restructuring happened through a consensus process that did not involve the government, and kept untouched the bond between the firm and the worker created by vocational training.

The mutual interest in preserving the long-term relationship between workers and firms in the insider markets, led to agreements aimed at reducing costs or to increase productivity without increasing turnover or reducing average job tenure. These agreements could involve on the workers’ side labour sharing, flexibility in hours and in labour mobility, wage concessions, reductions in absenteeism. In exchange for this, firms would guarantee continued investments in innovation and in the (vocational) training of workers, and job security.

It is crucial to understand that the Hartz reform did not touch the insiders market (manufacturing, finance, insurance and business, etc), that as we just said had already begun restructuring without government intervention. The reform made the welfare system less generous, while  allowing access to benefits even for workers with low earnings, thus de facto introducing incentives to low-paid jobs. Furthermore, it liberalized temporary work contracts, and made more flexible a few sectors subject to competition from posted workers (i.e. construction).

The combined result of reforms and endogenous restructuring yielded a spike in part time jobs, and an increase of employment. But it also widened the gap in earnings and in protection between workers in the export-oriented sectors and the others.

The second feature of the German system that made it resilient during the crisis is the existence of a dense network  of local public savings banks (the Sparkassen). Savings bank were a defining feature of the banking sectors of a number of European countries (e.g. Spain, Italy), but have progressively become marginal. Germany is therefore an exception in that its local savings banks are still a pillar of its economy.

Local savings banks have specific public interest missions, as they are involved in the development of local communities, and in financing households and firms (in particular SMEs). The law only allows operation within the region of competence, which shields them from competition while keeping them close to their stakeholders. Similarly, the ambit of their operations is limited (for example, they face limits in their capacity to engage in securities trading or in excessively risky financing).

To avoid that these limitations hamper their effectiveness and their solidity, the banks work as a network  among them. The network exhibits economies of scale and of scope, while remaining close, in its individual components, to local communities. Furthermore, the existence of solidarity mechanisms (rescue funds) ensures that temporary difficulties of a bank are tackled without spreading contagion.

The major private commercial banks, very active in international markets, did suffer like in most other countries, were a drain on public finances, and drastically contracted their lending to the real sector. The Sparkassen on the other hand kept their financing steady (especially to SMEs) and required virtually no state aid. As a consequence, the local savings banks cushioned the impact of the financial crisis on the German economy, and their continued financing of firms is certainly a major factor in explaining the quick rebound of the German economy after 2010.

If taken together, the banking sector and the labour market institutions design a remarkably efficient system, geared towards the establishment of long run relationships in which the interests and the objectives (between entrepreneurs and workers, between banks and firms) were aligned.

But this effectiveness did not come without costs. From a macroeconomic point of view, profitability and competitiveness increased, but also precautionary savings, induced by a less generous welfare state, and by the increased uncertainty faced by workers. The “success” of the German export-led economy, that had a 9% current account surplus in 2016, is based on the compression of domestic demand, and on a labour market that is increasingly split in two, and in which inequality increased dramatically.  The low unemployment that should make other countries envious hides a massive increase of the so-called working poor. (See figure 2 here)

I would push this even further: the Hartz Reform had a strong impact on labour market dualism and precariousness, but only a minor one in explaining the resilience of the economy. A recent CER policy brief makes a somewhat similar point.

Following the Jobs Act, the Italian labour market seems to be headed in a similar direction as the German one. The recent data released by ISTAT on labour market development certified the return of employed people to the pre-crisis peak (2008), thus marking, symbolically the end of the crisis. Yet, GDP is still 7% below its 2008 level, meaning that the increase of employment happened in low value added sectors (such as for example tourism and catering), and often with part-time contracts. These are typically sectors with low and very low wages, and stagnant productivity dynamics. At the same time, wages (but not employment) increase in manufacturing-export oriented sectors. The Italian labour market, in a sentence, is heading towards the same dualistic structure that characterizes the German one. This explains why, like in Germany, Italian domestic demand stagnates; why the increase in employment is obtained at the price of increased precariousness and of the working poor; why, finally, while the numbers say that the crisis is beyond us, the actual experience of households is often different. Italy, and to a minor extent Germany, are the best proof that employment and growth do not necessarily go hand in hand with increased well-being.

Focusing exclusively on labour market flexibility, Italy and in France only imported one element of the German “model”; and probably the one that is by far the least important.  The German capacity to put in place long term relationships, the real key to economic resilience success, is lost in our countries.

Mr Sinn on EMU Core Countries’ Inflation

December 17, 2014 16 comments

Two weeks ago I received a request from Prof Sinn to make it known to my readers that he feels misrepresented by my post of September 29. Here is his very civilized mail, that I publish with his permission:

Dear Mr. Saraceno,
I have just become acquainted with your blog: https://fsaraceno.wordpress.com/2014/09/29/draghi-the-euro-breaker/. You misrepresent me here. In my book The Euro Trap. On Bursting Bubbles, Budgets and Beliefs, Oxford University Press 2014, and in many other writings, I advise against extreme deflation scenarios for southern Europe because of the grievous effects upon debtors. I explicitly draw the comparison with Germany in the 1929 – 1933 period. I advocate instead a mixed solution with moderate deflation in southern Europe and  more inflation in northern Europe,  Germany in particular. In addition, I advocate a debt conference for southern Europe and a “breathing currency union” which allows for temporary exits of those southern European countries for which the stress of an internal adjustment would be unbearable. You may also wish to consult my paper “Austerity, Growth and Inflation: Remarks on the Eurozone’s Unresolved Competitiveness Problem”, The World Economy 37, 2014, p. 1-1,  http://onlinelibrary.wiley.com/doi/10.1111/twec.2014.37.issue-1/issuetoc, in which I also argue for more inflation in Germany to solve the Eurozone’s problem of distorted relative prices.  I would be glad if you could make this response known to your readers.

Sincerely yours
Hans-Werner Sinn
Professor of Economics and Public Finance
President of CESifo Group

I was swamped with end of semester duties, and I only managed to read the paper (not the book) this morning. But in spite of Mr Sinn’s polite remarks, I stand by my statement (spoiler alert: the readers will find very little new content here). True, in the paper Mr Sinn advocates some inflation in the core (look at sections 9 an 10). In particular, he argues that

What the Eurozone needs for its internal realignment is a demand-driven boom in the core countries. Such a boom would also increase wages and prices, but it would do so because of demand rather that supply effects. Such demand-driven wage and price increases would come through real and nominal income increases in the core and increasing imports from other countries, and at the same time, they would undermine the competitiveness of exports. Both effects would undoubtedly work to reduce the current account surpluses in the core and the deficits in the south.

This is a diagnosis that we share But the agreement stops around here. Where we disagree is on how to trigger the demand-driven boom. Mr Sinn expects this to happen thanks to market mechanisms, just because of the reversal of capital flows that the crisis triggered. He argues that the capital which foolishly left Germany to be invested in peripheral countries, being repatriated would trigger an investment and property boom in Germany, that would reduce German’s current account surplus. This and this alone would be needed. Not a policy of wage increases, useless, nor a fiscal expansion even more useless.

Problem is, the data speak against Mr Sinn’s belief. Since the crisis hit, capital massively left peripheral countries, and yet this did not fuel domestic demand in Germany. Last August I showed the following figure:

GermanDomesticDemand

It shows that after a drop (in the acute phase of the financial crisis) due to a sharp decline of GDP, since 2009 domestic demand as a percentage of GDP kept decreasing, in Germany as well as in the rest of the Eurozone. The reversal of capital flows depressed demand in the periphery, but did not boost it in Germany. Mr Sinn is too skilled an economist to fail to see this. The reason is, of course, that the magic investment boom did not happen:

2014_12_17_Sinn_1Mr Sinn, being a fine economist, could object that this is because GDP, the denominator, grew more fell less in Germany than in the rest of the EMU. Well, think again.

2014_12_17_Sinn_2Yes, France comes out as investing (privately) less than Germany. But we are far from an investment boom in Germany as well. Mr Sinn, will agree, I ma sure.

What basically happened, I said it before, is that adjustment was not symmetric. Peripheral countries reduced their excess demand, while Germany and the core did not reduce their excess savings. The result is that, if we compare 2007 to 2014, external imbalances of the periphery were greatly reduced or reversed, while with the exception of Finland the core did not do its homework:

2014_12_17_Sinn_0The EMU as a whole became a large Germany, running a current account surplus (it was more or less in balance in 2007), and relying on its exports for growth. A very dubious strategy in the long run.

The conclusion in my opinion is one and only one: We cannot count on markets alone, in the current macroeconomic situation, if we want rebalancing to take place. In the article he suggested I read, Mr Sinn states that a 4 or 5 per cent inflation rate would be politically impossible to sell to the German public:

Moreover, it is unclear whether the German population would accept being deprived of their savings. Given the devastating experiences Germany made with hyperinflation from 1914 to 1923, which in the end undermined the stability of its society, the resistance against an extended period of inflation in Germany could be as strong or even stronger than the resistance against deflation in southern Europe. After all, a rate of 4.1 per cent for German inflation for 10 years, which would be necessary to allow the necessary realignment between France and Germany without France sliding into a deflation, would mean that the German price level would increase by 50 per cent and that, in terms of domestic goods, German savers would be deprived of 33 per cent of their wealth. If the German inflation rate were even 5.5 per cent, which would be necessary to accommodate the Spanish realignment without price cuts, its price level would increase by 71 per cent over a decade and German savers would be deprived of 42 per cent of their wealth.

This shows all the logic of Ordoliberalism: It is impossible to sell inflation to the the German public, because this would deprive them of their savings. This argument only makes sense if one subscribes to the Berlin View that the bad guys in the south partied with hard earned money of northern (hard) workers. Otherwise the argument makes no sense at all, as high inflation in the core for next few years simply  compensates low inflation in the past. Should I remind Mr Sinn that the outlier in terms of labour costs  is not the EMU periphery, but Germany?

Also, I find it disturbing that, while acknowledging that inflation in Germany would be needed, Mr Sinn rejects it on the ground that it would be a hard sell. The role of intellectuals and academics is mostly to discuss, find solutions (or at least try), and then argue for them. All the more so if this is unpopular, because it is then that their pedagogical role is most needed. All too often public intellectuals abdicate to their role, and simply follow the trend. Should we all argue in favour of a euro breakup only because public opinion is less and less favorable to the single currency?

Finally, a short comment on another bit of Mr Sinn’s article:

And although the core countries would suffer [from high inflation], the solution would not be comfortable for the devaluating countries either. They will unavoidably face a long-lasting stagnation with rising mass unemployment and increasing hardship for the population at large. People will turn away from the European idea, and voices opting for exiting the euro will gain strength. Thus, it might be politically impossible to induce the necessary differential inflation in the Eurozone.

I don’t really see his point here. But let’s take it for good, just for the sake of argument. I think it is too late to worry about support for the euro in the periphery. It is hard to see how “excessive” inflation in the core would impose more hardness than seven years of adjustment, ill-conceived structural reforms, and self-defeating austerity.

So Mr Sinn, thank you for your mail and for the reference to your paper that I have read with interest. But no, I don’t think I misrepresented you.  The core of your argument remains that the burden of adjustment should rest on the periphery’s shoulders. And you failed to convince me that this is right.