Why German wages need to rise

An interesting disagreement occurred this week between Martin Sandbu and the Economist, which prompted a subsequent letter from Philippe Legrain (see also Martin again here). The key issue is whether the German current account surplus, which has steadily risen from a small deficit in 2000 to a large surplus of over 8% of GDP, is a problem or more particularly a drag on global growth.

To assess whether the surplus is a problem, it is helpful to discuss a key reason why it arose. I have talked about this in detail many times before, and a similar story has been told by one of the five members of Germany’s Council of Economic Experts, Peter Bofinger. A short summary is that from the moment the Eurozone was born Germany allowed wages to increase at a level that was inconsistent with the EZ inflation target of ‘just below 2%’. We can see this clearly in the following chart.

Relative unit labour costs, source OECD Economic Outlook, 2000=100

The blue line shows German unit labour costs relative to its competitors compared to the same for the Euro area average. Obviously Germany is part of that average, so this line reduces the extent of any competitiveness divergence between Germany and other union partners. By keeping wage inflation low from 2000 to 2009, Germany steadily gained a competitive advantage over other Eurozone countries.

At the time most people focused on the excessive inflation in the periphery. But as the red line shows, this was only half the story, because wage inflation was too low in Germany compared to everyone else. This growing competitive advantage was bound to lead to growing current account surpluses.

However that in itself is not enough to say there is a problem, for two related reasons. First, perhaps Germany entered the Eurozone at an uncompetitive exchange rate, so the chart above just shows a correction to that. Second, perhaps Germany needs to be this competitive because the private sector wants to save more than it invests and therefore to buy foreign assets.

There are good reasons, mainly to do with an ageing population, why the second point might be true. (If it was also true in 2000, the first point could also be true.) It makes sense on demographic grounds for Germany to run a current account surplus. The key issue is how big a surplus. Over 8% of GDP is huge, and I have always thought that it was much too big to simply represent the underlying preferences of German savers.

I’m glad to see the IMF agrees. It suggests that a current account surplus of between 2.5% to 5.5% represents a medium term equilibrium. That would suggest that the competitiveness correction that started in 2009 has still got some way to go. Why is it taking so long? This confuses some into believing that the 8% surplus must represent some kind of medium term equilibrium, because surely disequilibrium caused by price and wage rigidities should have unwound by now. The answer to that can also be found in an argument that I and others put forward a few years ago.

For this competitiveness imbalance to unwind, we need either high wage growth in Germany, low wage growth in the rest of the Eurozone, or both. Given how low inflation is on average in the Eurozone, getting below average wage inflation outside Germany is very difficult. The reluctance of firms to impose wage cuts, or workers to accept them, is well known. As a result, the unwinding of competitiveness imbalances in the Eurozone was always going to be slow if the Eurozone was still recovering from its fiscal and monetary policy induced recession and therefore Eurozone average inflation was low. [1]

In that sense German current account surpluses on their current scale are a symptom of two underlying problems: a successful attempt by Germany to undercut other Eurozone members before the GFC, and current low inflation in the Eurozone. To the extent that Germany can make up for their past mistakes by encouraging higher German wages (either directly, or indirectly through an expansionary fiscal policy) they should. Not only would that speed adjustment, but it would also discourage a culture within Germany that says it is generally legitimate to undercut other Eurozone members through low wage increases. [2]

From this perspective, does that mean that the current excess surpluses in Germany are a drag on global growth? Only in a very indirect way. If higher German wages, or the means used to achieve them, boosted demand and output in Germany then this would help global growth. (Remember that ECB interest rates are stuck at their lower bound, so there will be little monetary offset to any demand boost.) The important point is that this demand boost is not so that Germany can help out the world or other union members, but because Germany should do what it can to correct a problem of its own making.

[1] Resistance to nominal wage cuts becomes a much more powerful argument for a higher inflation target in a monetary union where asymmetries mean equilibrium exchange rates are likely to change over time.

[2] The rule in a currency union is very simple. Once we have achieved a competitiveness equilibrium, nominal wages should rise by 2% (the inflation target) more than underlying national productivity. I frequently get comments along the lines that setting wages lower than this improves the competitiveness of the Eurozone as a whole. This is incorrect, because if all union members moderate their wages in a similar fashion EZ inflation would fall, prompting a monetary stimulus to bring inflation back to 2% and wage inflation back to 2% plus productivity growth.    

Post-truth and propaganda

A long read on why it is time the rest of the media stopped treating Fox as TV news, and some UK tabloids as newspapers.

George Osborne becomes editor of the London Evening Standard. Donald Trump blames GCHC for bugging him because of something he saw on Fox News. The lines between right wing media and right wing politicians seem very blurred nowadays. This should not come as a surprise, because right wing media have been becoming much more like propaganda outlets than normal media organisations for some time. The conventions of journalism may have pretended otherwise, but it time we recognised reality.

Let me define two archetypes. The first, which could be called the truth purveyor, is the one we are familiar with, and which much of the mainstream media (MSM) like to imagine they correspond to. The aim is provide the best information to readers or viewers. The second is propaganda. One way of characterising the two archetypes is as follows. Readers have certain interests: objectives, goals, utilities etc. The truth purveyor will provide readers with the information they need to pursue those interests. (As exemplified here, for example.) Propaganda on the other hand, to borrow from Jacob Stanley, aims to provide information that will deceive people from seeing what is in their best interest. Propaganda provides information that supports a particular political goal or point of view.

Take, for example, the issue of welfare benefits. Media as the truth-purveyor type will try and present a rounded and accurate picture of those claiming welfare benefits. Right wing propaganda on the other hand will focus on examples of benefit fraud, or cases where the benefit recipient will be perceived by the reader as taking advantage of the system, with little or no attempt to put the example in any kind of context. This slanted coverage is designed to give the impression that benefit recipients are often scroungers and skivers. The political goal is to make it easier for governments to cut welfare payments, which in turn may allows taxes to be cut.

These are archetypes, and any media organisation will mix the two to some extent. Many would argue that even the most truth-purveyor type organisation may still embody certain assumptions or points of view that distort their readers view of what should be in their best interest. (As argued in Manufacturing Consent, for example.) Mediamacro is an example of this. But that should not blind us to what is happening elsewhere. Lines like “liberals’ nostalgia for factual politics seems designed to mask their own fraught relationship with the truth” [1] suggest nothing new is happening, let’s move on. That would be a huge mistake. It is like saying all news is propaganda, who cares. But because there are two archetypes, organisations can gradually move from one to another, and that movement is important. It played a crucial role in the success of Brexit and Trump.

In both in the UK and US there is a large part of the media which is becoming more and more like a pure propaganda outlet. We are used to thinking about propaganda as being associated with the state, but there is no reason why that has to be the case. In the UK and US, we now have propaganda machines that support political ideas that are associated with the far right, and political interests associated with the very wealthy. Their output is governed more and more by whether it assists those two goals.

Apologists for this right wing propaganda say that most media organisations have their particular political bias, and that will be reflected in the opinions you see in that media outlet. But I’m not talking about opinion pieces or leaders, but about the selection of stories and increasingly about making up stories. I cannot see either the Guardian, Mirror or MSNBC only reporting terrorist incidents by white supremacists, and ignoring those by Muslims. Nor would these organisations make up claims about foreign cities being ‘no go areas’. Suggesting an equivalence between The Mail and The Mirror, or between Fox and MSNBC, is a trap that many fall into.

Now it is natural, in a liberal democracy, that the part of the media that conveys propaganda should pretend it is just a purveyor of truth. When its propaganda becomes self-evident, it is also natural for it to claim that this is because it is others who are distorting the facts. In this sense, the fact that Trump and his supporters talk about the dominant liberal media producing fake news, and the right wing tabloids talk about bias at the BBC should not worry us at all. It is merely indicative that those making the allegations are in the business of, or supporting those, supplying propaganda. [2] More importantly, if we allow this attempt at deflection to move us away from examining what different parts of the media are doing, then the propagandists have won.

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I think it was Charlie Bean who first told me about the stupidity of a firm announcing that it was going to have to make redundancies, without specifying where those redundancies would be. It is foolish because the atmosphere of uncertainty created means that those most able to leave, who are almost certainly the brightest and best and therefore those that the firm would like to keep, end up leaving the firm because they can. Voluntary quits mean the firm no longer needs to create redundancies, but its loses its best quality staff to other firms.

I thought about this when reading about yet more examples of how EU citizens are currently being treated by this government. Colin Talbot has documented what is going on here, but there are literally thousands of similar stories. People who have lived and worked in the UK for years are told by the home office, when their application for permanent residence is turned down, to prepare to leave the UK. Applications which ask for a ridiculous amount of information and are turned down for often mindless reasons. It is a system designed to increase the chances that applicants will fail.

The effect this has, of course, is that those most able to leave the UK, who will often be the most able in terms of the importance of the work they do, will go. Refusing to confirm the rights of EU residents and sending them scary letters is how the UK government is making the same mistake as the firm that announces future unspecified redundancies. I am sometimes told that Brexit will allow the UK to choose the ‘best immigrants’, the ones that will contribute most to UK output and the public purse. Here we see Brexit achieving exactly the opposite: a system designed to encourage the best to leave.

But this is not a new Brexit phenomenon. As I described here, students wanting to come and study in the UK have faced a similar brutal regime, where a mistake by the UK bureaucracy - even when it is acknowledged as such - can lead to additional expense for the student and a period of uncertainty which can only set back their learning. Students midway through their course are told they have 60 days to find an alternative institution to sponsor them or face deportation. The UK Border Agency has no reason to believe that these are not perfectly genuine students who have paid good money to study in the UK, but it chooses to punish them because of alleged failings by a university.

There is an obvious pattern here. It is to treat those who are not UK nationals with a complete lack of humanity. It is, quite simply, very cruel. I talked above about how counterproductive it is, but even if it was not it remains very wrong. It is not something that any democratic government should do. Similar things are happening in the US as a result of Trump’s victory. This lack of humanity comes from a government that begins treating foreigners as a problem, as something to be discouraged, rather than as the people that they are. And it persists because a large part of the press deliberately ignores what is going on. That in turn reduces coverage in the broadcast media.

Contrast this with Germany, which has admitted around 1 million refugees over the last two years. Whatever the motives of the German government, German society adopted a ‘welcome culture’ to these refugees. There have been problems of course, but it is significant that the most serious you may have read about have been made up by certain US media organisations. Contrast this with the UK government shutting down the ‘Dubs amendment’ programme after only a few hundred refugee children had been admitted to the UK. For Germans it seems that refugees are people who have suffered and need help, but for the British they are something to fear and should be kept away at all costs.

Why is Germany welcoming a million refugees and the UK appears to do what they can to keep them out? Is the difference between the two countries something to do with an innate difference in national character? Do we in the UK allow our government to continue their inhuman treatment of foreign nationals because there is

“a special kind of British suggestibility – willingness to obey orders, thinking in generalisations, the search for panaceas, faith in power, which made many British capable of falling to deeper depths than many people of other nations”

Of course not. The above is a quote from Stephen Spender, visiting Germany in 1945, where I have changed German to British. After WWII it was common to believe that what happened in Germany under Hitler could only have happened if there had been some common abnormality in the German character. It was as mistaken then just as it is mistaken now to believe the British are particularly hostile to foreigners. But we should not be surprised when those outside the UK begin to think that way.

There is a much simpler explanation in both cases. The state propaganda machine of Nazi Germany was a critical ingredient in their rise to power and maintaining power. Hitler devoted chapters of Mein Kampf to the study and practice of propaganda. It is perhaps the best real world example of the propaganda archetype I described before. In the UK and US it is very different. Critically propaganda outlets do not have a monopoly of information, and they need to appear much like the rest of the media to retain their readers and their influence on the national stage. But a large part of the UK and US media is nevertheless increasingly acting as a propaganda vehicle, particularly in the area of immigration.

This change is measurable, as this report of a study shows. To quote “over the last 10 years [the UK press] appears to have been complicit in the narrowing of a discussion that is now characterised by an increasingly negative tone.” The anti-immigration propaganda in the Mail and Express reached a peak just before the referendum. As Liz Gerard describes here, these two papers printed on average two or three hostile immigration stories in each issue in 2016. The day before polling, the Mail printed six whole pages devoted to immigration. You would have to be a fool to believe these were ‘reflecting the interest of readers’: it was designed to push the referendum vote the way these papers wanted. It was pure propaganda.

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The are lots of stories around about a post-truth world created by social media. It is usually written up as if it is a new phenomenon created by new technology, but as Timothy Garton Ash notes ‘post-truth’ is nothing new. Equally the hype over Cambridge Analytica (here or here), whether it is accurate or not, is just the technological extension of something that is already happening, and has happened in the past. Most people still rely on the MSM for their news. Post-truth mainly comes from the part of the MSM whose business is propaganda, and the inability of others to treat it as such. Fake news stories on social media did not win the election for Trump. Fox News almost certainly did.

As Tim Harford notes, successful attempts to divert those in a democracy from the truth have a long history. Scientists published evidence that smoking caused lung cancer in the early 1950s. It took decades for that information to lead to campaigns to discourage smoking and for smokers to acknowledge there was a problem, and the reason it took decades was that the tobacco companies conducted a PR plan with that aim in mind. Exactly the same happened with climate change, with considerable success in the US as we are now witnessing with Trump’s election. As a tobacco firm wrote “doubt is our product”.

As Tim and George Lakoff explain, simply rebutting lies with facts can often be counterproductive. The Leave campaign's £350 million a week was a classic example. The more it was talked about, the more it became fixed in the mind of voters. The regrettable truth is that most people do not read the detail, but instead just absorb the headline. In many ways the EU referendum is a classic example of how facts can lose out to propaganda.

All this can just seem depressing, but it is not if we learn some obvious lessons. The first, which Ben Chu explains, is for policy makers not to fall into the trap of appeasement.

“Christina Boswell and James Hampshire have highlighted how the public discourse on immigration in Germany was transformed between 2000 and 2008. Social Democratic politicians used familiar arguments about the economic benefits of immigration. But they did this alongside a campaign to promote positive narratives about immigration and its place in the country’s history to counter entrenched perceptions of Germany being kein Einwanderunglsand (“not a country of immigration”). This twin approach largely succeeded in changing attitudes, flowering in the generous position taken by Angela Merkel’s Christian Democrat government towards Syrian refugees in the summer of 2015.

By contrast in the UK, at the same time, Labour began to talk up “British jobs for British workers” and never seriously rebutted the dominant and dismal narrative of the tabloid press about immigration being an economic burden and culturally corrosive, arguably helping to set the scene for the current bout of self-harming Brexit-related xenophobia.”

Now politicians here may respond that the German example is impossible given the strength of the propaganda coming from UK tabloids (compared to its relative absence in Germany), but that just strengthens my point that we should start recognising that propaganda for what it is. That recognition needs to start in the rest of the mainstream media. According to a study outlined here, “a right-wing media network anchored around Breitbart developed as a distinct and insulated media system ... This pro-Trump media sphere appears to have not only successfully set the agenda for the conservative media sphere, but also strongly influenced the broader media agenda, in particular coverage of Hillary Clinton.”

But the authors also note that “Our data strongly suggest that most Americans, including those who access news through social networks, continue to pay attention to traditional media, following professional journalistic practices, and cross-reference what they read on partisan sites with what they read on mass media sites.” What this traditional media needs to do, in both the UK and US, is to recognise propaganda for what it is, and treat it with the disdain that it deserves.

In the US that is quite a challenge because a lot of that propaganda is now created or recycled by the President himself. In the UK it is a challenge because the right wing tabloids have the government’s support, and the government holds the purse strings of the BBC. [4] It is very easy just to ignore what is happening, and carry on as usual. But this inability or unwillingness to recognise the danger posed by propaganda is part of the reason 2016 happened. Liberal democracy’s survival in the UK and US may depend on recognising and resisting what is in the process of destroying it.

[1] Taken from Stahl and Hansen. The implication that they draw, that propaganda as news or post-truth or whatever you want to call it can be combatted by a “democratic revival” seems simply naive. To see the profound difference between, say, the Blair government compared to what came before and after them, you only have to look at how they regarded academics.

[2] For those who say how do we know who is telling the truth, then you are part of the problem.

[3] And among academics, UK nationals as well. 

[4] And, it seems, increasingly supplies its journalists.

International GDP per capita comparisons

As I have noted before, it is one of the great ironies of UK politics that recent growth only looks respectable because of immigration. Because mediamacro does not connect dots, politicians can get away with talking about a solid UK recovery, even though it is only half respectable because of the immigration they say must be reduced. But large migration flows are not just a UK experience.

The focus on GDP rather than GDP/capita distorts international comparisons as well. I conducted a small twitter poll (something over 500 votes) asking which of these 4 countries had grown most rapidly from 2006 to 2015: Germany, Japan, UK and US. Now those who voted are by self-selection well informed about economics, but over half chose the wrong answer in a comparison where the winner is ahead by a mile. Here is a chart (using IMF data).

I suspect the main reason why less than 50% chose Germany is that we are so used to GDP comparisons, and both the UK and the US experienced large scale immigration over this period. Using GDP the US wins (with 12% growth), closely followed by Germany (10.5%) and the UK (9.5%) with Japan way behind at 3.5%. But both the US and UK numbers are hugely flattered by immigration.

Why did Germany do so well in terms of the average living standards of its people? We need to talk about demand and supply. As readers should know, Germany suffered from austerity just as the US and UK did. But as you should also know, this was compensated for by a large competitive advantage it had gained over its fellow Eurozone members because of slow wage growth from 2000 to 2006. Strong growth in net trade made up for austerity, leading to a comparatively strong output per head performance (and, going with that, a huge current account surplus).

How was this demand boost met in terms of increased supply? Not through more rapid productivity growth (measured in terms of output per employed person), which hardly increased over this period. Instead it was through an amazing decrease in unemployment. In 2006 the unemployment rate in Germany was 10%, whereas by 2015 it was less than 5%. This in turn reflects the Hartz reforms, discussed by Tom Krebs and Martin Scheffel here. As they point out, this reform created losers (in terms of risk, particularly) as well as winners in terms of average income per head.

All this emphasises the point that GDP figures can be a poor guide to growth in average incomes. It also puts into perspective claims by Conservative politicians, widely repeated by the media, that the UK has been doing better than everyone else. Over this reasonably long period (you can always cherry pick short horizons), Germany has clearly been doing better than anyone else among the major countries, with growth from 2006 to 2015 of over 11%. Next come a group of countries at around 4% growth, including the USA and Japan as well as Sweden and Switzerland. Below them is another group of around 2% growth, including the UK, Ireland and the Netherlands. Just behind at 1% is France and Belgium.

The UK is certainly not at the bottom of the league, with a number of countries with GDP per capita in 2015 still below 2006 levels. These include Spain, Portugal, Finland and Denmark, with really poor performances from Italy and Troika run Greece. But growth of even 4% over 9 years is nothing to be proud of. Among all these countries, only Germany can claim to have actually recovered from the recession. [1]

[1] Outside this established group, we have seen strong growth from Australia, Israel, and the Czech and Slovak republics, as well as some smaller countries.

German macroeconomics revisited

At the end of April George Bratsiotis and David Cobham organised a conference with the provocative title “German macro: how it's different and why that matters” which I unfortunately was not able to attend. Six of the papers presented, plus some additional papers on related themes, are published here. The papers by Peter Bofinger and Michael Burda are related to earlier work by both authors that I have discussed in earlier posts here and here.

Many of the themes in these papers have been briefly discussed in past posts. Peter Bofinger notes that the macro taught in German universities is little different from that taught elsewhere, but stresses the prevailing influence of Ordoliberalism and the ideas of Walter Eucken. Michael Burda emphasises the role of German self-interest in influencing the policy positions of German macroeconomists. As I note here, it is often difficult to distinguish between the relative importance of ideas and self interest.

This is particularly true when ideas and self interest reinforce each other. According to Bofinger, Ordoliberalism reacted to the demand problem identified by Keynes by stressing the importance of wage flexibility and sound money. Germany’s distinctive wage bargaining structure allows an unusual degree of flexibility. In the context of a fixed rate system or monetary union where other countries cannot respond in kind, this does indeed allow a way out of demand deficiency as we saw in the early years of the Euro. As a result, virtually the only country to survive to Eurozone recession largely unscathed was Germany.

I hope it does not need spelling out that this route out of demand deficiency only works by taking demand from other countries. [1] If Germany had its own currency and a floating exchange rate, any fall in domestic prices would be offset by an exchange rate appreciation. Luckily for Germany its neighbours, perhaps attracted by its ability to keep inflation low, have been eager join fixed rate systems or monetary unions where the wage cutting trick will work (see the book by Yanis Varoufakis reviewed here for example).

The only points I would add is that this unusual economic outlook is not confined to macroeconomics, and that it depends to some extent on a degree of insularity from international mainstream discussions of economic policy. It is hard to imagine a reputable UK or US research institute talking about the minimum wage and saying “minimum wages have time and again been shown to help some workers earn more at the cost of the low-skilled losing their jobs”, as if the work of Card and Krueger had never happened. I have sometimes wondered whether in Germany business has an influence on the economic debate that in the UK and US has been replaced by the influence of finance, but that at the moment is purely a speculative idea.

[1] An important point to note here is that if you have a target for the level (or path) of the money stock, then wage and price flexibility might get a closed economy out of recession if it was successful in raising inflation expectations. However the ECB has an inflation target and not anything like a price level target.

Understanding the austerity obsession

It has often been argued, loosely following Keynes, that economists should be like doctors

Martin Wolf writes “The austerity obsession, even [sic] when borrowing costs are so low, is lunatic”. The IMF, the OECD and pretty much the whole of informed opinion agree. Yet those subject to this austerity obsession are in charge of levels of public investment in the the US, Germany and the UK. One interesting question that arises is whether they are all suffering from the same disease?

The diagnosis in the case of the Republican party in the US is reasonably clear. Judging from the remaining presidential candidates and the actions of Congress the main economic goal is to cut taxes, particularly for the very rich. That requires, sooner or later, less public spending. What about evidence that more public investment would help everyone in the economy, including the rich? The problem is that this group suffers from the delusion that the only way to help the economy is to tax the rich less and starve the beast that is the state. It is a clear case of the patient being infected by the neoliberal ideology virus.

The condition of the ruling class in Germany, however, is much more difficult to diagnose. Some local doctors have labelled it the Swabian syndrome: a belief that the economy is just like a household, and the imperative is to balance the books. This seems like a case of labelling rather than explaining a disease. There may be an allergy involved: an aversion to Keynesian economics, and anything that sounds vaguely Keynesian. But the microeconomic case for additional public investment in Germany is also strong: although German roads are not in such a bad state of repair as those in the US, the German public capital stock has been shrinking for over a decade. One possibility is that Swabian syndrome is being encouraged by an ageing population that worry about their pensions. It will be interesting to see how this is influenced by recent injections of the refugee vaccine.

The nature of the illness in Germany is therefore more of a mystery than in the US. Unfortunately as contacts between German officials and those in the rest of Europe are frequent, we have seen numerous cases of this disease - whatever it is - spreading elsewhere, and in one particular case (Greece) the patient remains in a critical condition. The disease also produces complications after accidents: here Finland - currently in intensive care - is a case in point.

The Conservative Party in the UK also seem to have the symptoms associated with Swabian syndrome. As with Germany, the outbreak reached a peak around 2010/11. For a time it was thought that UK cases might be in decline, but last year saw a renewed outbreak. There are some, however, who argue that in reality the party are feigning the symptoms as a means of winning elections, while still others claim that tests have revealed clear traces of the ideology virus.

What has become clear is that the traditional way of treating the austerity obsession, which involves occasional counselling with well trained economists, is having little effect. We also now know that the financial crisis shock treatment only makes the neoliberal virus more virulent. Extended therapy is the only known cure for this virus. As for Swabian syndrome, our best hope may be that the public gradually develop an immunity to the disease as its consequences become clear.  

German exports and the Eurozone

I have argued that the low level of German wage increases before the financial crisis were a significant destabilising influence on the Eurozone, which also indirectly contributed to Germany taking a hard line on austerity. The basic idea is that Germany gained a significant competitive advantage over its Eurozone neighbours, which it has since been unwilling to unwind (through above average German inflation). What this competitiveness gain did was lead to very healthy export growth and a large current account surplus, and that additional demand meant that Germany did not suffer as much as its neighbours from the second Eurozone recession that policy created. Peter Bofinger has made a similar argument.

This argument is often criticised on the grounds that Germany’s healthy export growth was not primarily due to any competitive advantage, but instead was the result of non-price factors like strong demand from China for the type of goods Germany produces. This and other criticisms were recently made in a paper by Servaas Storm. One of the points made by Storm has itself been criticised by Thorsten Hild, and Hild’s point is entirely correct (see also Storm’s reply here). But the issue about what was the primary cause of strong export growth remains.

Trying to disentangle how much of German export growth was due to the competitiveness advantage they gained would require some econometric analysis which unfortunately I do not have time to undertake. But the point I want to make here is that if there has been a permanent positive shift in Germany’s exports (i.e one unrelated to price or cost competitiveness), then this strengthens the argument that I have been making. Before we get there, it is worth going through the basic macroeconomics involved.

Every country will tend towards some long run level of competitiveness. There are many ways of describing why this is: the need to obtain a balance between the production and demand for domestically produced goods, or the need to achieve a sustainable current account deficit. There are many reasons why this long run level of competitiveness could change over time, but in the absence of a plausible story about why that has happened to Germany (or equivalently, why a 7% of GDP current account surplus might be sustainable) it seems reasonable to assume that it has remained unchanged.

So if an economy in a monetary union, like Germany, moderates wages so that it gains competitiveness in the short term (where the short term could last a decade), this gain has to be unwound at some point. Just as the decline in competitiveness in the periphery needs to be reversed by creating below Eurozone average inflation there, the opposite applies to Germany.

Now suppose there has in fact been a permanent upward shift in the overseas demand for German goods. In the long run if nothing changed we would have an imbalance: the demand for German goods would exceed the supply, or the current account surplus would be unsustainable. The way the economy reacts to get rid of that imbalance is through additional German inflation. Not only must past gains in competitiveness be reversed, but competitiveness must decline even further to reduce the demand for German goods.

For those brought up on a mantra of the need to constantly improve competitiveness, this may seem perverse: getting punished for making goods other countries want. But of course it is not punishment at all. A decline in competitiveness is the same thing as an appreciation in the real exchange rate, and this makes consumers better off, because overseas goods become cheaper (in the jargon, there is a terms of trade gain). It is time for Germany to export a bit less, and start enjoying the benefits.

Posting note

For various reasons over the next month the frequency of posts may diminish. Don’t go away - I will be back.  

A crisis made in Germany

The headline in my latest article for The Independent may seem like a wild exaggeration. But if we are talking about a crisis that impacted on unemployment in the entire Eurozone (except Germany) rather than just the periphery, then I think it is reasonable. It was German policy makers that insisted that the Eurozone embark on general austerity in response to problems in the Eurozone periphery. It was the influence of the Bundesbank and others in Germany that helped the ECB raise interest rates in 2011, and delayed a QE programme until 2015. Those two things together created a second Eurozone recession.

Even if we stick to the periphery countries, the crisis outside Greece would have been a lot more manageable if the ECB’s OMT programme (which allowed the ECB to act as a sovereign lender of last resort) had been implemented in 2010 rather than 2012. It is politicians in Germany that have attempted to declare the OMT programme illegal. And none of this touches on the impact of Germany on Greece. I could also add (although it is not in the article) that if the Eurozone had adopted sensible countercyclical fiscal rules from 2000 the scale of the periphery crisis would have been reduced, and Germany had a large role in the deficit focused rules that were actually adopted.

Of course Germany did not make Greek governments behave in a profligate manner. Of course Germany did not force Irish banks into reckless lending. Their own banks may have helped facilitate both, but so did banks in other core countries like France, and in the UK for that matter. Yet German influence helped magnify the periphery crisis, and Germany was central in turning a periphery crisis into an existential event that impacted on pretty well every Eurozone country, except Germany.     

Competitiveness: some basic macroeconomics of monetary unions

From comments on an earlier post, it is clear how many people do not understand how a monetary union works. Thinking about it, I also realise that while the macroeconomics involved is entirely straightforward and uncontentious, it may only be obvious to someone who is used to working with models. As I do not want to restrict my readership to those with such knowledge, I thought a brief primer might be useful.

We need to start with the idea that for a country with a flexible exchange rate, you will not increase your international competitiveness by cutting domestic wages and prices. The reason is that the exchange rate moves in a way that offsets this change. This is what economists might call a basic neutrality proposition, and there is plenty of evidence to support it. The Eurozone as a whole is like a flexible exchange rate economy. So if wages and prices fall by, say, 3%, then the Euro will appreciate by 3%.

So what happens if just one country within the Eurozone, like Germany, cuts wages and prices by 3%. If Germany makes up a third of the monetary union, then overall EZ prices and wages will fall by 1%. Given the logic in the previous paragraph, the Euro will appreciate by 1%. That means that Germany gains a competitive advantage with respect to all its union neighbours of 3%, plus an advantage of 2% against the rest of the world. Its neighbours will lose competitiveness both within the union and to a lesser extent against the rest of the world.

That may seem complicated, but to a first approximation it is in fact very simple. The Eurozone as a whole gains nothing: the gains to Germany are offset by the losses of its union neighbours. For the union as a whole, it is what economists call a zero sum game. Germany gains, but its EZ neighbours lose.

One of the comments on this earlier post said that there was nothing in the ‘rules’ to prevent this, the implication being that therefore it was somehow OK. But it must be obvious to anyone that this kind of behaviour is very disruptive, and hardly compatible with Eurozone solidarity. An idea sometimes expressed that it represents healthy competition is wide of the mark. The only incentive it provides is for other countries to try and emulate this behaviour. If they all achieved that, nothing would be gained. The Eurozone inflation rate would, other things being equal, be lower, but other things would not be equal: the ECB would cut rates to try and get inflation back to its target.

The reason there are no formal rules about all this is straightforward: you cannot legislate about national inflation rates. What you could do, to incentive governments, is establish fiscal rules based on inflation differentials of the kind described here. That would have meant that as relative German inflation rates fell, the government would have been obliged to take fiscal (and perhaps other) measures to counteract it. Once again, this is a symmetrical case to what should have happened in the periphery countries. But if rules of this kind had been on the table when the Euro was formed, I’ll give you one guess about which country would have objected the most.

Was German undercutting deliberate?

In what I described over a year ago as the untold story of the Eurozone crisis, Germany held nominal wage increases below the level of other core Eurozone countries, gradually gaining a large competitive advantage over them. This had a number of consequences, but perhaps the most important is that when the Great Recession hit, Germany was much better placed than all the other Eurozone countries. (It is essentially a zero sum game, because the Euro exchange rate moves to influence overall Eurozone competitiveness, which is why I describe it as Germany undercutting its Eurozone neighbours.)

Up until now I have always been careful to avoid describing this as a deliberate beggar my neighbour policy. But one of the five members of Germany’s Council of Economic Experts, Peter Bofinger, writes:

“In 1999, when the Eurozone started, Germany was confronted with an unemployment rate that was too high by German standards, although it was still below the EZ average. The solution to the unemployment problem was typical of Germany’s corporatist system. Already in 1995 Klaus Zwickel, boss of the powerful labour union IG Metall, made the proposal of a Bündnis für Arbeit(pact for work). He explicitly declared his willingness to accept a stagnation of real wages, i.e. nominal wage increases that compensate for inflation only, if the employers were willing to create new jobs (Wolf 2000). This led to the Bündnis für Arbeit, Ausbildung und Wettbewerbsfähigkeit (pact for work, education and competitiveness), which was established by Gerhard Schröder in 1998. On 20 January 2000, trade unions and employers associations explicitly declared that productivity increases should not be used for increases in real wages but for agreements that increase employment. In essence, ‘wage moderation’ is an explicit attempt to devalue the real exchange rate internally.”

You still hear people say that the DM was overvalued when it converted to the Euro, but my research at the time suggested otherwise, and it is difficult to argue against the view that with today’s current balance surplus of over 7% of GDP Germany is grossly undervalued.

It is hard to overstate the importance of all this. German employers and employees connived in a policy that would take jobs away from their Eurozone partners. Whether this was done knowingly, or because of a belief is some kind of wage-fund doctrine, or something else I do not know. But it makes Germany, a country with perhaps a unique ability to cooperate on an internal devaluation of this kind, a dangerous country to form a currency union with. The thing I find extraordinary about all this is that Germany’s neighbours seemed to have let it happen without a whisper of recognition or complaint.

A stimulus junkie's lament

One ‘stimulus junkie’ has already had a go at this FT piece by the chief economist of the German finance ministry, but let me add three points. The first is just factual. What is the unusual feature of this recovery compared to previous recessions? It is fiscal austerity. In the past governments have not generally cut spending or increased taxes just as recoveries have begun, but this time they did. Now perhaps the slow recovery and fiscal austerity are not related. But textbook macroeconomics, a large majority of economists, and all the macro models I know say they are. If German officials and economists continue to ignore this fact, they will lose international credibility.

Second, German officials need to be very careful before they claim that recent German macro performance justifies their anti-Keynesian views, because it might just prompt people to look at what has actually happened. Germany did undertake a stimulus package in 2009. But more importantly, in the years preceding that, it built up a huge competitive advantage by undercutting its Eurozone neighbours via low wage increases. This is little different in effect from beggar my neighbour devaluation. It is a demand stimulus, but (unlike fiscal stimulus) one that steals demand from other countries. This may or may not have been intended, but it should make German officials think twice before they laud their own performance to their Eurozone neighbours. If these neighbours start getting decent macro advice and some political courage, they might start replying that Germany’s current prosperity is a result of theft.

Third, they should also think twice before writing that a misguided concern about the impact of austerity “contrasts with much more convincing global action to repair the banking sector”. As this IMF analysis suggests, very little has been done to reduce the effective public subsidy to large banks in the major economies, and hence to avoid the ‘too important to fail’ problem. This is because politicians continue to ignore calls for much larger capital requirements. The financial system may have been partially 'repaired', but it still has the potential to create another global financial crisis.

There is a pattern here. Simple, basic economics is being ignored. That cutting demand or transfers from government reduces overall demand. That a country in a properly formulated monetary union that experiences a period of below average inflation will gain a short term competitive advantage, but it subsequently has to undergo a period of above average inflation to undo that advantage. That equity rather than debt for firms performs an important role as a shock absorber, and financial firms are no exception. It is not too hard to understand why these basic points are ignored. When the interests of politics and money collide with straightforward economics, economics does not stand a chance. If the incentives for getting the economics right are weak, the idea that economics loses out to money and politics is also just basic economics.  

German Self-Interest

Michael Burda from Berlin’s Humboldt University has an interesting article in the Royal Economic Society newsletter, which is critical of views that I and others have expressed about the ‘problem with German (macro)economics.’ The key argument Michael Burda wants to make is that there is nothing peculiar or unusual about German economics, and what many of the critics interpret as either economic ignorance or distinctiveness is actually self-interest. To quote from his final paragraph: “It is not ordoliberal religion, but a mixture of national self-interest and healthy mistrust informed by experience that guides German economic policy today.”

Often trying to decide whether policies are the result of self-interest or particular ideas is difficult because both explanations fit the facts. What we really need are examples of German economic policy which follow self-interest but not dominant ideas, or vice versa. Now some might suggest ‘bailing out’ Greece and other periphery countries was a clear example, where the idea of European solidarity triumphed over self-interest. Unfortunately that will not work: the fact that Greece in particular did not default in 2010 and had only limited default in 2012 was in part to protect the interest of other EU banks. You could plausibly argue that Greece has suffered precisely because of German and other EU countries' self-interest.

In fact in many ways Germany has done rather well out of the EZ crisis. Henning Meyer points us to a study which suggests that, as a result of the crisis and Germany’s ‘safe haven’ status, the German government has saved more than E100 billion from 2010 to 2015 in debt interest. As Henning notes, this has helped Germany ‘set an example’ on deficits without having to do anything too painful. That is slightly more than its total loss if Greece completely defaults. It has also not done badly as a result of the profits the ECB has made on its lending.

Perhaps the largest benefit Germany has received from the Eurozone has been as a result of undercutting its fellow members around ten years ago. Everyone knows about the ‘excess inflation’ in the periphery during those years, but the story of insufficient wage inflation in Germany at the same time is not often told. This policy - which if it had occurred via exchange rates rather than domestic inflation would be called beggar my neighbour - may well have been accidental, but it is a key reason why Germany is the only Eurozone economy that has not suffered since 2010. Indeed, one interesting explanation of the general lack of interest in using fiscal policy for demand management in Germany is that for some time the country has been part of a fixed exchange rate system in which, with its particular wage bargaining system, it can fairly easily boost demand by changing domestic inflation.

What about the pressure from Germany on the ECB: first not to undertake the OMT programme in September 2012 which ended the non-Greek crisis, and then not to undertake QE? That is generally put down to extreme fears of inflation and fiscal dominance of monetary policy in Germany. Unfortunately it is also been in Germany’s self-interest. For example, if the ECB had been able to keep to its 2% inflation target, the earlier undercutting of its neighbours would have had to result in a subsequent period of German inflation above 2%. However Germany may well avoid this outcome as a result of Eurozone deflation, so that countries outside Germany will bear the cost of correcting the German competitiveness problem.

That self-interest is key to German policy gets important support from 2009 when alongside other counties Germany enacted a form of countercyclical Keynesian policy. Here we have a clear case where self-interest appeared to win out over a prevalent distrust of countercyclical fiscal policy.

In some senses I’m attracted to Michael Burda’s hypothesis. I once believed that the “problem with German macroeconomic policy is not that it is acting in the national interest, or otherwise, but that it is based on a discredited and harmful set of ideas”. But in my recent discussion on why these discredited ideas persisted, while I threw doubt on some popular accounts, I still failed to come up with a convincing story. There may also be an element of false optimism in focusing on belief in poor economic ideas rather than self-interest, if you also think (hope?) that these beliefs can be more easily changed.

For much the same reason I also think it is futile to try and convince Germany that it should embark on fiscal expansion ‘for the sake of the rest of the Eurozone’, partly because it contradicts self-interest, but also because Eurozone deflation means that we need fiscal expansion not just in Germany, but the whole of the Eurozone, so that ECB interest rates can be lifted above their lower bound. The problem over the last few years has not just been austerity in Germany, but austerity in the Eurozone as a whole.

So perhaps it is all just self-interest. But if that means there is nothing unusual about German economics, it does not let German economists off the hook. Germany was central to creating the second Eurozone recession through its insistence on fiscal austerity everywhere, together with unhelpful pressure on the ECB. Germany was also central in imposing harmful debt levels and austerity on Greece. Mainstream economics tells us this, but few German economists have been prepared to say so in public. German Keynesians who are involved in the policy debate that I have talked to tell me the prevailing climate is definitely anti-Keynesian. It is not the job of German academics to stay quiet about what mainstream macroeconomics tells us just because doing so suits the national interest.