25 November 2013

German Macho-economics - Wolf gang pacts 1 and 2

"The road up and the road down is one are the same."  Heraclitus 535 BC–475 BC 
Not all countries can run trade surpluses at the same time; someone's exports is someone else's imports.
"The world should rejoice at the positive economic signals the eurozone is sending almost continuously these days".  Wolfgang Schäuble 

G̶e̶r̶m̶a̶n̶ Schäuble Macho-economics Wolf-pact version one - German Surpluses
"Take Germany. In the late 1990s it was the undisputed “sick man” of Europe – seen by domestic and international commentators alike as uncompetitive and condemned to decline ...... A first wave of adjustment, starting in 2003, focused on strengthening employment incentives, streamlining the public sector, fixing social security and raising consumption taxes. Down to shop-floor level, companies and unions worked together to make labour more flexible........"  Wolfgang Schäuble 
Germany’s external balance deficits became substantial surpluses after the creation of the Euro. In effect, this was underpaying the German worker's contribution to output and overcharging the German consumer.

Why? Here's a slightly classical version.

When the sales value generated by the demand for a country's exports exceeds the sales value of its demand for imported goods, the excess value appears as surpluses in the country's trading account. The surplus is an excess demand (for exports relative to imports) and, as such, a pressure for prices of exports to rise relative to imports.  There is no internal eurozone system of exchange rates to do this in one movement. Hence the argument for economic reforms to ensure perfectly working competitive markets.  However, if the price mechanism works then this excess demand transmits a demand that leads to higher prices of resources producing German exports ie it ought to be signaling a rise in wages.

However, here lies Schäuble's "down to shop-floor level, companies and unions working together to make labor more flexible" - a strange meaning of flexibility that restricts German wages from being upward flexible.

When the price of labor is suppressed then the demand for other inputs (producing any given level of output) and other production mixes are suppressed,  This undermines real investment, distorting the production mix to screw up the economy's 'production function". Keeping wages down below their "market values" damages the efficiency and growth potential of an advanced industrial economy.

Thus to persistently maintain trading account surpluses is to perpetuate a disequilibrium; one that screws up the price mechanism in a way that doesn't allow the excess demand for German exports to be translated as a demand for investments in technology factories, etc.  To do it persistently, is to  move the economy towards a cheap labor one and away from the traditional German capital intensive one.

And so trading imbalances create investment problems (for a different way of looking at this see a previous post  National Output for Mummies 101)  and this is what the statistics show -  Germany has a huge private investment gap.
"The share of investment in gross domestic product is one of the lowest among industrialised countries. It has been declining rapidly, from an average of 23 per cent in the 1990s to less than 17 per cent today" Investment, not the surplus, is Germany’s big problem Fratzscher 18th Nov 2013
via CA Surplus and investment are highly negatively related.
Given how these distortions can impact investment, it is foolish to merely see trading surpluses as an improvement in competitiveness.  There's a hidden inefficiency problem The artifical reduction of wages relative to the cost of capital undermines investment and will affect the long term competitives of an economy.

International competitiveness is measured by the relative prices of domestic goods to foreign goods. When the word 'prices' is then replaced by the word 'wages', the above investment is keep hidden. Even worse, this is something that we really shouldn't being doing when economies are in disequilibrium as a result of a global finiancial crisis. Correcting for problems that appear as a result of a breakdown in global financial markets by interfering in labor markets to reduce wages to restore  "competitiveness" is an illusion.  Beg-thy-neighbor competitiveness reduces everyone's growth. Short-run gains come at the expense of under investment in capital and lower growth rates.

German trade surpluses and investment problem spills over into the rest of Europe. An imbalance in one market creates imbalances in others. By definition, Germany's trading account surplus means the country is a massive net lender to others. A surplus in one place implies a deficit in another place. These capital outflows were based on financial returns and guarantees that did not reflect economy's actual economic returns, but were based on balance of payments funding needs.  The surplus led to over-lending that fueled property and  bond (trading deficits have to be financed) bubbles that burst as unsustainable debt crises in the periphery. When the bubble burst, the risks were were minimized by lenders exerting political control - by doing whatever it takes - to extract measures on the borrowers.

This is dark side of the trading imbalance. The profits made by maintaining the imbalances are private, but the risks and losses are social, that is passed on to the public ie the tax payers. The public swallows this with the help of a media narrative that plays on national stereo types.  The debate is reduced to whether Hans or Costas is to blame. Obviously Costas is to blame. So his wife, children, friends, pets, neighbors, visitors and anything that happens to move within the national borders should pay.

A second strange idea is the macho idea that surpluses reflect a superior method of production or product: the German brand.  There are better cars in the world than Mercedes; but they don't dominant sales. There are worst cars in the world than Mercedes that can outperform it in reveunes.  It's all a question of price. If Indian (Land Rovers) and China invest better than Germany, then even Mercedes won't be cheap enough.

Another way to see the German trading surplus is as loss to the actual Germans who are produce it, as the result of an underpaid effort in producing excess output. In return for this, they are overpaying for the imports they consume.  Giving up something now for the future is an investment, this extra sacrifice does the opposite. Trading surpluses leaves the German economy either to disappear down a blackhole or sustain the demand for these surpluses to pay for someone's else deficit.  They also represent lost opportunities to provide social and public investments.  Schäuble is very proud "in streamlining the public sector, fixing social security and raising consumption taxes".

Germany is becoming a cheap wage rather than an investment economy. Trade surpluses are not good.  They don't represent how well you are doing, but how well you could have been doing.

Wolf-pact version Two - from German to Euro-wide surpluses (and deficits)

Surpluses in one part of Europe and idles resources in another is a gross mis-allocation of  resources. This cannot - no matter how good the country is at making cars -  be an efficient system.
"Everything flows and nothing stays." Heraclitus of Ephesus  
When the Eurozone stopped working, instead of dealing directly with the surpluses in the creditor countries, austerity was applied on the periphery.  The solution was to do what Germany did.  In these economies repressing wages reduced import demand rather than increased exports. (Besides if everyone is exporting, who is importing?) In effect, external trading balances are restored by creating mass unemployment and destroying the economy's internal markets.
"A second wave of expenditure restraint and reforms followed once the financial crisis was past its peak....Thanks in part to its education system, which is attuned to the needs of business, Germany has a youth unemployment rate below 8 per cent – the lowest in Europe" Wolfgang Schäuble 
Has there been a revolution in the German education system? Or is the Germany economy just sucking talented, skilled labor resources from the periphery economies where youth unemployment hovers around 50%?
"The adjustment was ambitious and sometimes painful but its implementation was flexible and adaptive. The European safety nets have provided a well-calibrated mix of incentives and solidarity to cushion the pain." Wolfgang Schäuble 
There is no solidarity or European safety net to cushion the pain. Safety nets may exist in the in the core, but they have been systematically ripped out in the periphery.  The "well-calibrated mix of incentives and solidarity to cushion the pain" disappears as one moves down from the creditor to the debtor nation.
"In just three years, public deficits in Europe have halved, unit labour costs and competitiveness are rapidly adjusting, bank balance sheets are on the mend and current account deficits are disappearing. In the second quarter the recession in the eurozone came to an end." Wolfgang Schäuble 
Again this is the cheap wage model, where competitiveness is not achieved by investing to improve productivity. "Bank balance sheets are on the mend" but inactive with little lending for investing in businesses. "Current account deficits are disappearing" as this what would happen when consumers become too poor to buy imports.

There is no end to the recession in the periphery and there is no liquidity where it is needed the most in the periphery.


Imperfect monetary unions worked by population movements.  Populations are being made to suffer or migrant.  The periphery economies of the Euro are forced, unwillingly but bonded by debt.  to apply internal devaluation.  The only real intent (excluding the increasingly but interestingly contradictory IMF) is not a major internal political and market reform of oligarchical and cartel market structures, but wage suppression (unit wage costs).

The obsession to create surpluses emphasizes cheap wages rather than sound economic investment.  As a result the core economies have a greater and greater appetite for labor resources.  In paricular
"Germany is ageing and shrinking. France and Britain will overtake it soon, in terms of population. Too few women enter the workforce and they have too few children. Germany is over-reliant on industry and underperforms in services. Over half of every generation leaves school after 10 years, often with only a rudimentary knowledge of English and similar cultural skills. Immigrants are still not welcome. Most of these problems could be fixed with quotas for women in senior management and for immigrants in the civil service and the police; allowing dual citizenship; and encouraging kids to stay at school. But these reforms are unlikely to happen." Guardian: Why Germany's strength is an illusion
This shortage not cleared (by demand and supply) by wages increasing, but by draining and selectivity picking from a large pool of idle labor resources from an increasingly poor periphery.

Again, not good news for German workers, as it will keep German wages low, but this time by labour resources (immigration) flooding in from the periphery to compete for jobs.  Its a toxic mix that will increase nationalism and racial tensions.

Thus Europe moves, disastrously, en mass towards a cheap wage model economy.  Even more disastrous, when one realize that the EU raises taxes from its working population to finance a system (Common Agricultural Policy CAP) that creates artificially high foods prices. A policy of lower wages with 38% of EU budget for the next five  years going to CAP.  Yet, only 5% of the EU population work on farms.  Something has to give.  Even without the political chaos and under investment, a cheap wage model of the economy is not sustainable when also coincides with a system that keeps food prices high.

Suppose somehow it does hold together, and labor flows back and forth between the core and the 'homelands' in the periphery in tune with the demands of  core's economy.  As cultural and national loyalties and prejudices increase, the pressure  (governments are forced to balance their  budgets) will increase on richer EU member to tighten up immigrant residency, voting and social benefits rights.  It then not that great a step for the European labor market to fragment into a kind of apartheid system with different class of rights and conditions in each of the 'euro homelands'.  Unless you are one of the fortunate few that will be reaping profits from such a system, it is good for no one....of any nationality.

1 comment:

  1. Edited to insert an extract from the Guardian: "Why Germany's strength is an illusion"

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