The Great Debate© is presented by Econintersect.com to expand our understanding of various topics of interest.
Apparently, relations between Angela Merkel and Barack Obama have come to where Gerhard Schröder and George W. Bush have been before: icy, un-cooperative, incomprehensible to each other. While trade surplus countries like China and Germany want to continue with the existing economic world order, the US and the European deficit countries are interested in change. However, there is a problem in communication since German politicians and economists in leading positions do not seem able to comprehend the problem.
Wolfgang Schäuble, German Minister of Finance, recently spoke his mind on these issues in an article in the FAZ (a copy is available online at his Ministry of Finance). In order to explain – and not to applaude – the German position let me highlight some defining parts.
Die Verwendung solcher martialischer Metaphern mag übertrieben sein, aber die deutsche Politik muss sich auf eine Zeit großer Herausforderungen einstellen. Und zwar aus zwei Gründen. Zum einen profitiert keine andere bedeutende Wirtschaftsnation so von der Offenheit der Weltwirtschaft wie Deutschland. Unser Wohlstand hängt überwiegend davon ab, dass in einer freien Weltwirtschaft Menschen weltweit unsere Güter und Dienstleistungen erwerben können.
Mindestens ebenso wichtig sind zum anderen das relative Gewicht und die Bedeutung unseres Landes in Europa.
Here Schäuble states that there are huge tasks for future German politics because of two reasons:
- German profits most from open trade, German wealth would depend on it.
These are axioms which are not questioned in the German mainstream, political or economic. Low growth rates and sinking real wages in Germany in almost all the years of 2000 up to the crisis are not seen as evidence of something going wrong. The issue of Europe is taken up further down:
Hier sind politische Führung und Orientierung gefordert, um nach einer Finanz und Wirtschaftskrise nicht auch noch in eine politische Legitimationskrise zu geraten. Zur Bewältigung der Folgen der Finanzkrise und zur Rückkehr auf einen Wachstumspfad müssen die Europäer einen langen und harten Kurs der Konsolidierung der Staatsfinanzen samt schmerzhaften Strukturreformen verfolgen.
Europeans must go on a long and hard path towards consolidation of public finances and structural reforms, the paragraph ends. There is more:
Um unsere gemeinsame Währung, den Euro, in Zukunft weiter zu stärken, wollen wir, und so hat es der Europäische Rat soeben beschlossen, einen permanenten Mechanismus zur Krisenbewältigung für zukünftige Krisen schaffen. Denn auch bei einer verbesserten Prävention durch einen verschärften Stabilitäts- und Wachstumspakt [Glossar] müssen wir uns für solche Krisen wappnen.
So, an improved growth and stability pact will protect us from future crises. It get’s more interesting than:
Betrachtet man das Geschehen auf den globalen Kapitalmärkten, welche die bedeutendsten Käufer von Staatsanleihen sind, dann kann man seitens der Emittenten von Staatsschulden – den Regierungen – einen weltweiten Wettbewerb um Ersparnisse und Investoren sehen.
Diesen Wettbewerb um Ersparnisse, den Deutschland als Benchmark-Schuldner der Eurozone tagtäglich eindrucksvoll für sich entscheiden kann, müssen wir sehr ernst nehmen. Nur wem die großen institutionellen Investoren, die Ersparnisse von Milliarden von Menschen verwalten, vertrauen, dem kaufen sie auch Staatsschulden in Form von Staatsanleihen ab.
The integration of global financial markets leads to a competition for global capital. This competition, which Germany wins day by day, must be taken seriously. Only if institutional investors (Krugman’s bond vigilantes!) which invest the billions of the people trust a government they invest into its bonds.
This is the view of Germany, both politicians and economists. There are exceptions, of course, but they are few. Peter Bofinger in the Sachverständigenrat is one on the side of economists, but I am not aware that there are dissenting views in either government or Bundesbank (or Germans in the ECB).
The problem with this view, besides being wrong, is that it degrades government. According to Schäuble’s view, politics should dress up for international bond investors. It should bow to the wishes of these investors, not to those of the people who got it elected. This is hardly the idea of democracy as it is normally perceived. Either the political power lies with the people, or with the bond investors. You have to pick a side.
Now for the problems in economic logic. (I will just name the most important ones since otherwise this would degenerate into a book.)
- The crisis started because of capital misallocation by the private sector. German banks, among others, invested money in the European periphery real estate markets directly and indirectly without understanding the consequences. The ensuing real estate bubble almost destroyed the European financial system and made government intervention necessary. Note that government budgets did not cause the crises. (Ireland’s debt/GDP ratio was 25 percent in 2006 and 2007, that of Spain 40 and 36. It was 66 and 64 for Germany.)
- If you export more than import, you must accept IOUs as payment. That means that if you are a net exporter you will send more capital abroad than you will get from abroad. The assumption here is that your trade balance rules, and your capital balance adjusts. It might be the other way around, like Schäuble thinks, but this is an unlikely scenario for Germany. It might make sense for the US, since the US-dollar is the reserve currency and China’s pegging the exchange rate means that capital flows into the US constantly. This is a very complicated issue that should not be circumvented by postulizing some view which is assumed to be always right.
- The idea that falling in wages in the deficit countries are the right way to come out of this crisis should be discredited since the publication of the General Theory. Keynes showed clearly (well, no, actually, he did not, but just look at IS/LM and think about what equilibrium here says) that the real economy and the monetary economy are two sides of the same coin. The equilibrium is one in which both markets are in equilibrium, and you cannot really say much about points which are off that equilibrium. In consequence, you have to think monetary/financial and real side together. So, falling nominal wages in Ireland and Spain will depress incomes. That means that debts, which do not come down with wages, will be harder to pay back. This will cause the financial crisis to reappear with a vengance and hurt existing German loans to those countries.
- How should adjustment happen alternatively? Well, you could always rise wages in the surplus countries, which is, well, mostly Germany. That would not cause a problem on the monetary/financial side, since it makes debt repayments in Germany easier and households are not indebted anyway. If you insist on falling wages in the deficit countries, falling tax income will probably lead to lower government spending. This might lead to demand falling in a downward spiral of falling incomes, falling taxes, falling government spending, falling demand, and so on. (The UK seems poised to go down that road.)
- Thinking about the medium run, countries should enact policies that enable their citizens to be more productive. Cutting spending on education is something which is probably not the appropriate policy to increase productivity in deficit countries. If competitiveness has to come through lower wages only, this will be a deflationary force which might push the whole euro zone into deflation. Paying back debt will become ever harder, and entrepreneurs will not like to see their margins evaporate and react by pushing input prices lower, leading to a potential deflationary trap.
- Migration from deficit to surplus countries is unlikely to solve the problem as well. European migration is still at low levels, and if anyone is moving at all it is the high-skilled. A severe case of brain drain is definitely what the deficit countries do not need at the moment, since that will damage their ability to repay debt in both private and public sectors. It’s certainly OK to be a visionary and hope for the maximization of European welfare without regard where the Europeans are located, but without a pan-European flexible labour market and with political entities at the national level this is a recipe for a European replay of Steinbeck’s Grapes of Wrath. Spanish voters will make their government responsible for a youth unemployment rate of 40% and a general rate of 20%. Pointing to job opportunities in Germany will not get the Spanish government re-elected, whether socialist or conservative.
The German position is the result of a misperception of the working of the economy. Real and monetary side of the economy should not be seen as isolated parts, since they belong together inherently. Those dealing with Mr Schäuble and his fellow countrymen should understand that there is no way to make them understand. There seems to be no competition of ideas at the top, ideology rules. Are you surprised that China agrees with the German position regarding global imbalances?
Did France Cause the Great Depression? by Douglas Irwin
Global Imbalances: Is Germany the New China? A Sceptical View by Joshua Aizenman and Rajeswari Sengupta
The Effect of a Renminbi Appreciation on US – China Trade Imbalances by Willem Thorbecke
Plaza II is the Wrong Approach for Global Rebalancing by Yiping Haung
Currency Manipulation by Asian Central Banks by Ajay Shah
China and U.S. Should Stop Finger Pointing and Get to Work by Jason Rines