Economic Rebalancing in Europe requires Germany to reduce Inequality at Home (UPDATE May 2014)

EU finance chiefs finally struck a bail-in deal for failing banks in the early morning of June 27. With this necessary (but not sufficient) step toward cleaning up Europe's banking sector out of the way, EU policymakers now need to tackle the fundamental causes of the euro crisis: the economic imbalances reflected in (still) widening current account imbalances in the eurozone (see "Euro Crisis Sees Reloading of Germany's Current Account Surplus").

Yes, it is true that the trade accounts of the countries in the Southern European periphery have improved. But that is largely due to lower import demand as a result of the collapse of the economies. Meanwhile, Europe’s export champion Germany continues to generate record export volumes and widening external surpluses, the last one at 7% of 2012 GDP or €240bln, globally the biggest in absolute terms. (see “Dissecting the miracle”) 

Just as powerful cars are mistakenly interpreted as a sign of the owner’s potency, Germans (mostly men) view their country’s superior export performance as a reflection of Germany’s economic potency. Yet, with each %age increase in Germany’s external surplus, the centrifugal forces tearing apart the common European currency zone are getting stronger. Hence, for those interested in preserving the euro and in maintaining the current euro membership intact, it is absolutely essential to reduce the economic imbalances in the euro zone. This requires:

(a) a correct analysis of developments that generated and still generate economic imbalances in Europe, and
(b) based on this analysis, a course of action for an economic rebalancing in the eurozone.

An excellent article by Michael Pettis, former JPMorgan trader/Managing Director and currently a professor of finance at Beijing University, does a pretty good job at both. The article has mysteriously disappeared from the internet, but his analysis can also be found in his book:

Pettis analysis starts with a real-world observation of the relationship between income concentration and national savings: As more and more wealth is concentrated in the hands of fewer people, consumption declines and national savings (defined as total production minus investment minus consumption) goes up, because the wealthier a person gets, the smaller the share of income he consumes. Hence, it is structural imbalances like income concentration and inequality in a country that determines national savings rates, not old-fashioned thrift. "In other words, national savings may have very little to do with household preferences and a lot to do with policy distortions."

When national savings are higher than the amount an open economy can or is willing to consume or invest profitably at home, the 'excess' savings are 'exported', e.g. as credits to foreigners to finance imports from the creditor country. The creditor country's current account then shows that its net export of savings (less net returns on investments) exactly equals its net export of goods and services: it has a current account surplus.  A current account deficit reflects the reverse: a shortfall of national savings compared with the country's consumption and investment needs, reflected in a shortfall of exports vs. imports. 

Germany is a case in point: following reunification in 1990 Germany ran current account deficits, importing capital to fund the reconstruction investments in the delapidated former DDR. To restore the usual current account surpluses, in 2003 Germany's powerful export lobby initiated and pushed through parliament a package of economic policy measures designed to improve competitiveness: Agenda 2010 restrained the growth of German wages and non-wage costs, causing the household income share of GDP and household consumption to drop and German savings rates to rise. As national savings soared, the German economy exported large and growing amounts of savings, financing the import of German consumption goods in the Southern European periphery and investing them badly in US mortgage-backed securities and sovereign bonds of eurozone countries (helped by financial regulations which treated sovereign bonds as 'risk-free' investments). As a result, while Germany's current account balance increased to 7.5% of GDP by 2007, offsetting current account deficits emerged elsewhere in the euro zone (15% of GDP in Greece, 10% in Portual and Spain, 5% in Ireland). 

(a) Summing up the analysis for Germany: as Agenda 2010 was implemented, the GDP-share of household income and household consumption declined. National savings rose because government consumption and investment also declined due to fiscal austerity and a lack of demand from the household sector. Income inequality skyrocketed as Germany's exporters garnered an ever larger share of income due to the booming exports to the Southern European periphery financed by Germany's excess savings. The result: large and growing economic imbalances in the eurozone, the danger of which is slowly being realized even in Germany (see "Der Fluch des guten Geldes", Manager Magazin, 18. Juni 2013).

b) A course of action for economic rebalancing in the euro zone would require reversing most, if not all, of the policies that led to this dangerously explosive situation. Michael Pettis correctly suggests that "the European crisis cannot be solved except by forcing down the German savings rate". Lowering the German savings rate can only be achieved by allowing German lower and middle-income households a much larger share of Germany's GDP. These income groups desperately need higher wages and a reinstalment of the social security benefits they had before Agenda 2010 (more generous pension and unemployment benefits a.o.). A cut in consumption taxes combined with a drastic increase in income taxes for higher income groups, a wealth tax, and a tax on financial transactions would complete the project.

By contrast, the Convergence and Competitiveness Instrument pushed by the Merkel government, i.e. Agenda 2010 re-loaded for the eurozone, would produce a contractionary shock not only for the eurozone but globally as the eurozone is the second largest economy in the world. It would:

- depress euro zone wages and generate euro zone current account surpluses 

- raise the value of the euro and increase the risk of deflation 
  (market data of May 2014 already confirm this expected development)

- persistent euro zone current account surpluses risk damaging trade relations with countries outside of the euro zone

The planned Transatlantic Trade and Investment Partnership (TTIP) and Obama's visit in Berlin

Following the first ever real-term cut in the EU budget and the launch of the "Convergence and Competitiveness Instrument" pushed through by David 'Starve the Beast' Cameron and Angela 'the Schwabian Housewife' Merkel, CameroMerkel's austerity cum competitiveness-Agenda 2020 for Europe is proceeding to step 2: the Trans-Atlantic Trade and Investment Partnership (TTIP) of 800 million people, designed to overcome Europe's alleged "competitiveness crisis" --->see Cameron's EU speech of January 23, 2013. Here are some key extracts:

“There is a crisis of European competitiveness as other nations in the world soar ahead..…Europe’s share of world output is projected to fall by almost a third in the next two decades. This is the competitiveness challenge and much of our weakness in meeting it is, frankly, self-inflicted….[through] complex rules which restrict our labor markets"..…and “excessive regulation”.

And from Cameron's speech to the World Economic Forum in Davos (2013):

"Europe is being outcompetet, out-investet, out-innovated and it is time we made the European Union an engine for growth, not a source of cost for business"...."You ought to deal with your debts, you ought to cut business taxes, you ought to tackle the bloat in welfare...."

This, of course, is music in chancellor Merkel's ears and explains why her initial plans of further institutional deepening of the EU (e.g. banking union, common fiscal policy etc.) are being delayed or have been completely put on ice. Instead, Merkel prefers the traditional British strategy of broader trade relations with as little government interference as possible. This also explains why TTIP fits perfectly into CameroMerkel's agenda. The potential benefits from institutional changes envisioned under TTIP are expected to be huge---> see extracts of my Harvard research paper on TAFTA in "Olli's follies and the Pros and Cons of TAFTA":

"Regulatory harmonization and the mutual recognition of each other’s product standards and certification procedures will facilitate market access and reduce production and distribution costs. Further, the security of market access and the guarantee of FDI property rights will diminish investor uncertainty and is bound to stimulate two-way trade and investment flows as well as job creation on both sides of the Atlantic." ....."TAFTA enjoys strong support among labor unions ..... who view the agreement as their “last chance” to introduce Europe’s labor and welfare standards in the US."...."Employer groups, on the other hand, are apprehensive about [an] expected upward pressure on US labor and welfare costs, and the potentially damaging effect on US competitiveness." [1]

The last sentence should give us pause: Knowing Cameron and Merkel and their close relations to  powerful corporate lobby groups, it can be expected that the traditional European labor and welfare standards our forefathers and -mothers fought and died for will be under heavy assault, including the standard sick leave protection continental Europeans enjoy, the 5-6 weeks annual vacation and the 5-day work week. A recent JP Morgan research paper on structural adjustment in the Euro area provides a flavor of things to come if US employers had their way (bold face markings by blog editor):

"....there are deep seated political problems in the periphery, which, in our view, need to change if EMU is going to function properly in the long run."......"Constitutions tend to show a strong socialist influence, reflecting the political strength that left wing parties gained after the defeat of fascism.....:  constitutional protection of labor rights; consensus building systems.....; and the right to protest if unwelcome changes are made to the political satus quo."......"Countries around the periphery have only been partially successful in producing fiscal and economic reform agendas, with governments constrained by constitutions...." (see JP Morgan's 16-page paper and comments here). 

Constrained by constitutional protection of labor rights and consensus building systems ? Not to worry: CameroMerkel's market-conform democracy will make amends. 

While Obama's words in Berlin (see extracts below) have soothed some of my concerns, they are just nice words and we have seen what happened to Obama's nice words about Guantanamo. Hence, it is important to be very very watchful and to supervise closely the upcoming TTIP negotiations (scheduled to begin already in July 2013 and expected to continue through 2014). Pan-European democratic supervision and input by all concerned social partners is absolutely essential ! 

For posterity, here are some extracts of Obama's Berlin 2013 speech directed squarely at Merkel's economic policy in the eurozone:

...."And now, as we emerge from recession, we must not avert our eyes from the insult of widening inequality or the pain of youth who are unemployed. We have to build new ladders of opportunity in our societies even as we pursue free trade and investment that fuels growth across the atlantic. America will stand with Europe as you strengthen your union. And we want to work with you to make sure that every person can enjoy the dignity that comes from work, whether they live in Chicago or Cleveland, in Belfast or Berlin, in Athens or Madrid - everybody deserves opportunity. We have to have economies that are working for all people, not just those at the top."

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[1] EIU Crossborder Monitor of June 21, 1995: “More Market Access: Trade Partners Wary of Bold Initiatives Globally.”

The European Parliament: sole custodian of democracy and social justice in Europe ?

There are rays of light in the sorry state of economic and political affairs in Europe. The question is whether these rays of light are the glaring lights of a fast approaching train or the soft lights of a new morning dawning in Europe. Let's hope it's the latter.

On May 23, the European parliament passed a resolution demanding more democratic accountability on economic reforms in general and decisions regarding reforms and policy measures under the planned 'Instrument for Convergence and Competitiveness' in particular. After the successful vote, Green economic affairs spokesperson Sven Giegold correctly stated:

"Decisions about the economic future of Europe should not be taken by a handful of representatives from national governments and EU officials behind closed doors. There is a need to ensure much greater democratic accountability of any further moves towards economic union. The Commission and Council cannot continue to by-pass democracy through arcane pacts and intergovernmental agreements." [such as Merkel's new baby, 'Convergence and Competitiveness' pact - note by the blog host].

Sven Giegold continued:

“Any EU-level coordination of national reforms and economic policies must be subject to scrutiny and approval by democratically-elected parliaments and any legal framework with that purpose needs to be adopted under co-decision. Greater involvement of social partners in reforms will also bring more transparency and acceptance of these policies and the EP has today made these points. MEPs also called on the Commission to ensure sustainable development and social investments are not neglected and are rather at the core of its focus."  Amen !

Seven days later, Madame la Chancellière Merkel and President Hollande met and made a number of bi-lateral decisions without the annoying influence of other eurozone members and the European Parliament. These decisions, as published at length in a press notice of the German information office, include President Hollande's wish to promote economic growth and allow each country to decide on the speed of fiscal consolidation. It also includes, of course, Merkel's obsessions: the continuation of 'growth-friendly' fiscal consolidation and the 'boosting' of competitiveness, competitiveness, and competitiveness some more.

That blew the kettle in the European Parliament. On June 10, an alliance of all major EP party leaders and a broad majority of EP deputies motioned for a resolution to strengthen European democracy, strongly rejecting the back-door policies of national leaders: ..."reminds the European Council that it does not have any Treaty-based prerogative of legislative initiative and that it must stop instructing the Commission on the form and/or content of any further legislative initiative..."  "...Reiterates that it cannot accept any further intergovernmental elements in relation to the EMU and that it will take all necessary and appropriate action within its prerogatives if such warnings are not heeded;...." "....Recalls that EU participation in the 'troika' system should be subject to democratic scrutiny by, and accountability to, Parliament;..."

Need I say more?  It was high time the elected representatives of the European people put their feet down  to stop the undemocratic decision making of national leaders and unelected technocrats.

Is the IMF (and its largest shareholder) loosing patience with Euro-Austerians ?

The IMF's admission of major mistakes in the design and implementation of its 2010 economic adjustment program for Greece can only be welcomed. The IMF staff report evaluating the stand-by arrangement for Greece includes a stinging critique of the EU commission which was more focused on EU deficit targets than on growth. The question on my mind is: why did this critique come so late and why now that the failure of fiscal austerity is strikingly obvious, not just in Greece ?  

All eurozone countries that implemented fiscal expenditure cuts now have HIGHER debt ratios than before, combined with slower or negative growth, rising unemployment, poverty, and desperation. With the troika's help, the Greek economy collapsed, shrinking by 30% in three years ! As Mark Blyth notes in his highly interesting presentation "Austerity - history of a dangerous idea" below: not even the Nazis were able to achieve this during their occupation of Greece. Although quite long (1 hour), I recommend listening to Blyth's talk in its entirety, as it remains extremely enlightening right through the end:

Coming back to my question regarding the IMF critique: why now ? And why didn't the institution stop the troika's austerity policies immediately after its realization that the fiscal multiplier had been substantially underestimated, as chief economist Olivier Blanchard and his team admitted last year ? (see the WEO of October 2012 and my post "The fiscal multiplier and austerity in the eurozone") Could it be that the IMF and particularly its largest shareholder, the US, is loosing patience with Germany's unwillingness to serve as a growth locomotive in the eurozone by strengthening German domestic demand via a general rise in German wages ? Or is it Germany's refusal to allow a thorough look into the books of German banks, thus preventing a true European banking union ? Yanis Varoufakis, a Greek economist, thinks that the IMF is considering an exit from the troika because of Germany's undermining of a European banking union 

Whatever the reason, the IMF's admission of substantial policy mistakes further strengthens the people's movement against austerity in Europe. This movement is getting stronger and more pan-European every day. This weekend, civil society organizations, trade unions, and NGOs from all over Europe, including many political leaders from Germany, are holding an Altersummit in Athens, Greece. Another pan-European movement is forming to stop the 'competitiveness and convergence pact' proposed by Merkel. (see "Another Europe is possible").

If nothing else, these pan-European movements against austerity and the implementation of market-fundamentalist, neo-liberal 'competitiveness' policies in Europe helps bring together progressive Europeans  to fight against the internationally well-connected financial 'elite' that supports these policies. 

Less Austerity in return for more 'Competitiveness' Reforms - a Pyrrhic victory for Europeans

It's official:  the European Commission confirmed that France, Spain, Poland, Portugal, the Netherlands, and Slovenia will be given more time to reach the 3% budget deficit target, thus allowing a slow-down of the pace of austerity cuts amid concerns over growth. To help reduce economic imbalances in the eurozone, the stronger economies were admonished to let wages rise and increase labor market flexibility to improve competitiveness.

Europe's policymakers were unable to hide any longer the overwhelming evidence of the utter failure of austerity: record unemployment esp. among the young; the closing of thousands of businesses and the destruction of millions of jobs; a deep, deflationary recession in the Southern European periphery, rising poverty and RISING public debt levels, exactly the opposite of austerity's intent. So far, the eurozone economy has endured the seventh quarter or nearly two years of shrinking GDP and the recession is now spreading to the core, including Finland, France, and the Netherlands. Despite this dramatic failure of austerity policies favored by Europe's Very Serious Nincompoops* (VSN), they continue to play shallow, games: to prepare for the G-8 summit in Northern Ireland, a 'colony' of the U.K., prime minister Cameron has ordered blighted shops to put on fake store fronts showing make-believe merchandise (see here).  

The quid pro quo of less austerity for more reforms is another such game. As noted in my post "Public Opinion in Germany turning broadly against Austerity", conservatives very openly recommend this strategy as "a new bargain between creditors and debtors" [1] to push through investor-friendly policies that would safeguard the value of their financial assets in Europe and open up new investment opportunities in the future. Investor-friendly policies are, of course, policies that reduce investment costs such as the flexibilization (lowering) of wages and non-wage costs and the loosening of labor protection laws, such as termination protection and such.

For Europe's working population, this "New Deal for Europe" (see the Financial Times of April 25) would, however, be a Pyrrhic victory as, in a recessionary environment, the loosening of labor laws and the flexibilization of wages and non-wage costs would first and foremost result in more unemployment, lower social protection, and lower wages (read the experience of German workers in my post on the Agenda 2010. Moreover, the spreading of the competitiveness doctrine (see my posts on the competitiveness dogma, part I, II, and III) throughout Europe would remake the continent into an über-efficient Anglo-Germanic Europe, crush the savoir-vivre of traditional France and the creative spirit of Italians and Spaniards, and extinguish the charming sensuality and inefficiency of the Mediterranean culture and everything that makes life worth living by assigning a clock to every activity.

Let's stop this nightmare NOW and preserve the rich diversity of European cultures by:

1.) firing the austere and competitiveness-crazy Schwabian housewife Merkel and her gang;
2.) by supporting those European leaders with the courage to stand up against the Merkel government;
3.) by supporting the recent resolution of the European parliament that insists on more attention to social justice, investments for the future, and more democratic decisionmaking with regard to reform policies in Europe (see the resolution of the European parliament of 23 May 2013 on future legislative proposals on EMU: response to the Commission communications).

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*derived from the German 'pups'
[1] see the Financial Times: "The New Deal for Europe: more reform, less austerity"