The Irrelevant German Consumer

Michael Heise

APR 15, 2014
Newsart for The Irrelevant German Consumer

MUNICHWith global rebalancing set to be high on the agenda at the next G-7 and G-20 meetings, Germany, with its persistent export surplus, will again come under pressure to boost domestic demand and household consumption. But the German consumer is a sideshow. What is needed is an investment surge in Germany and Europe, and a coordinated exit from ultra-loose monetary policies.

Massive external-account imbalances were a major factor behind the global financial and economic crisis that erupted in 2008, as well as in the eurozone instability that followed. Now the world economy is in the process of rebalancing – but not in a way that many people had expected.

Asia’s formerly huge external surpluses have declined astonishingly fast, and Japan’s trade balance has even slipped into deficit. China’s current-account surplus has fallen to 2% of GDP, from 10% in 2007. Investment is still the Chinese economy’s main driver, but it has led to soaring debt and a bloated shadow banking sector, which the authorities are trying to rein in.

The European Union, however, has built up a large external surplus, owing mainly to positive trade balances in the eurozone. The EU’s current-account surplus in 2014, at around $250 billion, will be even higher than that of emerging Asia. With oil prices still above $100 a barrel, the combined surplus of oil-exporting countries is of a similar magnitude. The United States, meanwhile, continues to run a sizeable current-account deficit of around $350-400 billion.

The surprise here is the continued growth in the EU’s surplus. The collapse in imports suffered by bailed-out countriesGreece, Ireland, Portugal, and Spain – was entirely predictable, given how sharply their economies declined. But few economists expected that these countries’ exports would improve as quickly as they did, especially in a subdued international environment. While Germany’s current-account surplus is roughly where it was in 2007, the combined external balance of the bailout beneficiaries plus Italy (which has been part of the trade turnaround) has swung from a pre-crisis deficit of more than $300 billion to an expected surplus of around $60 billion this year.

Looking ahead, the appreciating euro (another surprise, especially to the many observers who doubted its survival less than two years ago) will compress the eurozone’s current-account surplus to some extent. An exchange rate of close to $1.40 poses a challenge for many European exporters, including German companies. And the euro has revalued even more against the yen and a number of emerging-market currencies.

Nonetheless, the European surplus is too large to ignore, and Germany in particular will be asked once more to rebalance its economy toward higher domestic demand, which for many people implies the need for a fiscal boost. But the government is not obliging: Finance Minister Wolfgang Schäuble has just presented a balanced budget for 2015 – the first since 1969. And, while some observers are calling for Germany to “end wage restraint” and thereby encourage higher household spending, this has actually happened already.

There is, however, a lot that the government could do about investment, which has fallen by almost four percentage points of GDP since 2000, to just over 17% in 2013 low by international standards. The government could shift more government spending toward infrastructure investment. But, even more important, it should improve conditions for corporate investment at home, rather than watch German businesses move their capital expenditures abroad.

Germany’s attractiveness to investors would rise with simpler and more investment-friendly taxation, improved incentives for business start-ups and R&D, less bureaucracy and red tape, and no further energy-cost increases. Getting there will take time. But, given the favorable earnings situation and the corporate sector’s large cash balances, a rebalancing of the tax system could have a rapid impact. Investment from retained earnings should be as attractive as debt financing. And some temporary adjustments of depreciation allowances could kick-start capital spending.

The need for more investment in transport, telecoms, energy, and education certainly is not only a German issue. Given most European governments’ debt problems, the challenge is to attract more private capital into these areas. Improved regulatory conditions for long-term investments and savings would help. So would expansion of financing instruments for infrastructure investment – for example, by substantially increasing the supply of project bonds supported by the European Investment Bank.

Indeed, why not createEuropean Infrastructure Bonds,” backed by revenues generated by the investments or tax income from the countries that emit EIBs? This would not only spur jobs and long-term growth; it would also stem the rise in Europe’s external surplus.

But the challenge of rebalancing the global economy is also closely connected to central banks’ monetary policies. With credit and asset bubbles slowly but surely reappearing, the authorities’ goal should be to keep growth on a balanced and sustainable path – and thus to discouraging excessive risk taking.

This justifies the US Federal Reserve’s gradual exit from ultra-loose policies. Somewhat surprisingly, the Fed’s reduction of its monthly asset purchases has been accompanied so far by dollar weakness against the euro, which is fostering external adjustment. Looking forward, however, this may change. If the Fed remains alone in scaling back its monetary stimulus and bond yields rise further, the dollar will almost certainly strengthen.

Clearly, a coordinated effort to limit exchange-rate variations is advisable. If all countries try to keep their currencies weak, monetary expansion on a global scale will be over-extended. The fact that inflationary pressure is still low is not a reason to postpone planning an exit from ultra-loose policy; on the contrary, the time for such discussions is when inflation is low and markets are calm. Twenty years ago, markets panicked and bond rates soared as central banks hiked interest rates in the face of rising inflation. They should not repeat that mistake by waiting for inflationary pressuresfueled by rising oil and commodity prices and economic recovery – to return.

Michael Heise is Chief Economist at Allianz SE.

France is the new cauldron of Eurosceptic revolution

By Ambrose Evans-Pritchard 

Last updated: April 15th, 2014

Britain is marginal to the great debate on Europe. France is the linchpin, fast becoming a cauldron of Eurosceptic/Poujadist views on the Right, anti-EMU reflationary Keynesian views on the Left, mixed with soul-searching over the wisdom of monetary union across the French establishment.

Marine Le Pen’s Front National leads the latest IFOP poll for the European elections next month at 24pc. Her platform calls for immediate steps to ditch the euro and restore the franc (“franc des Anglaisin origin, rid of the English oppressors), and to hold a referendum on withdrawal from the EU.

The Gaullistes are at 22.5pc. The great centre-Right party of post-War French politics is failing dismally to capitalise on the collapse in support for President François Hollande.

The Parti Socialiste is trailing at 20.5pc. The Leftist Front de Gauche is at 8.5pc and they are not exactly friends of Brussels.

The heirs to Charles de Gaulle are watching their Right flank peel way to the Front National, just as the Tory flank has been peeling away to Ukip. Needless to say, they don’t like it. A party gathering over the weekend was a hubbub of Eurosceptic dissent.

Xavier Bertrand, the former employment minister, said it is time to abandon the Franco-German axis that has been the guiding principle of French foreign and economic policy for half a century. It’s important but it shouldn’t be the alpha and omega of France’s vision,” he said.

How can we pursue an energy policy if the interests of France and Germany are so different. It is better to work with the English on this subject, and the same goes for European defence. Let us recognise that the alignment with Germany is stopping us pushing for another ECB policy, one that favours growth and jobs,” he said.

This refrain was picked up in an astonishing column in Le Figaro by former editor Philippe Villin last Friday in which he called for a Latin front led by France and Italy to blow up the euro.

In an open letter to Italian leader Matteo Renzijust 17 years old at the time of Maastricht, and therefore uncompromised and free of EMU’s Original Sin – he warns the young leader that there is no hope of lifting Italy out of its low-growth debt-trap without a “return to the lira.”

Even if the euro fell to 1:1 against the dollar it still would not be enough to save Italy – says Mr Villinsince the intra-EMU gulf with Germany would remain.

He tells Mr Renzi to undertake a tour of southern capitals to forge a Latin alliance, then march on Berlin to inform Chancellor Angela Merkel that monetary union has become untenable. He should warn her that the end has come unless Germany does more than the bare minimum to keep EMU afloat.

She will of course refuse to budge – says Mr Villin – but that is not the point. The young Italian’s actions would set off market alarm, causing a precipitous drop in the euro and a bond crisis. This would be deliberate, if dangerous. It would force Germany to face up the choice it has so far evaded: accept a genuine fiscal/transfer union, or leave EMU. Mr Villin obviously prefers the latter. (So does the Bundesbank in my view.) “By precipitating this drama, you would save Europe and the Europeans”, he said.

I pass this on so readers can make their own judgment, reserving my own. What is striking is how such thoughts are gaining currency (excuse the pun) in the French political debate.

Three books have recently appeared arguing that the euro must be broken up in order to clear the way for genuine economic recovery, or even to save the European Project.

1. François Heisbourg, “La Fin du Rêve Européen”

2. Coralie Delaume, “Europe Les Etats désunis”

3. Steve Ohana, “Désobéir pour sauver l'Europe”

A further book by statesman Jean-Pierre Chevènement — “1914-2014: L’Europe sortie de l’Histoire?” – makes a fascinating case the EU has lost its way because it wrongly blamednationalism” for causing the two world wars. It has tried to build a superstate edifice by denying the nation-state soul of the European peoples (plural). Fine stuff.

France is a countryanimated by a spirit of rational liberty”, to borrow from Edmund Burke, and it has always seemed obvious to me that it would not fore ever tolerate mass unemployment, fiscal infeudation to Berlin-Brussels, and a state of affairs that has become so noxious in so many ways. It is hardly surprising that it is at last in the grip of a fresh revolution.

The Gaullistes are divided. The old guard will of course yield no ground on EMU. They cannot do so because they have worshipped at this altar all their lives. Some relative reformists are now clutching at the flimsiest of straws.

Laurent Wauquiez – a former Europe minister, no lesshas just written a bookEurope, il faut tout changer” (Europe, we must change everything) in which he calls for a return to a euro hard-core of Germany, France, Italy, Spain, Belgium, and Holland.

This strikes me as unworkable. Are they going to relegate the Slovenes, Slovaks, Finns, Latvians or Portuguese to non-voting status, or freeze them out of EMU altogether? You cannot run Europe on that kind of capricious basis. Such thinking does however show the intellectual policy swamp that has engulfed the grand venture of monetary union.

In the meantime, of course, we are assured that the EMU crisis is entirely behind us. Sunlit uplands lie ahead. This moment of malaise will pass. Yes, and pink elephants will fly over Mare Nostrum.

April 15, 2014 5:38 pm

‘Capital in the Twenty-First Century’, by Thomas Piketty

An economic, social and political history of the evolution of income and wealth

Yachts in the marina at Sag Harbor, New York©Alamy
Yachts in the marina at Sag Harbor, New York

Capital in the Twenty-First Century, by Thomas Piketty, translated by Arthur Goldhammer, Harvard University Press RRP£29.95/Belknap Press RRP$39.95, 696 pages

French economist Thomas Piketty has written an extraordinarily important book. Open-minded readers will surely find themselves unable to ignore the evidence and arguments he has brought to bear.

Capital in the Twenty-First Century contains four remarkable achievements. First, in its scale and sweep it brings us back to the founders of political economy. Piketty himself sees economics “as a subdiscipline of the social sciences, alongside history, sociology, anthropology, and political science”. The result is a work of vast historical scope, grounded in exhaustive fact-based research, and suffused with literary references both normative and political. Piketty rejects theorising ungrounded in data. He also insists that social scientistsmust make choices and take stands in regard to specific institutions and policies, whether it be the social state, the tax system, or the public debt”.

Second, the book is built on a 15-year programme of empirical research conducted in conjunction with other scholars. Its result is a transformation of what we know about the evolution of income and wealth (which he calls capital) over the past three centuries in leading high-income countries. That makes it an enthralling economic, social and political history.

Among the lessons is that there is no general tendency towards greater economic equality. Another is that the relatively high degree of equality seen after the second world war was partly a result of deliberate policy, especially progressive taxation, but even more a result of the destruction of inherited wealth, particularly within Europe, between 1914 and 1945. A further lesson is that we are slowly recreating the “patrimonial capitalism” – the world dominated by inherited wealth – of the late 19th century.

Some argue that rising human capital will reduce the economic significance of other forms of wealth. But, notes Piketty, “ ‘nonhuman capitalseems almost as indispensable in the twenty-first century as it was in the eighteenth or nineteenth”. Others argue that “class warfare” will give way to “generational warfare”. But inequality within generations remains vastly greater than among them. Yet others suggest that intragenerational mobility robs rising inequality of earnings of significance, particularly in the US. This, too, is false: the rise in inequality of earnings in the US over recent decades is the same however long the period over which earnings are traced. High-school dropouts rarely become chairman of GE.

An important finding is that the ratio of wealth to income in Europe has climbed back above US levels, notably in France and the UK. Another is the notably big recent rise in the income shares of the top 1 per cent in English-speaking countries (above all, the US) since 1980. Perhaps the most extraordinary statistic is that “the richest 1 percent appropriated 60 percent of the increase in US national income between 1977 and 2007.” Technology and globalisation can hardly explain this, since both were at work in all high-income countries. Indeed, the two most striking conclusions are the rise of the “supermanager” in the US and the return of patrimonial capitalism in Europe.

Third, Piketty uses simple economic models to explain what is going on. He notes, for example, that the huge rise in labour earnings at the top of US income distribution is overwhelmingly explained not by sports stars or entertainers but by increases in remuneration of managers. He argues that this is the result of the falls in marginal taxation, which have increased the incentive to bargain for higher pay, reinforced by changes in social norms. The alternative viewthat the marginal productivity of top managers has explodedis, he asserts, unpersuasive, partly because the marginal product of a manager is unmeasurable and partly because overall economic performance has not improved since the 1960s.

More interesting is Piketty’s theory of capitalist accumulation. He argues that the ratio of capital to income will rise without limit so long as the rate of return is significantly higher than the economy’s rate of growth. This, he holds, has normally been the case. The only exceptions from the past few centuries are when a sizeable part of the return on wealth is expropriated or destroyed, or when an economy has opportunities for exceptionally fast growth, as in postwar Europe or the emerging economies today.

This theory is built on two pieces of evidence. One is that the rate of return is only modestly affected by the ratio of capital to income. In the language of economists, the “elasticity of substitution” between capital and labour is far greater than one. In the long run, this seems plausible. Indeed, an age of robotics might further raise the elasticity.

The other is that, at least in normal times, capitalists save a sufficiently large share of their returns to ensure that their capital will grow at least as fast as the economy. This is especially likely to be true of the seriously wealthy, who are also likely to enjoy the highest returns. Small fortunes are eaten; big ones are not. The tendency for capital to grow faster than the economy is also more likely when the growth of the economy is relatively slow, either because of demographics or because technical progress is weak. Capital-dominated societies also have low-growth economies.

Fourth, Piketty makes bold and obviously unrealisticpolicy recommendations. In particular, he calls for a return to far higher marginal tax rates on top incomes and a progressive global wealth tax. The case for the latter is that the reported incomes of the richest are far smaller than their true economic incomes (the amount they can consume without reducing their wealth). The rich may even take themselves outside any fiscal jurisdiction, so enjoying the fiscal position of aristocrats of pre-revolutionary France. This fact blunts one of the criticisms of the book’s reliance on pre-tax data: over time, the ability of individual countries to redistribute resources towards the middle and bottom of national income distributions might dwindle away to nothing.

Yet the book also has clear weaknesses. The most important is that it does not deal with why soaring inequality – while more than adequately demonstratedmatters. Essentially, Piketty simply assumes that it does.

One argument for inequality is that it is a spur to (or product of) innovation. The contrary evidence is clear: contemporary inequality and, above all, inherited wealth are unnecessary for this purpose. Another argument is that the product of just processes must be just. Yet even if the processes driving inequality were themselves just (which is doubtful), this is not the only principle of distributive justice. Anotherto me more plausibleargument against Piketty’s is that inequality is less important in an economy that is now 20 times as productive as those of two centuries ago: even the poor enjoy goods and services unavailable to the richest a few decades ago.

For me the most convincing argument against the ongoing rise in economic inequality is that it is incompatible with true equality as citizens. If, as the ancient Athenians believed, participation in public life is a fundamental aspect of human self-realisation, huge inequalities cannot but destroy it. In a society dominated by wealth, money will buy power. Inequality cannot be eliminated
It is inevitable and to a degree even desirable. But, as the Greeks argued, there needs to be moderation in all things. We are not seeing moderate rises in inequality. We should take notice.

Martin Wolf is the FT’s chief economics commentator

Copyright The Financial Times Limited 2014.