By Martin Wolf
Published: March 23 2010 20:19
Germany says “nein”. That is the most important conclusion to be drawn from the debate on eurozone economic policy. What the German government is saying is that the eurozone must become a greater Germany. But this policy would have profoundly negative implications for the world economy.
This week’s letter to the FT from Ulrich Wilhelm, state secretary and government spokesman, and last week’s article by my friend, Otmar Issing, former board member of the European Central Bank, are significant not only for what they say but for what they do not say.
The point they make is that Germany will not risk undermining its competitiveness. The point they do not acknowledge is that the world economy has a difficult adjustment ahead, to which the eurozone and Germany need to contribute.
On the first point, Mr Issing is quite clear: “Following years of divergence between unit labour cost and losses in competitiveness in a number of countries, the idea is gaining ground that the economy with the biggest surplus, Germany, should help by raising wages in the interests of deficit countries and the community as a whole.” On the contrary, he insists, wages even in Germany are still too high, given the elevated unemployment.
I find it hard to disagree. Many countries entered the currency union without recognising the implications for labour markets. Rather than the reforms membership requires, they enjoyed a once-in-a-lifetime party. The party is over. With German unit labour costs stagnant and the euro still strong, labour costs in peripheral European countries must fall sharply. These countries have no alternative, within the currency union they chose to join.
On the second of the two points, however, Mr Wilhelm offers a disturbing paragraph: “The key to correcting imbalances in the eurozone and restoring fiscal stability lies in raising the competitiveness of Europe as a whole. The more countries with current account deficits are able to increase their competitiveness, the easier they will find it to decrease their public and foreign trade deficits. A less stability-oriented policy in Germany would damage the eurozone as a whole.”
I find it impossible to agree. What is fascinating about these remarks is that there is no mention of demand. Mr Wilhelm is inviting everybody to join a zero-sum world of beggar-my-neighbour policies in which every country tries to grab market share from the rest. At a time of global weakness, this is a self-defeating recommendation for both the eurozone and the world.
More precisely, what Germany wants to see is a sharp cutback in fiscal deficits throughout the eurozone. With the fiscal deficit contracting and output weakening, the way out for each country would be via falling relative unit labour costs and higher net exports. If successful, this would shift each country’s economic weakness to other eurozone countries or, more likely, to the world, via a bigger eurozone net export surplus.
According to the Organisation for Economic Co-operation and Development, the eurozone’s general government fiscal deficit will be close to 7 per cent of gross domestic product this year. Assume that this is to be cut swiftly to 3 per cent, while private sector financial surpluses remain close to 7 per cent of GDP, as is now implicitly forecast. Then the current account of the eurozone would need to improve by about 4 per cent of GDP. That would be about $600bn, or not far short of 1 per cent of world GDP.
Where does Germany think the offsetting shifts into greater external deficits might occur? This policy would surely make the post-crisis adjustment challenge for erstwhile deficit countries, including, not least, the US and UK, unworkable. Would an open world economy survive?
Maybe I am too pessimistic about the implications for demand of the envisaged fiscal tightening. Perhaps in some countries increasing the credibility of the fiscal position would stimulate private spending. Yet, overall, the eurozone would probably experience renewed demand weakness at home or export such weakness abroad.
Might an aggressive monetary policy make the difference? The ECB has been successful in sustaining rapid growth of narrow money during the crisis, more so, in fact, than the Federal Reserve and the Bank of England. But the growth of broad money has collapsed. Moreover, the aggressive monetary policy has failed to halt a sharp fall in nominal GDP, which shrank by 2 per cent in the year to the fourth quarter of 2009 inside the eurozone (see charts).
Unfortunately, monetary policy seems to be pushing on a string. It has made banks profitable and bankers richer, with modest benefit for the real economy. That is unlikely to change soon.
An alternative solution might be to help the world absorb larger export surpluses from the eurozone, the US, Japan and the UK. True, no sustainable exit from the present quagmire can be envisaged without increased net capital flows into emerging countries. It also seems evident that this is where the world’s surplus savings ought to end up. But it is going to take time and much reform to make this happen.
Let me make clear what I am saying and what I am not saying on the role of Germany in the eurozone and the eurozone in the world.
I am not saying Germany is at fault for making first-rate manufactured products. It is an admirable achievement. I am not saying Germany should make its workers uncompetitive or accept much higher inflation, either.
I am saying that Germany’s surpluses were made possible by other countries’ deficits, and so German stability by other countries' instability. I am saying that part of Germany’s net exports were illusory, paid for by excessive borrowing, often financed by Germans. I am saying that if peripheral Europe is to improve its external accounts, either Germany must offset some part of this, or the current account of the eurozone itself must shift towards surplus, with adverse impacts on the fragile world economy.
In short, economic policy is about more than competitiveness. When the world is trying to struggle out of a deep recession, demand matters, too. As the world’s fourth-largest economy and the core of the eurozone, Germany has a role to play in rebalancing global demand. I appreciate that this is a difficult challenge. It must be met, all the same.
Copyright The Financial Times Limited 2010.
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