How many times does it need to be said? The German model cannot be generalised to the Eurozone as a whole. However convenient politicians may find it to caricature and contrast the export success and budgetary probity of Germany or The Netherlands with the profligacy of Greece, Ireland, Portugal, Spain and other ClubMed members, when it comes to macroeconomics, the view conveyed is not merely simplistic – it is deeply dangerous. No matter that Greece cooked its budgetary forecasts and that Irish politicians pandered to wildly overleveraged banks looking for state-funded insurance, a financial squeeze is not the answer to recession. As the IMF has shown, when contraction is pro-cyclical – i.e., if the state tries to save more when the private sector has stopped spending – financial discipline generally makes things worse.[1]
Since the inception of the euro in 1999, the core countries – led by Germany – have kept the lid on domestic demand enabling them to keep inflation in check and to enjoy low interest rates. Low interest rates, wage repression and negligible inflation serve the interests of bankers by helping to keep the asset side of the balance sheet strong.
As to Germany export model, repressing domestic demand has helped export-led growth. Most important, as argued in a recent report by the Research on Money and Finance Group at the University of London SOAS, the euro has given Germany a stable exchange rate and a captive market; the country exports nine times more to the Eurozone than it does to China; an estimated two-thirds of its growth comes from net exports. In the absence of the euro, the recent crisis would have sent the DM skyward while peripheral currencies plunged, choking off its export-led recovery.[2]
But this is a dangerous game. It will be recalled that Germany nearly slipped into deflation in 2003, and that the real wage and the level of domestic demand hardly grew between 1999 and 2008. These trends entailed two costs. First, high and persistent unemployment in the Eurozone core has eroded the legitimacy of the Eurozone project; secondly, elsewhere in the Eurozone, ultra-loose monetary policy helped unleash a property bubble which burst when credit dried up in the wake of the collapse of Lehman Brothers.
Indeed, neither Ireland nor Spain can be accused of excessive government borrowing: back in 2007, the ratio of net public debt to GDP in Spain was only 20% while in Ireland it was a mere 12%.[3] Rather it was the private sector which ramped up its leverage as the property bubble grew. With the bust of 2008, the Irish government extended blanket guarantees to its banks. As recession gripped the real economy, the dole queues lengthened and tax receipts collapsed producing a deep hole in the budget – and although Spain regulated its banks more closely, like Ireland, it was the same combination of over-borrowing in the private sector and the effect of recession on public finances which made the country vulnerable.
Eurozone: Selected Eurobond holdings of German banks (2010)
Source: SpiegelOnline, 26 Nov. 2010, Photo Gallery
At the moment, while the Irish government deficit is close to 15% of GDP – triggering bond markets to panic and Messrs Cowen and Lenihan to summon the EU/IMF team – few seem to notice that this roughly matches the private sector surplus, in turn raising the question of whether the direction of causality is not from private savings to public deficit.
The current German and French government have clearly not thought this one through. For one thing, their generalised remedy for the Eurozone is the imposition of budgetary discipline in the form of a revised Stability and Growth Pact (SGP) with strong penalties for non-adherence. For another, a month ago the two governments agreed on a debt restructuring mechanism for member-states which would allegedly force bondholders to share the pain by taking a haircut. Doubtless such a scheme will appeal to taxpayers and sacked public-sector workers alike, but as Paul De Grauwe has noted forcefully, legitimating sovereign debt restructuring makes speculative runs more likely, not less so.[4]
Martin Wolf of the Financial Times has summed up the broad situation admirably:
At best, reliance on fiscal disciplines and sovereign debt restructuring is sure to generate massively pro-cyclical policy. At worst, it will generate serial depression and default among member countries. Moreover, this is also a global problem: the emphasis on deflationary adjustment in weaker countries risks turning the eurozone as a whole into a gigantic Germany, dependent on importing demand from the rest of the world…. [T]he eurozone is far too large to play such a role in the world economy.[5]
In layman’s terms, the German view – peddled as the prudence of the Schwabian hausfrau – is untenable. Not all Eurozone countries can balance their budgets by exporting their way out of crisis (i.e. by importing demand from the rest of the world). The export-led balanced budget model may work for the north’s bankers, but it cannot by definition work for Europe as a whole. As Jean-Claude Junkers is reported to have told the newspaper Rheinischer Merkurn: “Germany federal and local authorities are slowly losing sight of European public good, [and] that does worry me”.[6] It’s time for the Eurozone’s citizens to recognise that the uncritical acceptance of bankers’ economic doctrines will ultimately result in the euro’s disintegration.
Endnotes
[1] See http://www.social-europe.eu/2010/11/expansionary-fiscal-contraction-and-the-emperor’s-clothes/; also http://www.ft.com/cms/s/0/a553e836-edd2-11df-9612-00144feab49a.html#axzz16hbBQrRL
[2] See Research on Money and Finance (2010), ‘The Eurozone between austerity and default’, University of London, SOAS, November.
[3] See Martin Wolf, ‘Ireland refutes the German perspective’, Financial Times.
[4] See P. De Grauwe, ‘A mechanism of self-destruction in the Eurozone’, 9 November 21010.
[5] See M. Wolf, ‘Ireland refutes the German perspective’, Financial Times, 23 November 2010.
[6] See S. Weiland, ‘Merkel’s reputation on the decline in Europe’, Der Spiegel Online, 26 Nov 2010.
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“The German model cannot be generalised to the Eurozone”
Where are those strawmen claiming that? Afaics nobody here in Germany says so. Honestly, we DON’T CARE how other nations run their economy, we’re only intrested in not subsidizing any deficits of other nations in the long run!
“As to Germany’s export model, repressing domestic demand has helped export-led growth.”
No direct causal relationship! Obviously. After all, it is possible to repress domestic demand WITHOUT helping export growth. Or what else is happening in Greece?
“It will be recalled that Germany nearly slipped into deflation in 2003″
Good example! It will also be recalled that the allegedly so pro-German ECB REFUSED to expand the Geldmenge because infaltion in Spain was too high! Gladly, we managed to avoid inflation by using national policies to counter it. And, ok, we have to agree, if the ECB had mplemented the German proposals, the bubble in other parts of Europe would have become even worse. But still, this is THE most prominent evidence that the alleged German influence on the ECB is totally overrated! If only “experts” like Prof. Eichengreen would know that.
“Rather it was the private sector which ramped up its leverage as the property bubble grew.” And that was not a consequence of misguided growth oriented policies and foolish deregulation by the governments? Come on!
“Not all Eurozone countries can balance their budgets by exporting their way out of crisis (i.e. by importing demand from the rest of the world).”
Again, we NEVER said that! Those who can’t will have to shrink down to a sustainable size. Sry, that’s harsh, but we ain’t got no better ideas yet. We can’t and won’t finance large scale Keynsian programs for all of the rest of the EU (we’re only 80 million, EU is 500 million!). So, do you have any better ideas, plans that actually can be financed? Shoot! And don’t forget to show your calculations.
To put it ornithologically : Capitalism's chickens are coming home to roost! Jean-Claude Juncker seems to share the view, common in 26 of the the 27 EU member countries, that Germany should continue to sacrifice its national interests to suit everyone else and continue to be the paymaster and lackey of all and sundry who wish to sponge off it. Is the resentment at Germany's economic success anything more than just mean-spirited envy? Why should such a successful country play by other people's rules to its own disadvantage? It's high time that the country that subsidises everyone else is given scope to re-write the 'rules'.