Following Germany’s Lead to Economic Disaster

Balanced budgets, wage restraint and more competitiveness for everybody – this is the result of the last European summit and the new definitive solution for the Eurozone crisis. Eurozone leaders (with the exception of David Cameron) have decided to follow the German way of doing business: since the euro’s introduction Germany has actually done everything it now demands from the other eurozone members. But be wary: it will mean suffering. This is why the people of the eurozone should at least know what they are getting into when they follow Germany’s lead.

Let’s begin with reviewing Germany’s economic performance since the beginning of the Eurozone. It has been dismal. With average yearly growth rates of 1.7 % between 1999 and 2008, Germany had the second lowest growth among all eurozone members, only followed by Italy with an average growth of 1.5 %. Only half of German growth was driven by domestic demand; the other half was driven by export surpluses – by definition other countries’ deficits.

Source: Eurostat, own calculations

The reason for both low internal demand and strong export surpluses was the fall of real wages: While real wages all over the eurozone have increased in the last ten years, German real wages have actually declined by 4 %. The fall in income led to low spending on consumption and imports; on the other hand, the German wage decline has massively increased German price-competitiveness vis-à-vis its eurozone trading partners and thus boosted exports.

Source: Eurostat, own calculations

Why did wages fall? First, the government at the time – a coalition of social democrats and the green party – reduced government spending exactly when the economy needed a boost, and second, it de-regulated labour markets. Especially in the first half of the 2000s, the German government wanted to be the poster child of fiscal rectitude and meet the Maastricht criteria at all cost whilst on the other hand cutting income taxes for the rich. To close the deficit government spending, especially public investment and public sector employment was cut – even though Germany already had one of the smallest public sectors in the OECD. While the rich got richer, public schools, railways and streets began to collapse, spending on education was reduced and unemployment rose.

However, unemployment was deemed ‘structural’ and not caused by low growth. So the red-green government ‘reformed’ the labour market, cutting unemployment insurance and tightening conditions for access to social welfare – while abstaining from introducing a minimum wage. Chancellor Gerhard Schroeder’s explicit goal was to create a low-pay sector in which the long-term unemployed would find jobs. The lack of minimum wages and the higher pressure on the unemployed caused a severe downward wage trend.  The share of the low-pay sector (less than 9 € per hour) in overall employment strongly increased from 15 % in 1998 to 22 % in 2005 and hasn’t fallen since. It is now close to the size of the British low-pay sector but with one difference: without minimum wages, there is no bottom for German wages. Tax cuts and pressure on the poor had their natural consequence: nowhere in the OECD did inequality increase as much over the last ten years as it did in Germany.

That all those policies didn’t lead to a total economic and social collapse had only one reason: today’s crisis countries got into debt and imported German products en masse, financed by German banks. Since credit demand was flat in Germany’s stagnating economy, banks readily lent to governments, households and companies abroad. The only strong impulse for growth came exactly from those countries that German public opinion now marks as lazy spendthrifts; and from which the German chancellor Merkel now demands to do exactly what Germany did in its long period of economic stagnation.

Source: Eurostat

However, there is a crucial difference between Germany’s economic environment in the last ten years and the crisis countries’ situation right now: There are no more spendthrifts out there to save the day. Whatever crisis countries now do to increase their competitiveness – and they are already drastically cutting wages and costs – there are fewer and fewer countries out there willing and able to buy those now more competitive goods and services. The new European rules – which demand everybody simultaneously to save more and improve competitiveness – will exacerbate economic and social problems in the crisis countries and drag the whole euro area into the economic abyss. Not a pretty sight. But this is what following the German model will lead to. Be prepared.

  • Marx' ghost

    Fair analysis : and now what? Which example could Europe follow?

    • eosand

      no. that is not a fair analysis, it is a superficial analysis. during the last ten years, germany's exports into the euro-countries declined relatively to non-euro countries and above all non-europe countries. the euro-periphery-countries on the other hand increased deficits with non-euro countries and above all non-europe countries. if germany would raise wages, the euro-periphery-countries would not profit from this, but non euro-countries would.

  • Marx' ghost

    ok, but who should? France, Britain or Italy do not seem to prepare a shining future for the rest of us.

    • eosand

      although that would not help the piigs, germany should raise wages in order to strenghten the domestic market and stop poverty-tendences in germany, financing via tax raises of the "upper" class. if not the 53% of the kohl-era, at least 50%.

      the piigs are lost for decades. spain, for example, instead of strenghten their weak scientific ground and transform their knowledge to products (medical products, biotechnology), allocated money in constructing. virtually almost all spanish people speculated in housing. for years spain built more than germany, france and greatbritain together. there was a lot of money in spain. they consumed it, instead to invest. furthermore traditional industries like shoe-industry were extinguished. spain imports shoes from china now. spain threw away a chance that appears one,two times in century.

      the euro is bullshit. therefore: first heavy recession, then inflation, then the euro break.

      • http://www.uncafelitoalasonce.com/ Aitor Calero Garc&ia

        "virtually almost all spanish people speculated in housing". I think it's not only the debtor fault, but also the lender's one. Where all of this money came from? Yo seem to forget that a great part of this housing bubble was in the coast of Spain, and many of them were houses sold to Germans, English and French.

        Yes we built a lot, but we had a lot to build. We were far behind the rest of Europe in infrastructure development and modern housing due in part, to 40 year of dictatorship.

        Spain, complained strictly with the Euro Growth and Stabiltiy Pact when both France and Germany broke it. Now what?

      • eosand

        lenders were the "cajas". they still have a big balance sheet problem, this means "air" in the left side. and of course, there were not only construction at the coast. and that what was built at the coast were frequently vacation locations of the spanish. furthermore there were heavy speculation in the towns, where the same flat was sold after one or two years for a higher price several times during the bubble time. and the cajas were financing this. the housing prices that you can read actually in the offerts of the agencies are totally ridiculous. and via this, the spanisch population almost as a whole created the misery, not the government, which moved along the rules. ah, sells to french and germans are not the problem. this houses are paid or not credited by the cajas.

      • Alex

        Eosand; you are talking about the construction bubble in Spain without providing data, that's very scientific…

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