I have argued
that the low level of German wage increases before the financial
crisis were a significant destabilising influence on the Eurozone,
which also indirectly contributed to Germany taking a hard line on
austerity. The basic idea is that Germany gained a significant
competitive advantage over its Eurozone neighbours, which it has
since been unwilling to unwind (through above average German
inflation). What this competitiveness gain did was lead to very
healthy export growth and a large current account surplus, and that
additional demand meant that Germany did not suffer as much as its
neighbours from the second Eurozone recession that policy created.
Peter Bofinger has made a similar
argument.
This argument is often criticised on the grounds that Germany’s
healthy export growth was not primarily due to any competitive
advantage, but instead was the result of non-price factors like
strong demand from China for the type of goods Germany produces. This
and other criticisms were recently made in a paper
by Servaas Storm. One of the points made by Storm has itself been
criticised
by Thorsten Hild, and Hild’s point is entirely correct (see also
Storm’s reply here).
But the issue about what was the primary cause of strong export
growth remains.
Trying to disentangle how much of German export growth was due to the
competitiveness advantage they gained would require some econometric
analysis which unfortunately I do not have time to undertake. But the
point I want to make here is that if there has been a permanent
positive shift in Germany’s exports (i.e one unrelated to price or
cost competitiveness), then this strengthens the argument that I have
been making. Before we get there, it is worth going through the basic
macroeconomics involved.
Every country will tend towards some long run level of
competitiveness. There are many ways of describing why this is: the
need to obtain a balance between the production and demand for
domestically produced goods, or the need to achieve a sustainable
current account deficit. There are many reasons why this long run
level of competitiveness could change over time, but in the absence
of a plausible story about why that has happened to Germany (or
equivalently, why a 7% of GDP current account surplus might be
sustainable) it seems reasonable to assume that it has remained
unchanged.
So if an economy in a monetary union, like Germany, moderates wages
so that it gains competitiveness in the short term (where the short
term could last a decade), this gain has to be unwound at some point.
Just as the decline in competitiveness in the periphery needs to be
reversed by creating below Eurozone average inflation there, the
opposite applies to Germany.
Now suppose there has in fact been a permanent upward shift in the
overseas demand for German goods. In the long run if nothing changed
we would have an imbalance: the demand for German goods would exceed
the supply, or the current account surplus would be unsustainable.
The way the economy reacts to get rid of that imbalance is through
additional German inflation. Not only must past gains in
competitiveness be reversed, but competitiveness must decline even
further to reduce the demand for German goods.
For those brought up on a mantra of the need to constantly improve
competitiveness, this may seem perverse: getting punished for making
goods other countries want. But of course it is not punishment at
all. A decline in competitiveness is the same thing as an
appreciation in the real exchange rate, and this makes consumers
better off, because overseas goods become cheaper (in the jargon,
there is a terms of trade gain). It is time for Germany to export a
bit less, and start enjoying the benefits.
Posting note
For various reasons
over the next month the frequency of posts may diminish. Don’t go
away - I will be back.
