Reflections on the German Economy. A Macroeconomic Approach
By Egon Neuthinger
Introduction by Heiner Flassbeck
Egon Neuthinger, born in 1926, is a German economist who has been working on macroeconomic issues for half a century in several research institutions. I learned to know Egon at the beginning of the 1980s and I have always been impressed by his clear mind and his outstanding engagement to revive and restore macroeconomic thinking. Even now, at the age of 90, he does not stop fighting for a more balanced approach to German economic policy. This is very admirable. We are happy to publish his thinking about the flaws and shortcomings of the policies that Germany has been following for too long.
Heiner Flassbeck
- General introduction to the series
In the following weeks, we will publish a series of articles on the performance of German economy. The German economy was and is at all sides rated as highly efficient and successful. At the same time the country owns a broad and reliable system of social welfare arrangements. This combination of market orientation and socially motivated state interventions dates back to the fifties when the basic foundations of the economic and social order were laid. The label and outcome of these two constituent ingredients are ideally expressed in the well-known conception of a “social market economy”. We will argue that, over the decades, some deeply problematical and rather unpleasant features of the economic structures have emerged. These are misalignments in internal demand and the recent tremendous upsurge of the current account surplus. Both constellations have to do with the policy of keeping real wages increases below productivity increases. The high current surplus should be addressed by economists and economic policy because they are indicative of a substantial disequilibrium. German economists and policy makers should therefore start a thorough debate about ways and means to gradually restructure the German economy in the direction of more reliance on internal aggregate demand.
The articles will deal with several topics that contributed to the specific development and current structure of the economy. We will start with the long term effects of monetary policy. The main goals of monetary policy were the attainment and accomplishment of durable price stability and the achievement of a structural positive current account. The basic orientation of the policy framework will be presented. The series will provide valuable insights with respect to the workings and the sectoral interdependences within an economy. We will deal also with the consequences of the balance sheet depression and reflect upon on the stagnation issue which has come up, given the slow recoveries of our economies.
- Misconceptions about the German economy
On first sight the present state of the German economy might be judged quite or even highly satisfactory: Economic growth is around 1 1/2 % at its potential rate, unemployment is rather low at about 6%, the employment ratio is high, the public sector account is balanced or even attains surpluses and public debt in relation to GDP is declining. All this takes place in an environment of a tranquil and even deflationary price climate. In German debates this state of events is highlighted by an overwhelming part of German economists, of policy makers and policy advisers and the majority of the German public. It is thus quite understandable that German economists and policy makers advise other EMU Governments which are less “successful” or are even in a dismal state to follow the German example and pursue similar economic policies of “structural reforms”.
These policies were advocated to be in line with traditional German ORDO-visions of strengthening market forces. After the Great Recession in 2008/09 Germany used its increased influence and power especially to complete the legal and institutional framework of EMU with the aim of securing policies in member states for sound public finances and reducing surmounting public debts, restructuring the private sector by cutting overly wages and rents as well as superfluous public expenditures as basic conditions for “assistance umbrellas” for troubled member states. These “austerity policies” are defended as indispensable for regaining worldwide and sustainable competitiveness of EMU enterprises and corporations. It is true that this neoclassical and neoliberal circumscribed policy approach is accepted as the natural environment of today’s economies by most EMU and EU Governments. Seen from a worldwide view the kernel or gist of the doctrine is also shared by other developed market or capitalist economies, i.e. of the United States, Japan, the United Kingdom and Canada and by emerging markets. Policy experiences of the US, Japan and the UK yet indicate differences from the EMU credo in some areas.
However, within the mainstream, substantial omissions and incorrect judgments exist about Germany. The fundamental mistake that the majority of German economists and policy-makers is their refusal to acknowledge the large or fundamental disequilibrium in the German demand and production structure as is manifested in the huge current account surplus of 8% of GDP. The current account surplus has in the meantime developed into a “structural life saver “as the neo-Austrian economist Fritz Machlup once said. The German economy simply “needs” foreign demand and net export of such magnitudes at present. There might be substantiated controversial opinions and perceptions on the meaning “fundamental” in this respect but if Germany at present needs such a large net foreign demand the term “fundamental” is justified. The second flaw in the German policy attitude is that the role of wages is not understood as the most important factor attributing to the emergence of the tremendous current account surplus. Internationally, German wages have in the past been always on the lower side seen. But since the middle of the nineties, a truly dramatic wage moderation, if not wage dumping, has been implemented. Plain economic reasoning leads one to conclude that this wage development is the main cause of the dramatic upsurge of the current account surplus. The counterpart is a corresponding lack of internal demand. This self-evident connection of causes and effects is widely ignored within the mainstream debate; the export performance is rather declared as the consequence of superior German powers of innovation and product creation.
The following elaboration deals with the causes of this German constellation. It tries to explain that there were strong intrinsic and immanent peculiarities of the German ways of economic thinking and acting. The outcome of German development is not quasi natural or God given, but the result of specific short and long –term policies. The phenomenon of the current account runs like a red line through the decades to its present climax. We see the current account surplus as a fundamental i.e. decisive imbalance. Hence, this is what we concentrate upon.
We start by presenting some introductory statements and views of some highly influential German economists. It is not a coincidence that they belong to the community of former Central Bankers. In the Wallstreet Journal (Europe) of November 6, 2014 two high ranked German economists, Otmar Issing, former member of the Executive Board of the European Central Bank, and Ludger Schuknecht, director general and chief economist of the German Ministry of Finance, a former member of the ECB, published an article on “The Truth About Germany`s Post –Reform Deficits”. The authors’ aim is to justify the German supply side policies of 2003 as a successful operation as well as the structural reforms and the fiscal consolidation. According to them, the cuts in public expenditures from 2003 onwards “laid the foundation of sound public finances, high employment and growth.” This German “road to success” is recommended as an example which other countries of EMU, especially France and Italy, should follow. Still more succinctly, Issing stated in the Financial Times of October 23, 2014, Issing wrote:
“Imagine you are asked to give advice to a country on economic policy. The country enjoys near full employment, its growth is (…) at full potential. There is no underusage of resources –what economists call an output gap- and the government’s budget is balanced but the debt level is far above target. To top it all, monetary policy is extremely loose. This is exactly the situation in Germany (…) Where is the economic textbook that argues that such a country should run a deficit to stimulate the economy?”
Issing then rightly stresses that on account of a decaying infrastructure public and also private investment should be increased but that social expenditures should be reduced in order to avoid rising public debt. As you can see, there is no reference in these statements to the current account surplus and how it has come about. And this is wrong. It is not admissible to analyze the overall structure of an economy and to leave aside important features that one does not want to address.
The above statements and opinions reflect the specific kind of economic reasoning which is now mainstream in Germany. With regards to the policy makers, the credo is naturally more deeply rooted within the Christian Democratic Party (CDU) and the Christian Social Union (CSU), but the Social Democrats are also seemingly more and more drawn towards it. And naturally, the large majority of the public in Germany follows.
The origin of this way of economic thinking dates back to the fifties or at least to the seventies and eighties. Its essence found entry into the Maastricht Treaty. In its framework the dominance of monetary policy with the aim of price stability was established; the other two main legs of economic policy, namely budgetary policy and wage policy operate within the overall framework of the monetary environment. Monetary policy as the macroeconomic budget constraint became the primary macroeconomic policy instrument. The main task of budgetary policy is the allocation of economic resources in the most efficient way within the principle of sound public finances. Wage policy is responsible for the attainment of a high grade of employment. In terms of economic theory: this is the Neoclassical Assignment. The achievement of the essential macroeconomic targets, price stability, the allocation of resources and full employment is each assigned separately to each of these three main legs of economic policy. The reader may recognize that such an assignment relies heavily on the harmonization and equilibrium drive and on the self-regulation of the economic system. State actions are not needed in such a framework.
The opposing view is called the Cooperative Assignment approach. It was the Dutch economist Jan Tinbergen who, already in the fifties, considered these essential economic targets as a common task of all three policy domains and called for continuous coordination between them. The theoretical view behind the cooperative solution is the Keynesian inspired disbelief and denial that economies left to themselves can in the longer term deliver satisfactory economic and social results. The cooperative approach was not envisioned in the Maastricht Treaty of 1992 as a policy option. It was judged unfeasible on theoretical and practical grounds, although there is ample reason to expect that this refusal was made on ideological grounds.
Issues of cooperation issues were but a small part of the annual guidelines in the reports of the European Commission approved by the European Council and they had only the character of recommendations. And while the tasks of monetary policy within EMU have remained rather unchanged since the original Maastricht-Treaty, the prescriptions for budgetary policy have sharpened stepwise via the Stability and Growth Pact and, eventually, though the European debt brake, which allows deficit financing of only 0,5 % of GDP in economic normal times. In reality, this means that the main goal of policy consists of creating a balanced budget in the longer term. In contrast, in the cooperative solution, an important part of economic policy is assigned to wage policy. In the Maastricht Treaty there was no reference to wage policy at all; wage developments were seen as the outcome of market forces. Admittedly in the annual policy guidelines wage policies were mentioned and recommended, for example real wage rises below increases in productivity.
At the 1999 summit of Cologne, however, wage policy was explicitly made part of the policy framework. This was achieved mainly by Austrian and German policy makers and especially the then Federal Minister of Finance Oskar Lafontaine and his advisers. With the establishment of the Macroeconomic Dialog (MED) in addition macroeconomic coordination, although a weak one, for all actors of economic policy, including the social partners, a Social Democratic Keynesian consensus was created. National nominal wage developments were to be oriented at the ECB-price target of somewhat below 2% plus the national trend productivity increases. Such a wage equation, quasi the Golden Rule for wage policy in a monetary union with fixed exchange rates, is by itself price neutral, it ensures a constant income distribution and it is also neutral in terms of employment. But most importantly in the case of a monetary union with fixed exchange rates, this wage formula is neutral with regard to international competitiveness. Wage policy along these guidelines does not itself create fundamental macroeconomic imbalances that emerged in the EMU. It goes without saying that in an environment of economic policy in which the importance of competitiveness among the member states and against the rest of the world is stressed as a sine qua non for the survival of EMU, this wage rule should be self- evident and in no need of further elaboration. Unfortunately, the wage formula did not find entry into practical economic policy because the governments of the EMU lacked the good insight and the competency to accept the new amendment. It is useful in this context to remind that in a perfect flexible exchange rate system wages that are not in line with productivity would be cancelled out by ensuing exchange rate movements. Thus the Golden Wage formula in a monetary union secures a competitive wage development, but it does not lead to major imbalances between the countries.
It is in this context illuminating to note the structure of sectoral balances in 2015: The current account surplus amounted to 8.7% of GDP. The private sector surplus was 8.1% and the surplus of the public was 0.7 %. Remarkably, the surplus balance of the non-financial corporations is 4.1% of GDP. Favourable factors like the exchange rate and oil prices certainly played a role. Corporate investment is nonetheless still far away from a satisfactory pace and structural distortions remain. The German Economic Research Institute predicts in its latest report a current account surplus for 2020 of about 5.25 % of GDP. In any case, the question has to be raised and answered whether in such a configuration the usual caveats against deficit financing prevail.
Part 2 will deal with the two fundamental factors of the German economic performance: wages and prices.