Economics and politics - comment and analysis
26. September 2015 I Heiner Flassbeck I Economic Policy, Europe, General Politics

What is politics? A note on the discussion of the Left about the Grexit

This article was published September 10 in German.

A discussion about politics is always a discussion about power relations. If you want to solve a problem by political means, you need the political power to do so. Within democratic states, elections decide (at least in theory) who gains the authority to exercise power. Between states, the situation is much more complex. If one government wants to force another in a direction it does not want move to, it must have the power to do so. To that end, credible threats need to be formulated, sanctions need to be envisaged. From that vantage point, the position of Greece vis-à-vis the Eurogroup and Germany was easy to understand. In one word, Greece had no power. The other players had all the trump cards: no ifs and no buts, we have the money, you need it, you give in.

When we discuss the relationship between Germany and the debtor countries, what must be understood above all is the dominant power position of the creditor. Germany has built up a tremendous position of power within Europe because of its (unjustly acquired) superior competitive position and its extremely high current account surpluses. It is, economically speaking, better off than any of the other European member states, because it managed to export much of its unemployment. It is also the largest creditor. So, inevitably, deficit countries turn to Germany when they are cut off from the capital market because their economies are considered to be uncompetitive (in comparison to Germany).

All of this means that any negotiations will be characterised by extremely asymmetric distributions of power. What can the debtor countries do in such a situation? The only thing left for them (and this is what some of their defenders on the left say) is to hope for insight on Germany’s part. They can hope to explain the macroeconomic conundrum and hope that Germany will understand it. Perhaps Germany will show foresight, vision and willingness to abandon its position. But all of this is extremely naive.

Why should the German government, under the leadership of the CDU party, do such a thing? Another political constellation, another coalition, is not be expected in years to come because, although Germany has problems of its own, the overall situation is still better than in most other countries. But this is the death knell. For the CDU, it is essential to take the position that directly supports the interests of German industry, regardless of how destructive these policies are from a macroeconomic point of view (I have argued this in detail here – in German). German industry will never agree to a policy that amounts to conceding a part of the market to other countries, although that is exactly what is needed to resolve the crisis. Aside from this, anyone who counts on the SPD to formulate rational macroeconomic policies should read their discussion paper that has just been published. The stalemate is complete.

The European countries can only achieve something tangible if and only if they manage to formulate a credible threat to German economy. In the current circumstances, this can be done in one way only: they have to threaten to exit the euro zone, with a sharp depreciation of their own new currencies and even with massive protectionist measures (see the appendix below). All these measures amount to the same, namely to block German export or to make it prohibitively expensive. That is the only real leverage that debtor countries can hope for. But inside the EMU this threat is hollow because it is tantamount to a further reduction of their domestic wages, without which it will be impossible to regain competitiveness (which is in turn the only alternative to the measures mentioned above). How can you threaten with a measure that hurts yourself more than you counterpart?

Is there nothing that can be done by a small country? Obviously, the threat of a Grexit does not worry Germans politicians. Economically speaking, Greece is unimportant. Its economy is simply too small for a Grexit to have a substantial negative effect on the German economy. Greece could have threatened Germany by playing a pioneering role. It could have resisted austerity, indeed Syriza for its first term did try to to fight austerity, hoping to create a domino effect. Just imagine the re-ordering of power relations were France, Italy or Spain to change sides. These are sufficiently big economies. It would suffice that two or three of these countries draw a line in the sand on austerity policies and oppose Germany by threatening to leave the euro-zone. The German neo-liberal, mercantilist, nightmare would rapidly come to an end. But this has not happened. Politicians lack the courage to stand up to Germany, they are afraid of the chaos that may result or ideologically wedded to the austerity agenda. But it can, of course, not go on like this. The most likely scenario is that, at one point, the euro will cease to exist, because anti-European nationalist governments will sooner or later pull the plug by using the only option they have: the exit.

Those who opine such a scenario and argue that the euro must not fail, play directly into Germany’s hands. Those who want to preserve the cohesion within the euro area at almost any cost in order to prevent nationalism, but at the same time fail to provide a viable strategy to confront Germany’s mercantilism, are naive. History shows that a huge disequilibrium of power never lasts and never goes unpunished. Finally, those who propose a further expansion of European policies in the hope of taming Germany this way should remember that this was exactly the hope of many when the European Monetary Union saw the light of day. It is nothing but self-deception.


The threat from other countries to damage the economy of a mercantilist aggressor is indispensable and essential, because, otherwise, even a halfway functioning market economy across national boundaries would have never existed. I recently explained this as follows:

“One can hardly deny that, in economics, the idea of competition refers to a competition between companies. Businesses should prove themselves in competition under equal conditions (and this includes equal pay for equal work in the first place!) in their efforts to improve productivity in the production or the goods and services that are being produced” (see for the full text here in German).

This is, of course, nothing else than market competition. However, this situation fundamentally changes if a country as a whole develops a competitive advantage over other countries. Advantages on such scale have nothing to do with the performance of individual companies. It is not because these companies perform better than foreign ones. It is because of economic policies that distort the competition between domestic and foreign companies. The precise nature of the advantage does not matter much. It can be a lot of things: import duties, corporate tax scales, subsidies, the undervaluation of currency or policies aimed at keeping wage growth below productivity growth so that wages rise less than abroad. Whatever it is, the point is that such measures are beneficial for domestic companies and detrimental to foreign ones, regardless of how economically strong or weak these companies are. Furthermore, such policies will always systematically harm overall growth.

The harmful consequences of preferential treatment were recognised many decades ago. Countries have the right to oppose such artificial advantages and protect their businesses. In accordance with the rules of the World Trade Organization, countries can introduce duties, depreciate currencies and start legal proceedings against countries that support dumping practices. Political pressure on domestic wages to compensate for the wage advantage of foreign countries is possible and permitted. Often, the simplest way out was devaluation. Whenever a country ended up in a crisis of its balance of payments, so that the risk existed that it could no longer finance its imports without having to borrow on the capital market (often with high interest rates), the solution was usually found in a devaluation of the currency. This was the case in the Bretton Woods system and in the European Monetary System, when exchange rates were still flexible and adaptable. Devaluation makes imports more expensive, but it makes exports cheaper and reduces in this way the dependence upon the capital market.

Fixed exchange rates embody, as it were, the promise of trading partners to not undercut one another. Flexible exchange rates become unnecessary. But fixed exchange rates depend on non-undercutting. Once undercutting starts, the system heads towards crisis. This is what Germany did. Germany chose to go down the path of undercutting all other member states of the European Monetary Union by implementing mercantilist policies: let’s tighten our belts, put pressure on wages, undercut our trading partners, export our unemployment (an analysis of mercantilism can be found here). Germany effectively broke the cornerstone agreement of the European Monetary Union. If the European treaties had been drafted in an intelligent way, the European member states would be able to introduce import tariffs to compensate for the German dumping.

The problem is that the European treaties were not designed well, as can be easily seen. The Commission is very serious in bringing member states to the European Court of Justice when it turns out that they give preferential treatment of any kind to a specific company. Take, for example, the case of Volkswagen. Volkswagen received state subsidies – a sale of land below market prices and state guarantees, due to the direct involvement of government in the ownership of the company. The Commission suspected distortion of competition and called for compensation.

However – and this is the crux of the matter – the Commission is powerless if a country implements policies – tax cuts and pressures on wages – that favour all domestic companies. The reason is that such policies remained national matters: national competitiveness and national tax sovereignty. This is the fundamental incoherence. Subsidies, tax cuts and pressures on wages distort competition in exactly the same way as individual subsidies or preferential treatments for individual companies. The difference is that, overall, the damage that is caused is much greater, because now everybody abroad suffers from dumping. If the European treaties did not exist, European member states could take Germany to the World Trade Organization and start a legal procedure against German dumping with great prospects of success. And without the common currency, the countries would be able to depreciate their currencies and break the dominance of German mercantilism. As it is now, the euro is an iron cage.

This argument shows that it does not matter whether a nation is efficient or productive. Every nation must be as productive as it can be. But no country can live for a long time below living standards that are made possible by its productivity: other nations will follow suit and adapt, and a race to the bottom will result. Since it would be extremely foolish if all nations tried to live below their means just because one nation does so, compensation mechanisms of the type described above (i.e. customs duties, currency devaluations or legal proceedings for unfair competition on the level of states) must come into existence.