Many economists have been analyzing the world economic crisis in public arenas these last few years, and particularly the Eurozone crisis since Greece began its slide off the slippery slope. Many of these analyses have been on the mark. A few have been wildly off the mark, and a few, even by outstanding economists, have just missed the bull's eye. The reasons why are illuminating in showing just how easily one can misdiagnose a problem even when coming to it with the best credentials.
Alan S. Blinder (Princeton) and Martin Feldstein (Harvard) are honorable men, but also outstanding economists. And they have both recently published extensive op-eds on the Eurozone crisis in leading newspapers. Yet, informed and astute as they are (Blinder for example published one of the best road maps of the US subprime mortgage crisis in the New York Times in 2009: Six Errors on the Path to the Financial Crisis), their analyses are both flawed, interestingly enough in complementary ways. Putting them together, however, gets us a little bit further on the road to solving the problem.
Let me start with Blinder's The Euro Zone's German Crisis in Dec. 13's Wall Street Journal (unfortunately, WSJ articles are inaccessible to anyone without a subscription). Blinder is on the mark in claiming that the Eurozone crisis is primarily due to Germany. Unfortunately, he makes this claim for entirely the wrong reasons. By examining the statistics on unit labor costs (ULC), he correctly identifies the competitiveness problem between Germany and the EZ periphery (it has been widely known that German unit labor costs are a lower outlier on the index ranking EZ ULC evolution). But by neglecting that unit labor costs are defined as a quotient of nominal wages and productivity, he jumps to the mistaken conclusion that this must be due to some "German productivity miracle." In fact, quite the opposite is the case: German productivity growth in the period 2001-2011 was at best mediocre. The low value of German ULC is almost entirely due to something I (among many others) had long ago identified as what one can variously call "wage restraint" or "wage dumping": German nominal wages have risen much slower than her productivity, and very much slower than her EZ trading partners. Essentially none of Germany's ULC advantage is due to exceptional productivity growth.
Here are the facts, as I presented them in an (as yet unpublished) letter to the editor of the WSJ on Dec. 18, and in an email on Dec. 20 to Professor Blinder:
To his great credit, Professor Blinder readily admitted to this mistake in his analysis in an email reply (I was apparently not the first one to point it out to him). It makes a world of a difference whether German competitiveness advantage is due to superior productivity growth or, if you'll pardon a Marxist terminological indulgence, superior exploitation of her workers. But before wallowing in Marxist self-righteousness I would qualify this observation in two ways. First, a mature open economy in which wage growth systematically lags productivity creates a conundrum for its trading partners, since it is out of long-run macroeconomic equilibrium and can only maintain employment levels by, e.g., generating export surpluses (i.e., it is underconsuming). This characteristic of the contemporary German economy - an excessively low consumption share - has been repeatedly highlighted by Professor Peter Bofinger (the "token" Keynesian on the German Council of Economic Advisers). Thus German employment is dependent on finding someone "willing" to be the consumer of last resort and overconsume, i.e., run a current account deficit (financed by German and other banks), and until 2008 that was to a large extent the EU periphery. This is exactly analogous to the relationship between China and the USA over the last 20 years. German workers may have been content with this "exploitative" relationship since it guaranteed them relatively higher employment rates (by EU standards).
Second, German competitiveness also really does derive from the fact that Germany continues to enjoy an advantageous specialization pattern: it still produces the things high-growth countries demand, both in the rest of the EU during the housing boom, and even now in emerging markets, and that they cannot (yet) produce themselves - specialized capital goods and producer intermediates like chemicals, and high-end automobiles. So hats off to Germany for defending her industrial comparative advantage, but there is no justification in calling this a "productivity miracle." Rather, you can take your pick of "obsessive wage restraint," "wage dumping,", or "super exploitation."
We now come to Martin Feldstein's A weak euro is the way forward in the Dec. 19 Financial Times. Feldstein again identifies the Euro crisis as a balance of payments problem resulting from divergent competitiveness, and like Blinder, attributes this in part to superior German productivity growth ("Productivity in Germany rose much faster than it did in Italy, Spain and France" - while we have already seen that this is true to an extent for the first two, it was definitely not true for France or even Portugal). He then goes on the propose a devaluation of the Euro as an essential part of the immediate corrective for the current account deficit EZ countries.
While it is clear that a Euro devaluation with respect to the rest of the world would boost exports and restrain imports for the block as a whole (but impact individual countries differently, probably benefiting Germany most of all, and Portugal and Spain least), it is less clear that this would provide the internal rebalancing of current accounts within the EZ that the crisis mandates. Feldstein points out that over 50% of peripheral EZ trade is with partners outside the EZ. But to gauge to what extent a devaluation would correct the current account deficits, we need to know where these deficits come from.
To do so, I have looked at the bilateral trade flows between key peripheral and core EZ countries, in this case Italy and Spain on the one hand, and Germany on the other, using the OECD STAN Bilateral Trade database. The disadvantage of this method is that it excludes bilateral trade in services, tourism, transfers etc., that enter into the current account but not the balance of trade. The difference is small for Spain but significant for Italy:
Italy is actually in trade surplus until 2004, but the current account is always negative and consistently lower than the balance of trade. Where this is coming from deserves further analysis (interest payment transfers to foreigners on national debt?). In any event the trade deficit is a surprisingly insignificant part of Italy's problems.
I now calculate the bilateral balance of trade (BOT) deficit with respect to Germany as a percentage of the country's balance of trade with the entire world:
Alan S. Blinder (Princeton) and Martin Feldstein (Harvard) are honorable men, but also outstanding economists. And they have both recently published extensive op-eds on the Eurozone crisis in leading newspapers. Yet, informed and astute as they are (Blinder for example published one of the best road maps of the US subprime mortgage crisis in the New York Times in 2009: Six Errors on the Path to the Financial Crisis), their analyses are both flawed, interestingly enough in complementary ways. Putting them together, however, gets us a little bit further on the road to solving the problem.
Let me start with Blinder's The Euro Zone's German Crisis in Dec. 13's Wall Street Journal (unfortunately, WSJ articles are inaccessible to anyone without a subscription). Blinder is on the mark in claiming that the Eurozone crisis is primarily due to Germany. Unfortunately, he makes this claim for entirely the wrong reasons. By examining the statistics on unit labor costs (ULC), he correctly identifies the competitiveness problem between Germany and the EZ periphery (it has been widely known that German unit labor costs are a lower outlier on the index ranking EZ ULC evolution). But by neglecting that unit labor costs are defined as a quotient of nominal wages and productivity, he jumps to the mistaken conclusion that this must be due to some "German productivity miracle." In fact, quite the opposite is the case: German productivity growth in the period 2001-2011 was at best mediocre. The low value of German ULC is almost entirely due to something I (among many others) had long ago identified as what one can variously call "wage restraint" or "wage dumping": German nominal wages have risen much slower than her productivity, and very much slower than her EZ trading partners. Essentially none of Germany's ULC advantage is due to exceptional productivity growth.
Here are the facts, as I presented them in an (as yet unpublished) letter to the editor of the WSJ on Dec. 18, and in an email on Dec. 20 to Professor Blinder:
I was a not a little taken aback by the premise of your Dec. 13 WSJ op-ed "The Euro Zone's German Crisis," since it is completely unsupported by economic statistics. I sent the following letter to the editor to the WSJ on Dec. 18, which to date has not been published:
"While Alan Blinder's recent piece "The Euro Zone's German Crisis" (WSJ Dec. 13) has the great merit of refocusing attention on the competitiveness imbalances at the heart of the Euro crisis (something that Paul Krugman, Martin Wolf, Paul de Grauwe and numerous others, including my humble self almost a year ago in the New York Times, had also identified), I must take issue with his characterization of the problem as stemming from a "German productivity miracle." OECD figures on labor productivity for 2001-2007 show Germany's annual rate of growth to be only 1.4%, exactly equal to France's and Portugal's, but lower than Austria's (1.9%), Belgium's (1.5%), the UK's (2%), Greece's (2.3%!), Hungary's (3.7%), Ireland's (2.9%), or Sweden's (2.9%), not to speak of non-EU competitors like Japan (2.1%) and the USA (2%). Of the major EU economies, only Italy and Spain had lower rates of productivity growth. Thus Germany's exceptional ability to undercut competitors on unit labor costs can only be due to the evolution of the numerator of that index, i.e., the rate of growth of nominal wages, which has variously been referred to (even by such diplomatic personalities as Mme. Lagarde) as "wage dumping" ("Lohndumping" in German). And indeed independent studies have shown that German wages have significantly trailed German productivity growth and inflation, leading to an absolute fall in median German real wages over the last ten years.
Since these productivity measures do not take qualitative components of competitiveness - the traditional strength of German industry rather than price - fully into account, a stickler could argue that they underestimate German productivity growth. Still, it is highly misleading to speak of a German productivity miracle instead of a German wage scandal."
German productivity growth rates after the onset of the crisis 2008 are even more dismal because of Germany's high export dependency (world trade collapsed faster than domestic demand), the high procyclicity of productivity, and the specific 'labor hoarding' resulting from Germany's extensive use of short-work programs. Thus the German unit labor cost outlier in the 2000 decade is almost entirely due to 'wage restraint' or 'wage dumping.'The OECD spreadsheet on which I based this analysis is available here.
To his great credit, Professor Blinder readily admitted to this mistake in his analysis in an email reply (I was apparently not the first one to point it out to him). It makes a world of a difference whether German competitiveness advantage is due to superior productivity growth or, if you'll pardon a Marxist terminological indulgence, superior exploitation of her workers. But before wallowing in Marxist self-righteousness I would qualify this observation in two ways. First, a mature open economy in which wage growth systematically lags productivity creates a conundrum for its trading partners, since it is out of long-run macroeconomic equilibrium and can only maintain employment levels by, e.g., generating export surpluses (i.e., it is underconsuming). This characteristic of the contemporary German economy - an excessively low consumption share - has been repeatedly highlighted by Professor Peter Bofinger (the "token" Keynesian on the German Council of Economic Advisers). Thus German employment is dependent on finding someone "willing" to be the consumer of last resort and overconsume, i.e., run a current account deficit (financed by German and other banks), and until 2008 that was to a large extent the EU periphery. This is exactly analogous to the relationship between China and the USA over the last 20 years. German workers may have been content with this "exploitative" relationship since it guaranteed them relatively higher employment rates (by EU standards).
Second, German competitiveness also really does derive from the fact that Germany continues to enjoy an advantageous specialization pattern: it still produces the things high-growth countries demand, both in the rest of the EU during the housing boom, and even now in emerging markets, and that they cannot (yet) produce themselves - specialized capital goods and producer intermediates like chemicals, and high-end automobiles. So hats off to Germany for defending her industrial comparative advantage, but there is no justification in calling this a "productivity miracle." Rather, you can take your pick of "obsessive wage restraint," "wage dumping,", or "super exploitation."
We now come to Martin Feldstein's A weak euro is the way forward in the Dec. 19 Financial Times. Feldstein again identifies the Euro crisis as a balance of payments problem resulting from divergent competitiveness, and like Blinder, attributes this in part to superior German productivity growth ("Productivity in Germany rose much faster than it did in Italy, Spain and France" - while we have already seen that this is true to an extent for the first two, it was definitely not true for France or even Portugal). He then goes on the propose a devaluation of the Euro as an essential part of the immediate corrective for the current account deficit EZ countries.
While it is clear that a Euro devaluation with respect to the rest of the world would boost exports and restrain imports for the block as a whole (but impact individual countries differently, probably benefiting Germany most of all, and Portugal and Spain least), it is less clear that this would provide the internal rebalancing of current accounts within the EZ that the crisis mandates. Feldstein points out that over 50% of peripheral EZ trade is with partners outside the EZ. But to gauge to what extent a devaluation would correct the current account deficits, we need to know where these deficits come from.
To do so, I have looked at the bilateral trade flows between key peripheral and core EZ countries, in this case Italy and Spain on the one hand, and Germany on the other, using the OECD STAN Bilateral Trade database. The disadvantage of this method is that it excludes bilateral trade in services, tourism, transfers etc., that enter into the current account but not the balance of trade. The difference is small for Spain but significant for Italy:
| Measure | Percentage of GDP | ||||||||||||
| Year | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | |||
| Country | |||||||||||||
| Italy Current Account | -0.48 | -0.05 | -0.87 | -1.37 | -0.88 | -1.60 | -2.50 | -2.42 | -3.15 | -1.93 | |||
| Italy Balance of Trade | 0.13 | 0.52 | 0.49 | 0.13 | -0.11 | -0.72 | -1.42 | -0.61 | -0.68 | -0.41 | |||
| Spain Current Account | -3.97 | -3.96 | -3.27 | -3.53 | -5.26 | -7.35 | -8.95 | -10.00 | -9.61 | -5.19 | |||
| Spain Balance of Trade | -4.61 | -4.22 | -4.03 | -5.13 | -6.91 | -8.15 | -8.66 | -9.50 | -9.23 | -4.34 | |||
Italy is actually in trade surplus until 2004, but the current account is always negative and consistently lower than the balance of trade. Where this is coming from deserves further analysis (interest payment transfers to foreigners on national debt?). In any event the trade deficit is a surprisingly insignificant part of Italy's problems.
I now calculate the bilateral balance of trade (BOT) deficit with respect to Germany as a percentage of the country's balance of trade with the entire world:
| Measure | Percentage of GDP | |||||||||
| Year | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 |
| Country | ||||||||||
| Italy BOT World | 0.1 | 0.5 | 0.5 | 0.1 | -0.1 | -0.7 | -1.4 | -0.6 | -0.7 | -0.4 |
| Italy BOT Germany | -0.4 | -0.4 | -0.6 | -0.7 | -0.9 | -1.0 | -1.0 | -1.1 | -0.9 | -0.9 |
| Italy-Ger % Share in BOT | -298.2 | -78.9 | -117.1 | -542.3 | 873.1 | 142.4 | 70.8 | 186.7 | 136.5 | 222.6 |
| Spain BOT World | -4.6 | -4.2 | -4.0 | -5.1 | -6.9 | -8.1 | -8.7 | -9.5 | -9.2 | -4.3 |
| Spain BOT Germany | -1.0 | -1.1 | -1.2 | -1.5 | -1.8 | -1.8 | -1.8 | -2.3 | -1.9 | -0.9 |
| Spain-Ger % Share in BOT | 22.0 | 26.6 | 30.7 | 29.2 | 26.5 | 21.5 | 20.3 | 23.7 | 20.8 | 21.6 |
Thus we see that the Spanish bilateral trade deficit with Germany is a consistently large part of Spain's very large BOT deficit with the world: between 20% and 30%. This will be unaffected by a Euro devaluation, as presumably will be revenues from tourism transfers, etc. from Germany and the rest of the EZ core. (I have to qualify this by pointing out that a Euro devaluation would make holidays in Turkey relatively more expensive for German tourists than one in Spain, thus indirectly benefiting the latter without directly effecting Spanish prices for Germans.) For Italy, the BOT deficit with Germany is as much as 222% of its world BOT deficit, meaning that it is already running a trade surplus with much of the world outside of the EZ core. Its EZ-core trade relations are the overwhelming cause of its trade deficit (what is causing its even larger current account deficit is impossible to say at this point). Thus, while this is only a first-order analysis of the effects that a Euro devaluation would have on the balance of trade/current accounts of Italy and Spain, it should be clear that any change in their "terms of trade" that only impinges on the non-EZ world but not with the EZ-core will not go very far in solving their problems.
We can conclude that any solution to the Eurozone crisis that does not trigger deflation, leaves Germany's competitiveness with respect to the rest of the world unchanged (i.e., avoids a beggar-thy-neighbor devaluation policy) but realigns the internal EZ imbalances, must do the following:
- raise German wages with respect to EZ-peripheral wages;
- devalue the Euro by a corresponding amount.
The paradox of why Germany has shunned this mutually advantageous solution while tenaciously clinging to the Euro still remains, however, and is the subject of my last blog, What does Germany want (and why she can't have it)?
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