The austerity of others

Still preparing the foreword for the German edition of 'Austerity. The great failure'. Another comment often heard in German debates about austerity is this:  'Why should we care about austerity in Greece and other distant places? That's their problem. We're doing fine and that's all that matters.'

Below are 7 reasons--in no particular order--why Germans should care about what's going on in the European periphery. (As discussed in the previous post the claim that Germany is doing well is rather dubious in itself. But won't rehash this here.)

(1) Much of German growth depends on exports and most German exports are to European countries. If Germany's main trading partners don't grow the market for German exports is smaller and Germany grows less. Germany is doing better if everyone else is doing better.

(2) The crisis in the European periphery has in part the result of German export surpluses. The German trade surpluses correspond to trade deficits in the crisis countries. These deficits were financed with credits (taken out by the private sector). When the credit bubble burst, governments stepped in, their borrowing costs rose and this led to the Euro crisis. The trade imbalances need to be limited to have a stable Euro. A stable Euro is in Germany's economic interest because only with a common currency is a European free trade zone a truly integrated market.

(3) Since German exports were financed by credits in the periphery Germany has a strong interest that these countries do not default on their debt. Otherwise all the beautiful things that Germany has sold to these countries will ultimately not be paid for. Germany's economy needs a stable financial framework with solvent trading partners.

(4) Strong imbalances in the standard of living in an area where people are free to move will lead to significant migration. In other words, if the crisis in the periphery will be deep and long enough people will move from there to Germany. Often that's hailed as flexibility and a solution to Europe's unemployment problem. But this solution is not without problems. First of all, there are not enough jobs in Germany to employ everyone who moves there in the hope of getting a job. Second, large scale immigration creates social and economic problems. Even the very limited immigration from Romania and Bulgaria that is taking place now is extremely controversial in Germany. One might wonder if German society would really be able to handle large scale immigration without creating a dangerous political backlash. Third, it can hardly be in Germany's interest to empty the European periphery of the most skilled and ambitious individuals. That would harm the long term growth prospects of these countries and make it harder to every overcome unequal levels of economic development in Europe.

(5) Economics is not everything: if the economic and social crisis in the European periphery is not solved then it may well turn into a political crisis. There are signs of political instability in Greece, Italy and to a lesser extent in Spain. Germans ought to know from their own history how quickly an economic downturn can lead to the collapse of democracy. Today, the danger of political collapse and conflict in Western Europe is often underestimated. During the last 50 years the European Union has delivered on its main promise: keeping peace and stability in Europe. But this task was made easier by growing prosperity and a stable geopolitical context. The cold war was a period of tension but it also had a stabilizing effect. This macro conflict overshadowed and repressed other possible conflicts. Now the cold war is over and we live in a multi polar world that is a lot more fragile. As others have pointed out our world resembles that before World War I in many ways. If you add economic decline to this new international complexity a new era of instability and conflict may be the consequence.

(6) Germany could use this opportunity to polish its historical record. Modern Germany was created in the late 19th century and since that time its main contribution to European history were violence, instability and destruction. That's not uncommon for European nations but Germany still stands out. There were more benign periods in Germany's history but now would be an occasion to go down into history for once as the nation that brought peace and prosperity to Europe instead of the usual war and destruction.

(7) Compassion, perhaps? This is a somewhat old fashioned argument that many in today's debates brush aside all too easily. However, the notion that caring about your fellow human beings is a precondition to creating a good society and leading a fulfilling and happy life is central to European culture. It can be found in the writings of the pagan philosophers of antiquity, in the religious traditions of Europe and even in the thoughts of the hard-nosed writers of the enlightenment. Political decision need to take into consideration these ethical norms and values on which out societies are built.

Vorsprung durch Austerität?

One of the most common German objections to a critique of austerity will go something like this: 'What's wrong with austerity? We went through tough labour-market reforms, welfare cuts and have limited our government spending and look how well Germany is doing now.'

The main problem with this view is of course that Germany is not doing well. That's both in terms of economic growth and in the terms of living standards.

Clearly, German growth has been much stronger than in Greece, Spain and in the other crisis countries. But that's not because Germany has done so well but because these countries have done so badly. If you compare Germany's economic performance with the average of the OECD countries (a selection of the world's economically most advanced countries) there isn't much to brag about. Since 2007, when the crisis hit most countries, German growth has been above average only in four years and mostly not by more than a percentage point. In two years it was below average. That includes 2012, the last year in the statistic, when average growth in the OECD was 1.5% while Germany  grew at a meager 0.7%. If you compare Germany to the US, its performance looks even weaker. The American economy grew 2.8% in 2012. That's four times the German growth rate. And that's despite the fact the German growth is propped up by unparalleled export surpluses.

There is no question that Germany has done better than many other countries: it is one of the few countries in Europe to have reached pre-crisis output levels again. The GDP of most other European countries is still below what is was before 2007. But that does not change the fact that being at 2007 output levels when it is 2014 is no reason for celebration.

The weakness of growth in Germany has also had a negative effect on employment. This is sometimes obscured by good unemployment statistics: German unemployment is low at 5.5% (2012). But to some extent this reflects more institutional arrangements than economic strength. The average number of hours worked per worker has declined substantially from 1422 in 2007 to 1397 in 2012. In other words, after seven years of 'recovery' employment has still not returned to pre crisis levels.

Not only is Germany's economic recovery rather anemic but its benefits are also distributed very unevenly. Substantial parts of the German population are experiencing low or declining standards of living. Real wages declined from the early 00s and have only started to grow again recently. In 2012 they were at the same level as in the late 1990s. Partly as a result of this even many workers in full time employment have to rely on forms of public subsidies to make ends meet. Those who completely live off public subsidies feel the effects of the welfare cuts of the last decade. For many Germans even the weak recovery does not coincide with improving standards of living. A recent survey found that the poverty risk in Germany is below EU average. But it is still higher than in all of Germany's neighbors with the exception of Poland.

Germany is also falling behind in many other areas that depend on public funding. In international comparisons German schools, universities and infrastructure are rarely rock bottom. But neither can do they occupy top spots.

The weak economic development and the standard of living crisis are direct results of Germany's own austerity policies. Mainly under the auspices of Gerhard Schröder's Agenda 2010 the labour market was liberalized and welfare provisions were cut. Subsequently, public spending was restricted by legislation limiting deficit spending. These policies resemble closely those applied today in the European crisis countries and have similar effects. The weak development wages, benefits cuts and restrictions on public spending have depressed domestic demand. The result are depressed levels of investment and weak growth.

That the economic results are not worse is due to the fact that the weakness of domestic demand has in part been compensated by extraordinarily strong exports. (It is far from clear that low labour costs are responsible for the export boom. The quality of German products may be a more likely explanation for the strong international performance of Germany's export economy.)

Germany has in this way avoided outright economic crisis but it still has an economy that is performing far below its potential. The fact that Germany is in a better position compared to many European countries should not obscure the fact that it is achieving only a faction of what it could and should aspire to in terms of economic strength and standard of living.

Ultimately, the problem is a political and social one rather than an economic one. In order to perform better economically, domestic demand would have to be strengthened. In the short run this would mean increasing government spending and in the longer run it would require a substantial redistribution of incomes in favor of low incomes which would boost domestic demand. (Lower incomes tend to be spent completely while higher incomes are usually saved in part.)

This could be a path to stronger growth and also a way out of an export oriented growth model that is in large part responsible for the troubles of the Euro. However, income redistribution is as contentious in German politics as anywhere else. Instead of facing Germany's economic difficulties large parts of the German public prefer to ignore Germany's economic weaknesses and lecture the rest of the world about an imagined success story.

Austerity, German edition

A German edition of 'Austerity. The great failure' is in the making and I am preparing a foreword to address some of the peculiarities of the German debate about 'Austerität'.

Over the last months when I told German friends what I was working on they usually went 'Austerity? What's that?'. And, once you explain what austerity is many will be bewildered by the notion that anyone could consider it to be a failure. This is not only because Germany is not feeling the pinch of the current crisis as much as other countries. It's also because of the ways in which certain economic beliefs have become part of (West) German national identity in the post-war period. Foucault has made some very insightful remarks about this in the 70s in his lectures at the Collège de France. I will try bring some of this into the foreword.

But in order to gauge what passes through the mind of German readers when they hear 'Austerität' I have asked some German friends and colleagues to send me their questions and comments.  I will distill them and reply on this blog as a way to develop and share my own ideas.

Please feel free to write with comments and questions (even if you're not German.)

Making Costa-economics work

The whole idea youth unemployment could be solved if the kids weren't so precious about working as baristas is of course ludicrous. There simply aren't enough jobs in Europe's coffee bars (or in any other sector for that matter). 

That's unless you engineer a major increase in the consumption of coffee. The EU could issue every european citizen with vouchers for free coffees for the whole year. Coffee bars that accept the vouchers and can redeem them for cash at the EU. The bill could be footed by issuing 'coffee bonds' that are collectively backed by all EU countries. There are probably better ways to solve the problem of unemployment. But this kind of Keynesian 'economic caffeine' would at least work. As opposed to the kind of supply-side schemes that we're seeing at the moment. 

More Italian jobs

'Get a job at Costa' is the UK employment minister's recommendation for the young unemployed. The underlying idea is the same that inspires Renzi's Jobs Act: there are enough jobs we only need to help the unemployed to find them. Or, if job seekers are too precious about where to work, pressure them to accept any job. (Under Renzi's legislation job seekers would loose unemployment benefits after turning down more than one job. This is similar to the penalties introduced in Germany as part of Schröder's Agenda 2010.)

Seen in this light, job market reform is certain to do wonders for Italy and the rest of the southern crisis countries. They don't have Costa but coffee outlets abound and once unemployed youngsters finally find their way there we'll see a swift return to full employment. All that's needed now is a huge, and I mean huge, increase in coffee consumption.

Learning from past masters

If François Hollande was trying to learn from history he got it badly wrong. Many people have already commented on the fact that he had a mistress thinks that 'supply creates its own demand'. As Dean Baker pointed out, this assertion 'startled many of his supporters ... along with fans of evidence-based economics everywhere'. Say's law was a central tenet of classical economics in the 19th century. But it turned out that it was wrong nearly a century ago: the experience of the Great Depression and the Keynesian revolution in economic analysis convinced most economists that demand could remain weak over prolonged periods and lead economies to work below full capacity.

However, the main problem is that Hollande is not alone with the view that the key to solving the economic crisis lies on the demand side. His misfortune was to exaggerate this claim. But most economic policy in Europe is driven if not by Say's law, then by some version of economics that puts supply first. See my last post on Renzi's Italian jobs act. This is despite the fact that the evidence strongly suggests that programs to stimulate demand effectively boost growth and employment. (See Baker's article and the links in there.)

But what works economically seems to have become completely irrelevant. Supporters of austerity in politics, among economists and in the public at large seem to be driven by a completely different set of motives. I will come back to this issue on this blog but it's also what I write about in 'Austerity: the great failure'. Now forthcoming very very soon.

The Italian jobs act

'Jobs act' is what Matteo Renzi, the newly elected leader of the centre-left Democratic Party in Italy has called his proposed bill for economic reform and job creation. The English title is presumably a reference to Obama's American Jobs Act of 2011. And why should Italy not take inspiration from the US? Obama's jobs act was defeated in congress but the other elements of his economic policy which were based on the same principles have worked comparatively well. The economic recovery in the US has been much stronger in the US than in Europe and in particular the job market looks a lot better. (See an up-to date summary.) In the European context Italy is doing particularly badly. Not as badly as Greece or Spain but still unemployment has reached nearly 13% and youth unemployment is above 40%.

So is this Renzi emulating Obama? A case of successful learning from very recent history? Unfortunately not. The two draft bills don't have much more in common than the title. The core provisions of Obama's bill would have cut 245 billion USD of payroll taxes to increase workers net pay. It would also have extended unemployment benefits that were running out to the tune of a total 50 billion USD and spend over 100 billion USD for infrastructure projects, the modernisation of schools and colleges as well as the hiring of additional teachers, firefighters, etc. At the time economists expected the bill to create over a million jobs within a year and add more than a percentage point of growth to the US economy. All of this as a result of a 'positive boost to aggregate demand'. In other words, this was a thouroughly Keynesian bill.

Renzi's job act is a very different animal. It's about creating a more flexible and dynamic labour market. The basic idea here is that if it becomes easier to hire and fire people then more people will be hired. In this view rigidity of the labour market is causing unemployment. If we become better at matching supply and demand for labour then unemployment will decline. But that supposes that somewhere hidden there is a significant demand for labour that merely needs to be unleashed or that lower costs will somehow lead to an increase in output. This is completely different from Obama's proposal that was based on the view that demand needed to be increased through government spending and tax cuts.

Despite its American title Renzi's bill is based on the same notions that have underpinned European economic policies over the last years. If the proposal becomes law it will work just as well as Europe's policies have worked so far.

NB: The Euro of course limits the political choices that Italy can undertake individually. But the Eurozone as a whole would be very well advised to emulate some of the more demand oriented policies that have been applied in America.

In praise of economic history

'I can’t think of a time when history has been as useful as a guide to current events (and current action, if only policymakers would listen) as it has since 2008', says Paul Krugman on his blog. 

He's right, of course. But why are policy makers not listening? That may be in part the fault of historians. For fear of oversimplifying or distorting the complexity of historical events they're often too cautious about making historical comparisons. To some extent they're right. But the problem is that if professional historians don't make historical comparisons, unprofessional historians will make them for them.

An other issue is that political decision depend only in part on knowledge and insight. Power and interests play a big part in the events that historians study and that has not changed in the present. Take the decades before the French Revolution when many people knew and said out loud that there was something wrong with the fiscal system of the Ancien Régime. But the set-up and the power relationships of the system did not allow for reform within the existing framework. 

Is history trying to tell us something, and if so, what?

Asks Chris Clark in his own piece on the lessons from 1914 and on learning from history in general. Great piece. I am tempted to steal this para as a description of what this blog does: 

'It remains important that we challenge manipulative or reductive readings of the past when these are mobilised in support of present-day political objectives. The recourse to history is most enlightening when we understand our conversations about the past are as open-ended as our reflections on the present should be. History is still "the great instructor of public life", as Cicero said. Being blind to the future, we have no other. But it is an eccentric educator.' 

Whose national interest?

The second similarity between 1914 and 2014 that Münchau sees is that the narrow minded pursuit of national interests led/leads European powers to slide into disaster. Today, he argues, the different Euro-countries look at the crisis through different lenses. The result is political stalemate because no consensus can be reached on how to solve the crisis.

This is Münchau's map of national interests: Germany sees the crisis as a problem of moral hazard. The crisis countries spent beyond their means and don't work hard enough. Italians reject German supply side economics and want 'macro economic coordination'. The French and Spanish resent outside interference in their national affairs. Fins and Dutch view the crisis countries with the same critical eye as the Germans. And the British don't really care about all of this but only use the Euro crisis as a backdrop for national politicking.

The notion of 'national interests' is always a bit questionable and is highly problematic both in 1914 and 2014. Chris Clark stresses that the motives that guided European government in 1914 do not easily fit the categories of national interest. Instead, group interests of political cliques and economic lobbies played important roles. Other historians before him have made this point even stronger. Indeed, one has to wonder in what way the German ambition of annexing steel and mining areas in northern France were part of the nation's interest. The German soldiers who died in the war and their families would probably have preferred a longer life in a smaller Germany to becoming pawns in the imperial plans of German industrialists and generals. 

Can the notion of national interest be applied with any more benefit to the Euro crisis? Some doubts may be in place. The German government is not alone in pushing a political agenda that is informed by 'supply side' economics in general and more specifically a good dose of neoliberalism. In the crisis countries many among the political elite and in the public agree to this narrative. Are Italians really all closet keynesians? Certainly not Monti and there is no political party of any consequence that bases its program on an economic analysis that is radically different from Merkel's. In Greece there is, Syriza, but despite its remarkable success it remains a minority party. The same pattern is true in other crisis countries. 

Some governments of the crisis countries ask for a slower pace of austerity compared to what the German government demands. But this is not because they disagree in principle. It's mainly because it is them, rather than Angela Merkel, who have to face the angry crowds with the pitchforks. If Merkel's constituency was not in Rügen but in Crete she, too, might prefer a slower paced austerity.

The austerity policies of Europe are not a German project but they're being carried out with broad political support across the Eurozone. Moreover, there are substantial parts of the German public that don't agree with the austerity policies and that don't benefit from them either. Among those who don't agree there is, well, Münchau himself. And while there is broad support for Merkel's policies the left wing party Die Linke (over 8% in the last elections) has mounted a principled opposition. 

Finally, Germany's economic model that relies on strong export surpluses and low labour costs is far from being in the 'national interest'. Many German workers have low salaries and their living standards are not keeping pace with the overall progress of prosperity. Many Germans and many German companies may be doing well but the nation as a whole is not necessarily. 

That European governments from Lisbon to Berlin are preferring 'supply side' economics to a Keynesian reading of the crisis is less to do with national interests and more with the domestic implications of alternative policy models. Anyone adopting a Keynesian approach has to address the problem of weak domestic demand and this leads inexorably to the issue of the distribution of wealth and incomes. And this is for many politicians, German or not, the 'third rail' of economic policy. 

Sleepwalking into disaster, again?

The first thing to say is that the 1914-2014 comparisons that are cropping up in public debate at the moment are different from the Brüning analogies of last year in important respects. That's just as well because the historical events that are being invoked were fundamentally different: Brüning's were economic policies that aggravated an economic crisis with dramatic political consequences. In contrast, the immediate causes of the First World War were diplomatic and military. The misguided political decisions of European powers in the run-up to 1914 did not lead to an economic disaster but to a war. True, this war caused economic instability well into the post-war period. But primarily the First World War was a political and military event with political and military causes.

Therefore the analogies that we are seeing today are not, as in Brüning's case about the economic issues. Rather commentators highlight what they see as similarities in the patterns of political decision making in 1914 and today. Wolfgang Münchau points to two analogies in particular:  (1) today, as in 1914, the pursuit of narrow national interests lead European nations to jeopardize stability (2) the principal decision makers now and then were not sufficiently aware of the size of the risks that they are taking by insisting on this parochial approach. Let's look first at the second part of his analogy and keep the first part for another post.

 I think this kind of comparison is overstating the naiveté of political actors now and then. It is a topos of historical writing that WWI was unlike any conflict before and that contemporaries did not expect it to be as long and destructive. But is it really true that contemporaries did not and could not know what kind of war they were risking? It is true that WWI represented a new type of industrial warfare. But there had been wars in the decades before WWI that had clearly foreshadowed the fact that industrialisation would profoundly change warfare along with virtually all other aspects of life. As Thomas Laqueur points out in his review of Chris Clark's 'The sleepwalkers':

'Why Europeans should have remained unaware that in the American Civil War hundreds of thousands of men had been mowed down as they crossed open fields against the fire of new and more accurate rifles is puzzling. But the history of the imagination is not a history of sleepwalking, whatever else it is.'

 And today? Can policy makers claim to be unaware of the economic risks they are running? Given the historical experience of the Great Depression and the disastrous political and social effects of  deflationary economic policies in the interwar period it is hard to argue that today's political leaders or members of the public are unaware of the risks that are associated with today's handling of the Euro crisis. Not everyone may be an expert in 20th century history but the analogies are widely discussed in media outlets that enjoy broad readership. Krugman, Münchau and other Cassandras don't write in obscure publications but in some of the most widely read and respected news outlets in the western world. It is true that their views are controversial and that mainstream opinions are dominated by other approaches. But no one who is in charge today can cite ignorance as a defense if things go pear shaped. Policy makers and voters have been warned.

When looking at 1914 and 2014 we need to ask why many actors took decisions that endangered European stability. But I doubt that ignorance of the possible consequences should feature very prominently among the answers.

Start digging your trench

When I started to write this blog about a year ago comparisons of the current situation with the 1920s and 30s were all the rage. Brüning seemed to be everywhere.

But that is so 2013. Now it looks like it's 1914 all over again. Chris Clark wrote about the parallels between Euro crisis and outbreak of WWI a while ago in his book 'The sleepwalkers'. Now Angela Merkel apparently read the book and slammed it--figuratively--on the table of the last European summit. Wolfgang Münchau agrees with her at least partly. Only Timothy Garton Ash does not quite buy the comparison. (Of course Gideon Rachman beat everyone to the 1914 comparison by using it already early last year in an article about the tensions between China and its neighbours.)

This is fertile ground for this blog and there will be much to say about 1914-2014 comparisons in the coming weeks. While I am organising my thoughts get in the mood by watching this.

I'll be back...

after two weeks. That's what I said in my last post. It took me a bit longer. Apologies for that.

The reason for my silence was this. Publication date should be end of March.

Regular posting will resume now.