The current Eurozone crisis seems at the moment to be all about economic reform in Greece, which includes the imposition of further crushing austerity ad infinitum. This is bound to keep Greece in recession, even if the so-called ‘structural’ reforms prove to be beneficial. It seems that Germany and its paymasters dominate decisions made regarding the potential resolution of the crisis. But the Greek government will find it extremely hard to pay down debt without a strong economic recovery. Likewise in the rest of the Eurozone periphery, although there, private debt is more of a problem. Quantitative easing by the European Central Bank is helping to keep interest rates low and has weakened the currency which, all else being equal, will boost net exports of the Eurozone to the rest of the world and hence help to raise growth. This will tend to be at the expense of demand in the rest of the world, so it is far from an ideal outcome. In addition, the Eurozone as a whole is a fairly closed economy, so a lower currency will not boost growth sufficiently to bring down high unemployment to satisfactory levels. What the Eurozone needs is a larger expansion of domestic demand, and this must come from those countries with current account surpluses. This step is vital to a successful resolution of the crisis and the benefits would be felt widely across the Eurozone economy. The largest economy with the potential to do the greatest good in this respect is Germany.
The German economy is currently running a current account surplus of more than 7% of GDP. Given the size of its economy, this is big and its acts to drain aggregate demand from its trading partners. Other northern European countries are running surpluses but they are much smaller economically than Germany, so I will focus on the latter example to keep the analysis fairly simple.
Germany’s economy is growing but at around 2% per year, which is sluggish. Many Germans see the country’s high savings rate and good export performance as strengths. However, since the foundation of the euro, wages for ordinary workers have stagnated, as have domestic consumption and investment, while the overall savings rate has risen, resulting in large current account surpluses (surpluses reflect positive net domestic saving, while deficits are the result of net domestic borrowing – this is a matter of accounting). Some see the high saving rate as a result of cultural thriftiness, but they are the result of economic forces: wage restraint by trade unions, competition from workers in Eastern Europe, and the deregulation and casualization of the low-pay segments of the labour market. If wages rose more rapidly in Germany, this would boost consumption and the living standards of German workers, and imports would tend to rise, boosting export demand in Germany’s trading partners, including in peripheral Europe. Overall, wage rises need to match productivity rises to resolve the economic imbalances that are contributing to the crisis. This has actually started to happen, but it needs to be sustained to be effective.
After the Second World War, and particularly the 1960s, Germany had its ‘economic miracle’ of rapid growth in productivity, living standards and employment. It has run current account surpluses based on strength in manufacturing exports, on and off, for many years, but before the creation of the euro, it could revalue its currency to help restore balance both internally and externally with its trading partners. This had the effect of preventing its current account surplus from becoming too large, by boosting consumption and imports. Now it is locked into the euro, this option is no longer available, so large surpluses and sluggish domestic demand are the result, which act as a drag on growth across Europe.
If the German government really wants to save the euro and bring benefits to ordinary German workers without negatively affecting growth in the rest of the world, surely worthy goals, it must enact policies which boost domestic demand and imports in order to reduce its current account surplus. Tax cuts could potentially have this effect, but Germany also needs public investment in infrastructure, so an increase in public spending is also necessary. These policies need not create a large budget deficit but any kind of deficit seems to be anathema to politicians there, so these ideas may not wash. Some have suggested deregulation of certain product markets, which might include trading hours, and the opening up of particular professions. In general microeconomic and macroeconomic reforms which boost domestic consumption and investment would go a long way towards reducing net domestic saving and, the flip side of this, raising spending, boosting imports from the rest of the Eurozone and reducing the current account surplus. Germany needs to act as a locomotive for growth in the single currency block, rather than a drag on it.
If such policies were enacted, net exports and growth in the peripheral countries would receive a boost. How much is difficult to predict, and a full analysis would require data on trade flows between individual countries. Greece does not have a large tradable goods sector, so one might argue that it would benefit little from these changes. However, it would still benefit to some degree, and my argument is that change in Germany is a necessary condition for resolving the crisis, rather than a sufficient one. Greece also needs some sort of industrial strategy aimed at building up its productive and tradable sectors. Whether this involves simply deregulation or more detailed intervention is beyond the scope of this post. But with a significant boost to net exports and growth, Greece and other countries in the Eurozone periphery could reduce their budget deficits and even move them in to surplus without causing aggregate demand and growth to stagnate. Public debt as a proportion of GDP could fall over time, alongside private debt. Unemployment would fall, and the current misery would start to be reversed.
Sadly however, as the experience of the former Greek finance minister and economics professor Yanis Varoufakis has shown, the dominant EU leaders do not seem very interested in economic ideas and debate, except those of austerity and debt repayment which, without a significant rebalancing of the economies involved, will fail. So the ideas for policy outlined above, which would potentially benefit millions of ordinary people across the EU, restore prosperity to the Eurozone, and help to save the euro itself, are falling on deaf ears. To reiterate: those countries with current account surpluses, namely in northern Europe, and particularly Germany, must change as much as the periphery. Without such change, the whole European project will continue its dangerous trajectory, and may ultimately fail.