Martin Wolf of the Financial Times pens an interesting piece this week on misguided economic policy in Germany which he claims is holding back the economy of the Eurozone. As I see it, a major problem is the German government’s focus on its current account surplus as a symbol of success, particularly of its manufacturing exports. This masks a weakness in domestic demand and excessive domestic savings. In fact a current account surplus, by definition, reflects a surplus of domestic savings over investment, coming from households, firms and the government. In Germany, all three of these sectors are running a financial surplus: they are net savers. This is a problem, as it forces the Eurozone, with Germany as the dominant member, to depend on external demand for growth, helped along by a relatively weak currency. With global demand currently weakening, this source will not be consistently forthcoming. The Eurozone is still growing, but unemployment is far too high overall, which represents a huge waste of economic resources, not to mention the social cost.
If German domestic demand were to grow much more strongly relative to global demand, this would tend to reduce its current account surplus. This would help the rest of the Eurozone to expand more rapidly and rebalance away, in the case of its financially weaker members, from a dependence on debt-fuelled consumption. They could then begin to reduce their public and private debt burden. The world economy would benefit substantially from a faster growing Eurozone.
For German domestic demand to grow faster in a sustainable fashion, its companies need to invest more of their retained earnings and its households need to see wages grow faster in order to stimulate consumption. While higher wages might lower profits to some degree, since they represent a cost to firms, they could also lead to a faster growth in consumption, which would encourage firms to invest as they see demand for their output rise.
This kind of focus on demand as the driver of growth, and the potential for growth to be ‘wage-led’ is an argument commonly made by post-Keynesian economists. If growth is wage-led, the effect of rising real wages on demand outweighs the fall in profits, so that investment and expanding output are ultimately stimulated by rising consumption.
The alternative is for growth to be ‘profit-led’, in which case the effect of a fall in profits created by a rising wage share in output dampens investment and growth. In this case, cuts in wages raise profits and lead firms to increase investment. This argument tends to be made more by Marxist economists. Michael Roberts, who writes an often interesting blog here, maintains a relentless focus on changes in the rate of profit as the source of growth and recessions under capitalism. For him, a recession, with rising unemployment and falling wages and capital values, is necessary to restore the rate of profit and get capitalists investing once again.
According to other Marxists, there is a contradiction under capitalism between the production of profits and their ‘realisation’, or their transformation into money upon sale. For the production of profit, capitalists would like the lowest costs possible in order to maximise their potential gain. For its realisation, they need consumers to have sufficient funds to buy the goods or services they have produced. Thus in the latter stage, higher wages in the economy are beneficial. Every capitalist would like his own wage bill to be at a minimum, but the wage bill of other firms to be at a maximum in order to generate sufficient demand for his or her output. Hence the contradiction and tension within capitalism.
There is therefore some overlap between Keynesian and Marxist ideas, with both making the case that wages and consumption need to be sufficient to contribute towards demand for produced output. Arguably, both Keynes and Marx also laid great emphasis on investment as the ultimate driver of growth. In turn, expected profits drive investment. But there is a case to be made that consumption is part of the source of realised profits, and that today’s realised profits shape tomorrow’s expected profits.
Roberts argues that weak profitability and excessive corporate debt are holding back investment across the world, rather than a ‘savings glut’ which is weakening aggregate demand and from there investment spending. But it is also possible to argue that, to return to Germany as our example, excessive savings and weak consumption are weakening domestic investment prospects. The excess savings, which are unable to be invested in domestic production, are then exported to other nations.
Excess corporate debt has been cited by Richard Koo in his analysis of balance-sheet recessions, in which firms and households use income to save and pay down debt, rather than borrow, consume and invest. German firms may be in this situation. If so, there could be a role for the government to run a modest deficit and invest in infrastructure, which the IMF argues has been neglected in a number of rich countries, including Germany. This may help to crowd-in private investment, depending on the projects chosen.
Alongside a boost to public investment, an agreement between Germany’s trade unions and the relevant employers could help to lift wages and domestic consumption, boosting domestic investment relative to domestic savings, if the economy is indeed wage-led.
If the economy is profit-led, then public investment, and expanded opportunities for domestic private investment, should raise productivity, allowing scope for both profits and wages to rise. Germany relied on stagnant wage growth over a decade from 2000, which many economists argue helped create the financial and trade imbalances that led to the Eurozone crisis.
As I have argued before, a change of course in the Eurozone is required, not least in Germany, for the imbalances to be resolved and for the crisis to end. Given the size of the Eurozone economy, this would benefit the rest of the world. Otherwise the potential for a break-up, with all the turbulence that will involve, becomes stronger by the day.