The Eurozone is mired in economic stagnation. While overall growth is positive, it remains too weak, at under 2%, to reduce unemployment to satisfactory levels, particularly in countries such as Greece and Spain. A lack of widely shared prosperity is undermining the legitimacy of the EU political institutions, but there seems to be no appetite in the ‘core’ Northern countries to change course. What to do?
Two weeks ago I discussed the apparently different cultural attitudes to saving and consuming in the UK and Germany in recent years, and drew the conclusion that these attitudes were driven by economic factors. It would benefit both nations if their economies ‘rebalanced’, and in opposite directions. This would involve Germans becoming more ‘profligate’ by reducing net national savings and the British becoming more ‘prudent’ by increasing net national savings.
The UK is not in the euro, but it has significant trade and investment links with the Eurozone. It has been saving too little relative to investment, as well as investing too little, and accumulating foreign debt at a rate that will have to be reduced at some point. This is reflected in its large current account deficit, of around 6% of GDP.
The economic weakness of the Eurozone is actually greater than the growth figures allow. Its level of domestic demand has been growing far to slowly, and growth has only been sustained by the boost given to net exports brought about by the weakness of the euro. This weakness is partly due to the European Central Bank’s programme of quantitative easing, and the policy of negative interest rates. Together they have made monetary policy exceptionally loose.
The Eurozone economy is vulnerable to a downturn in world trade, which would negatively impact its exports, and reveal its weak growth in domestic demand. A prosperous eurozone, and a prosperous world, requires a more rapid expansion in the latter. The current stance of monetary policy, while supportive of growth, is proving insufficient. Other policies are needed.
The key actor in this tragedy is Germany, the largest economy in the Eurozone. Germany is running a current account surplus of nearly 9% of GDP. Another way of putting this is that German national savings rate is far too high. A current account surplus means that net national savings (total savings minus total investment) are positive, while a current account deficit means that net national savings are negative (investment exceeds savings).
Restoring prosperity to the Eurozone requires more than loose monetary policy and a weak currency which, while it contributes to a current account surplus for the zone as a whole, necessarily drains demand from the rest of the world. It is a ‘beggar-thy-neighbour’ policy. Faster growth in domestic demand in the eurozone requires a rebalancing of the German economy. It was arguably stagnant wage growth in the latter from the early 2000s until recently that created the large imbalances that led to the Eurozone crisis.
While a popular interpretation of the Eurozone crisis blames profligate governments in the peripheral nations, government borrowing prior to the eve of the Global Financial Crisis in 2007 was minimal, aside from the case of Greece. It was the buildup of financial imbalances between the core and periphery members and the associated asset price booms in the latter which, when they collapsed, led to recession and an inevitable rise in government borrowing. Public deficits were a symptom rather than a cause of the crisis.
Weak wage and consumption growth in Germany in the 2000s, allied with it joining the fledgling euro at a favourably low exchange rate, meant that growth there relied on exports, rather than domestic demand, which remained weak. These processes fueled a rising German current account surplus, reflected in a rising national saving rate. In the absence of the euro, this would have led to a stronger Deutschmark, which would have put downward pressure on the surplus, and promoted stronger growth in domestic demand. But with a fixed exchange rate, this was no longer an option and the resulting imbalances led to the wider crisis.
With Germany as the dominant economy and creditor in the Eurozone, it needs to take a lead and reverse its recent habit of relying on net exports for growth. To be fair, wage and consumption growth has been stronger of late, but this arguably needs to be sustained, and at a stronger rate. Public investment on necessary infrastructure would also help, both on the demand and the supply-side, boosting spending and encouraging private investment and faster productivity growth over the longer term. This could be funded by borrowing or from higher taxation on the wealthiest households, who tend to have a lower propensity to spend their income. Higher growth in wages could be coordinated by the larger trade unions, something which is achievable in Germany, with its tradition of workplace cooperation between employers and unions. Policies which create new private investment opportunities are also desirable.
In short, Germany needs to rebalance its economy towards a faster growth in domestic demand relative to foreign demand, in order to reduce its current account deficit, which currently remains a drain on its trading partners. In the process this would boost imports from other members of the Eurozone, helping countries such as Spain and Greece grow faster and reduce unemployment.
These changes would also help the UK, as a major trading partner of Germany, reduce its own current account deficit by increasing demand for the UK’s exports. The recent fall in the pound should also help this process, but without adjustment in Germany and other surplus countries, this will be difficult, and in fact impossible, if there is no change in the latter.
Having said all that, it seems that these necessary changes, while economically feasible, may prove politically impossible, while leaders in the German government, as well as those in the institutions of the EU and Eurozone, are wedded to a narrative which places blame for the crisis on profligate governments in the peripheral nations. This is an incomplete account which misses the point that borrowers require lenders, and that both are in some sense ‘to blame’. The key players need a new narrative, which takes the economics of global imbalances into account, and avoids simple appeals to cultural proclivities.
As already mentioned, this is a continuing tragedy, particularly for those suffering unemployment and poverty. Much of this is a direct result of misguided policies whose outcomes have undermined confidence in political institutions across Europe.