Heiner Flassbeck – Harz IV and the purpose of economics

Here is the latest post from Heiner Flassbeck, formerly of UNCTAD, and who now runs his own consultancy which focuses on macroeconomic questions.

The post explores how a decade of wage repression following the Harz IV reforms in Germany resulted in weak growth in wages relative to productivity, which in turn weakened growth in domestic demand and led to a boom in exports. The piece contains some useful charts comparing the growth in foreign and domestic demand in Germany and France.

These trends created major economic imbalances in the eurozone which in the long run proved unsustainable as they weakened economic performance in the region and were a major factor behind the global financial and eurozone crises.

Whether you are a supporter or detractor of the ‘European project’, these arguments should not be ignored. They point to the need for reforms to the structure of policymaking in the eurozone, particularly in Germany, it being the largest country with the largest current account surplus. Such reforms are needed in order to promote widespread prosperity and help to safeguard the future of the region. On the other hand, if this need is neglected, the disruptive breakup of the eurozone cannot be ruled out.

Flassbeck concludes as follows:

“In order to counter the centrifugal forces in Europe, Germany must lead the way by withdrawing its reforms and normalising wage developments. On the other hand, Germany would undoubtedly be hit hard economically in an exit scenario of Italy or France. It would have to reckon with its production structure, which is extremely export-oriented and which was formed in the years of monetary union, being subjected to a hard adjustment. The German recession is already showing how susceptible the country is to exogenous shocks.

The basic decision in favour of the euro can still be justified today with good economic arguments. The dominant economic theory, however, has ignored these arguments from the outset and politically disavowed them. Built on monetarist ideas in the European Central Bank and crude ideas about competition between nations in the largest member state, the monetary union could not function. All those who want to save Europe as a political idea must now realise that this can only be achieved with a different economic theory and a different economic policy that follows from it. Only if the participation of all members of society in economic progress is guaranteed under all circumstances and the competition of nations is abandoned can the idea of a united Europe be saved.”

Asia’s ‘other communist dynamo’ – Vietnam and economic transformation

Moneyweek magazine recently ran a piece extolling the virtues of the Vietnamese economy and pinpointing it as an emerging market worth investing in. Perhaps as an unintended consequence of Trump’s trade war, Vietnam may benefit from US-China tensions as production and exports shift away from China to some extent. However this outcome remains highly uncertain, since Vietnam itself may also become a victim of US tariffs.

The story of Vietnam since it began its own version of China’s ‘opening up’ and path of development as a ‘socialist-oriented market economy’, called Doi Moi, literally meaning ‘renovation’, has to date been pretty successful. This began in 1986, and since 1990 the country “has notched up the world’s second fastest growth rate per person after China”. This has led to dramatic falls in poverty as wages have kept up with or exceeded productivity, which has itself grown fairly rapidly. Continue reading

On catch-up industrialisation

In a number of previous posts on development and industrial policy, I have mentioned the concept of ‘catch-up’. I thought it might be useful to define it in some detail, so here is Akira Suehiro of the University of Tokyo, taken from his comprehensive work Catch-Up Industrialization (2008, p.3-4):

“Catch-up industrialization is a pattern of industrialization frequently, indeed necessarily, adopted by late-industrializing countries and late-starting industries. It is an essential aspect of any attempt to reduce the gap in national wealth between developing and developed countries.

The many varieties of catch-up industrialization generally have the following two points in common.

First, latecomers to industrialization enjoy the advantages of “economic backwardness”, or the advantage of being able to make use of technologies and knowledge systems developed by countries that have gone before. It is expensive and time-consuming for any country to independently develop new technologies and products, not to mention new industrial structures or management organizations. Latecomer countries can achieve great savings of time and capital by adopting the necessary technology and know-how from countries that have already industrialized.

It follows that an important challenge for governments and enterprises in latecomer countries is how to go about importing, adapting, and improving foreign technologies and systems as smoothly as possible. From this fact of life stem many of the most striking features of catch-up industrialization: strong government leadership, positive involvement by financial institutions (with corporate finance through commercial banks rather than stock-markets), development of information-sharing systems between government and private sector and between assemblers and suppliers (intermediate organizations, keiretsu, etc.), the continuation of family businesses such as zaibatsu in corporate management, and the development of distinctive production management control systems in the workplace (the kaizen and just-in-time systems, workers’ commitment to management, etc.).

The second common feature among latecomers to industrialization is that they have to start by importing most industrial products. For some time they have to earn the foreign currency to pay for these imports through exports of primary products such as mineral and agricultural products. In order to reduce imports, the latecomer countries launch a policy of domestic production and import substitution, starting with relatively low-tech, labor-intensive industries. Consider, for instance, the case of textile products. If a country has just commenced domestic production of synthetic fiber products, that necessitates imports of the chemical raw materials, plus the machinery and equipment to process them. The country has to export textile products to get the necessary foreign currency for these imports, while also commencing production of chemical products and machinery at home.

A cycle consequently develops: from importing to domestic production, then to exporting (or overseas production), then to re-importing. At the same time it is important to establish a trade policy centered on import substitution and export promotion, and an industrial policy aimed at the protection and fostering of domestic industries. In short, trade and industry are inextricably interlinked. It follows that under the conditions of this first phase, with its dependence on imports and its need to conserve limited supplies of foreign currency, an important challenge for those who would catch up is the effective distribution and control of available economic resources. This means that a set of policy structures – regulations on trade, tariffs and investment, export-led industrialization, tie-ups with foreign capital to foster export-oriented industries, etc. – constitute another feature of catch-up industrialization.”

Sun hats and development

I recently bought a new sun hat (stay with me). A label inside reads ‘made in China’. Replacing my previous hat was well overdue, as it was more than 20 years old. Out of curiosity and before getting rid of it, I checked inside and saw a label, which also read ‘made in China’. I must be something of a geek, as this got me thinking about the manufacture of clothing and development processes.

It is notable that China is manufacturing and exporting clothing such as this, just as it was twenty years ago. The hats are not dissimilar. Of course, the Chinese economy is the largest manufacturing nation in the world and exports a huge amount of goods of all kinds. But according to this experience, companies there are still involved in the manufacture of quite basic clothing. Continue reading

The UK and China: exporting our way to prosperity?

george-osborneBBC Economics Editor Robert Peston has an interesting post on his blog today on the UK chancellor George Osborne’s visit to China and his attempt to boost exports to the world’s second biggest economy. Apparently Osborne wants China to be the UK’s second biggest export market. Given China’s already vast domestic market, and even vaster potential given its population of 1.3 billion and the scope for incomes to catch up with the richest countries, this aim is to be welcomed. Continue reading

Growth in net exports as the motor for UK recovery in an ideal world

The UK economy is currently stagnating and may even fall into a triple-dip recession if growth proves to be negative in the first quarter of 2013. I have already written about the importance of fiscal policy in supporting recovery in a balance sheet recession, when nominal interest rates can hardly fall any further. However in the longer term, a sustainable recovery can only occur if the UK economy re-balances away from over-reliance on borrowing for consumption and financial bubbles and towards exports and private sector investment.

Recent UK trade performance has been poor, with a persistent deficit on the current account of the balance of payments, despite a substantial devaluation of the pound in trade-weighted terms since 2008. Sterling has depreciated by around 25% since then, with no discernible improvement in the current account.

If net exports (ie exports minus imports) were to grow rapidly, this would be exactly the kind of stimulus to demand that the UK economy needs. If sustained this demand from abroad for the output of UK-based companies would improve the current account and at some point stimulate investment in new capacity and employment as firms reach capacity constraints. Unemployment would fall more rapidly as GDP grows, and with falling jobless numbers and rising national output would come reduced welfare payments and increased tax revenues. The budget deficit would therefore fall from its current level even without extra cuts in public spending and increases in tax rates which are current policy in the UK. With increasing national income, household deleveraging could occur more rapidly, restraining consumption as individuals continue to save and pay off accumulated debts, while not leading to continued stagnation or even recession. All of this re-balancing would happen in an ideal economic world.

Sadly, we are not living in such a world, at least not yet. About a half of UK exports go to the EU, and much of that to the eurozone. The eurozone is currently in recession, partly due to the mindless pursuit of austerity across the continent (see graph at link). Recession among our European neighbours drags down their demand for UK exports. With the equally mindless pursuit of austerity in the UK, and the UK private sector in substantial financial surplus, where is demand to come from? The answer is: nowhere, unless private or public spending increase substantially. Despite having interest rates at record lows, UK business investment is languishing. Business as a whole is sitting on enormous cash surpluses, so the funds for investment are there, without the need to borrow. But it is quite possible that the lack of demand for their output is keeping investment plans on hold. If there is not prospect of increased sales, what would be the point in expanding capacity? A looser fiscal stance until recovery is established could help, especially if it took the form of public investment in goods and services with a low import content. Some leakage of an increase in demand to spending on imports is probably inevitable, reducing the multiplier as spending goes abroad, but suitably targeted public spending could minimize this effect.

The largest component of aggregate demand for the national income is consumption expenditure. Since the beginning of the recession households have chosen to save more, albeit relative to negligible rates of saving on the eve of the crisis, and they are paying down debt. This is to be welcomed as it helps to re-balance the economy and make it less dependent on unsustainable debt-fueled private spending for consumption. But it does act as a drag on growth. Throw in higher inflation generated by a weaker pound and therefore dearer imports, including commodity prices and the effect is compounded.

So when taking account of a drag from private consumption and languishing private investment, net exports, and the squeeze induced by the government’s austerity programme, there are no sources of demand left to generate a decent rate of growth and recovery for the UK. Despite the fact that the government is still running a substantial deficit, if the private sector is trying to run financial surpluses (ie with income greater than expenditure) greater than that of the public sector, then aggregate demand will fall and the economy will be dragged into recession.

But what if growth is not determined by demand but by supply in the long run? Well, Keynes did say that ‘in the long run we are all dead’, implying that policy-makers should act now to improve economic performance, rather than waiting for the long run to occur and hoping for the best (sounds a bit like the Cameron-Osborne strategy!), but in my opinion supply is just as important as demand, and the two elements interact in the growth process.

Those on the right of the UK Tory party are clamouring for steep tax cuts funded by steep public expenditure cuts, and deregulation, to ‘kick-start’ growth. This is all about the economics of incentives and stimulating entrepreneurial efforts, but ignores the importance of demand. Given that UK productivity has been falling recently, meaning that despite a stagnant economy, employment has actually been rising in the private sector, while real wages are falling, it might be thought that growth is not constrained by demand-side but by supply-side factors. The UK remains a ‘flexible’ economy with a ‘flexible’ labour market, as rated by the World Economic Forum on the issue, so if there are supply-side constraints, it is more likely that these are due to stagnant investment in capacity, which includes worker training, as well as relatively low levels of R&D and poor infrastructure. Since companies are unlikely to invest in new capacity and employment if they have low sales prospects, demand is important to stimulating investment. On the supply-side, if firms’ profits are taxed too heavily, or if wages take too large a share of earnings, they may once more come to the conclusion that it is not worth investing: these are supply-side constraints on growth. Neither of these sorts of constraints seem to be important at the moment. Wages are stagnant while firms are sitting on large cash surpluses, while the rate of corporation tax is not high by international standards. Demand seems a more likely constraint at the moment.

As long as firms have the capacity to increase production in response to a rise in demand, the expansion of net exports remains the most desirable route to recovery. But as discussed above, this is not presently forthcoming, especially while a turnaround on the continent looks remote in the short term. So the next-best source of growth must be domestically-led, in the form of a looser fiscal policy and incentives for UK-based firms to invest their cash surpluses in new capacity and employment. A boom in house-building would help as well! We are not powerless in the face of adversity.