Short-run stabilisation policies will not do: the case for a Keynesian New Deal at the European and global level

Eckhard Hein

The world economy is still struggling with its most severe crisis since the Great Depression of the late 1920s and 1930s. On the one hand, the present crisis began as a financial crisis which started with the collapse of the subprime mortgage market in the US in summer 2007, which then gained momentum with the breakdown of Lehman Brothers in September 2008 and reached another climax with the Euro crisis in early to mid 2010. On the other hand, the present crisis began as a real crisis well before the financial crisis, with an economic downswing in the US. The financial crisis and the real crisis reinforced each other, and the world economy was hit by a decline in real GDP in 2009 – something not seen for generations. Major regions in the world are only slowly recovering from this decline, in particular the Euro area, the UK and Japan. Furthermore, none of the economies which have been hit severely will have returned to the pre-crisis growth path by the end of 2010. Therefore, massive underutilisation of productive capacity, high unemployment and a downward pressure on wages will have to be tackled in the future.

Beyond inefficient regulation of financial markets, increasing inequalities in income distribution and rising current account imbalances at the global scale and within the Euro area are the main underlying causes for the severity of the global financial and economic crisis and for the recent euro crisis. The US and Germany are two important complementary examples of current account imbalances, the US being the major current account deficit country and Germany one of the important current account surplus countries.

The credit-financed consumption boom in the US prior to the crisis was highly fragile because it was set against a background of rising inequalities and a falling labour income share. Domestically the US had to rely on rising property prices in order to allow for increasing indebtedness to fuel steady increases in consumption demand. Regarding the relationship with the rest of the world, a sharp depreciation of the US-dollar, which would have been required in order to improve international price competitiveness of US producers and thus the current account, had to be avoided in order to guarantee steady capital imports without having to raise domestic interest rates. The erosion of such a constellation in the subprime mortgage crisis and the following downswing not only affected the US, but also the rest of the world, in particular the current account surplus countries. On the one hand, if their capital exports were into highly speculative US markets they were devalued by the financial crisis, and therefore the financial crisis quickly infected these surplus countries. On the other hand, the markets for exports collapsed and the current account surplus countries were thus infected by the real crisis as well.

While the dynamic consumption-driven model of the US had to rely on the willingness and the ability of private households to go into debt – and of the rest of the world to supply credit – the stagnating German neo-mercantilist model aiming at increasing net exports by means of wage moderation, in particular, had to rely on the willingness and the ability of the rest of the world to go into debt. This German model was thus as fragile as the US model. The moderate growth rates were dependent on the dynamic growth of export markets, while increasing capital exports carried the risk of contagion in the case of a financial crisis.

The German strategy was not only suboptimal for Germany; it has also been a major reason for the current account imbalances within the Euro area which are at the roots of the Euro crisis in 2010. Germany’s consistently weak domestic demand growth, as well as its rising international competitiveness due to extremely moderate wage developments, has been a drag for other Euro area economies which had to accept negative current account balances, in some countries (Spain, Ireland) mainly associated with private sector deficits, in others (Greece, Portugal) also with public sector deficits. In the course of the crisis, public sector deficits and debts in these countries increased because of fiscal stabilisation, making liberalised financial markets speculate about the sustainability of this process. Of course, the housing price bubbles, particularly in Ireland and Spain, as well as too expansive fiscal policies and wage developments in the deficit countries have also contributed to the current account imbalances within the Euro area.

The breakdown of the world economy in the financial and economic crisis could finally be halted by monetary policy interventions providing liquidity on a massive scale and, in particular, by massive fiscal expenditure programmes. A collapse of the Euro area could be prevented in the short run by the intervention of the IMF in cooperation with the other Euro area countries bailing out Greece. However, due to the underlying imbalances, the world economy is unlikely to return to its pre-crisis growth path. In particular, the US will not be able to act as the driver of world demand any longer. The European Union or the Euro area are far from replacing the US as a world demand engine and rather suffer from their internal contradictions, mainly caused by the German neo-mercantilist economic policy strategy. Therefore, major parts of the world economy are presently threatened by a period of deflationary stagnation, high unemployment and pressure on wages; in particular when fiscal expansion comes to an end and governments attempt to reduce public deficits and debt. For the Euro area this will be accompanied by the threat of disintegration.

What is required in the present constellation in order to turn towards a sustainable growth path with (close to) full employment and to rescue the Euro area is a Keynesian New Deal at the European and the global level. The policy package of a Keynesian New Deal should address the three main causes of the severe crisis: inefficient regulation, increasing inequality in income distribution and imbalances at the global and the European scale. It should thus consist of three pillars:

(i) Re-regulation of the financial (and the real) sector. This includes measures, which increase transparency and reduce asymmetric information and thus uncertainty in financial markets, generate incentives for long-run growth, and contain systemic instability.

(ii) Re-orientation of macroeconomic policies along (post-)Keynesian lines. Monetary policies by central banks should target low real interest rates and should care for stability of the financial sector. Wage and incomes policies should take over responsibility for stable inflation rates and stable income shares, which implies that nominal wages should rise at a rate given by the sum of economy wide productivity growth trend plus the inflation target. Fiscal policies should take care of real stabilisation in the short and the long run and of a more equal distribution of income and wealth. The latter implies active redistribution policies by means of tax and social policies. The former requires that governments run permanent deficits (surpluses) in order to maintain aggregate demand at a level consistent with full employment, stable inflation, and a roughly balanced current account in the long run, and that they actively fight short-run shocks by means of counter-cyclical fiscal policies.

(iii) Re-construction of international macroeconomic policy co-ordination – in particular on the European level – and a new world financial order. On the European level, the institutional setting of the ECB and its monetary policy strategy have to be modified such that the ECB is induced to pursue a long-run monetary policy of low real interest rates. The Stability and Growth Pact has to be replaced by a means of coordination of national fiscal policies which allows for the short- and long-run stabilising role of fiscal policies. External stability, i.e. sustainable external balances, should be a primary target, and member countries should be symmetrically induced to correct for current account surpluses and deficits. The orientation of labour market and social policies towards deregulation and flexibilisation will have to be abandoned in favour of re-organising labour markets, stabilising labour unions and employer associations, and Euro area-wide minimum wage legislation. On the global level, the return towards a world financial order with fixed but adjustable exchange rates, symmetric adjustment obligations for current account deficit and surplus countries, and regulated international capital markets, as suggested by Keynes’s (1942) proposal for an International Clearing Union, should be attempted in order to cope with the imbalances that have caused the present crisis.

---

Download this article as pdf

---

Eckhard Hein is a Professor of Economics at the Berlin School of Economics and Law.

---

Further reading
Eckhard Hein and Achim Truger (2010): Finance-dominated capitalism in crisis – the case for a global Keynesian New Deal, Berlin School of Economics and Law, Institute for International Political Economy, Working Paper 6/2010:
http://www.ipe-berlin.org/fileadmin/downloads/working_paper/ipe_working_paper_06.pdf

The German economic model emerges reinforced from the crisis

Stefan Beck

Christoph Scherrer

For years, the business press has portrayed the German economic model as hopelessly atavistic in the face of dynamic Anglo-Saxon financial innovation and comparatively high growth rates. Recently, however, the economic historian Werner Abelshauser argued that the financial crisis would vindicate the German model of capitalism. In his view, the fading lustre of Anglo-Saxon capitalism, in particular its model of corporate governance and dominance of shareholder value, should again lead to the German or “Rhenish” model of diversified quality production and its institutions becoming more attractive.

We argue here that Germany’s response to the crisis has reinforced the central strategies and core institutions of the German economy. At the same time, the model has become more and more exclusive and has begun to foster European and international economic imbalances.

One of the German model’s most salient lines of continuity is the maintenance of a trade surplus. After the period of stagflation in the 1970s, the Bundesbank reacted with policies focusing on rigid monetary and currency stability, in which priority was given to price stability. As a result, domestic consumption was stifled while exports remained the main source of growth. The focus on exports was shared by the trade unions, including the most powerful among them, IG Metall which supported the drive for productivity through the institutions of co-determination, and ensured that unit labour costs would not be driven up by wage demands exceeding productivity gains. The success of this strategy led to the coinage of the term “Modell Deutschland” in the mid-1970s.

Socially and economically, the model became less inclusive long before the financial crisis hit. In particular, the reforms of the social democratic and green coalition government of Chancellor Schröder shifted the German model towards institutional deregulation and a price-competitive strategy that included moderate wage increases, tax cuts and fiscal consolidation.  Its core objective, however, remained the same: fostering growth through exports. During the present crisis, the focus on companies’ core workforces has been reinforced.

The impact of the Financial Crisis
Unlike the US and many European countries, Germany did not enjoy a debt-driven real estate boom before the crisis. The resulting slower growth in comparison to its neighbours made Germany the object of much ridicule in the business press. In the absence of a real estate bubble, however, one would have expected that Germany might have survived the crisis unscathed. In fact, the German government believed that because of a lack of exuberance, its economy would be rather immune; which explains why the government acted rather belatedly to the crisis that eventually hit Germany at the end of 2008. It reached the German economy via two channels, the first being finance. Many of its banks were overexposed to “toxic” speculative papers originating mainly in the US and Ireland. Some of the big private banks, especially Commerzbank and Hypo Real Estate, and top public banks (the Landesbanken) had to be rescued by public guarantees of gargantuan proportions, totalling €400 billion. The more important channel, however, was trade. The export industry, the heart of the German model suffered immensely through the collapse of international demand. The automobile industry, in particular, suffered because of the overlap of the financial crisis with the energy crisis. The capital goods industry lost sales because consumer industries postponed capital investments when faced with a drop in demand.

The most visible outcome of the German model, its export success, proved to be the Achilles heel of its economy. However, the German model of close cooperation proved its worth. Despite the significant decline in GDP of 5%, job losses were miniscule (about 80.000 or 0.3 %). Some elements of the German model contributed to this “miracle”. General stabilizers of the welfare state made intentional deficit spending less necessary. Whereas discretionary measures to re-inflate the economy (Konjunkturpakete I & II) accounted only for €78 billion for the years 2009 and 2010, i.e. around 3.3 % of government expenditure per year, overall government expenditure increased in 2009 by 5%. These stabilizers were enhanced by the willingness of the government to fund part-time support for workers. In 2009 the duration of part-time support was extended up to 24 months and its use reached a maximum of 1.5 million workers in May 2009 (compared to 70.000 in 2007) and then dropped again to around 900.000 workers in the first quarter of 2010. Expenditures of the Federal Employment Agency for short-term work totalled more than €5 billion in 2009.

Industry-wide collective bargaining brought about noticeable real wage losses. According to the ILO Global Wage Report, in 2008 and 2009, German workers had to accept a decline in monthly real wages of more than 0.5% (ILO 2009). Decentralisation and co-management bore fruit: In about 30% of all firms, overtime accounts have been reduced – some even going negative (“Zeitschulden”), one out of four firms reduced the use of subcontracted work, and nearly every third used other measures to increase internal flexibility. In sum, about 1.2 million jobs were preserved by reductions of working time. Lay-offs predominantly hit workers with temporary contracts.

Co-determination was also defended in another arena. The attempt to rid VW, Europe’s largest car manufacturer, of state and trade union influence, failed. Under Chancellor Merkel, the federal government successfully retained the stake of the German State of Niedersachsen in VW, despite attacks from the European Commission. Because of this state’s stake in VW, the Porsche’s strategy to finance a takeover of VW, with cash from VW, was muted. Instead, VW took over Porsche, allowing the work council of VW to retain a strong voice. At the end of 2009, exports had picked up again and seemed to justify the current strategy.

The core of the German model, close cooperation of capital, labour and the state in pursuit of export surpluses, has actually been strengthened in the crisis. Success of the corporatist crisis management, however, may bring about the German model’s own demise, with export success perhaps squeezing out neighbours who cannot shield themselves via currency depreciations - e.g. southern EU members.

International consequences of Germany’s trade surplus and macroeconomic restraint strategy of growth
The Greek and Euro crises in 2009 and 2010 were portrayed by the German government and by most of the media as the result of a weak, spent-thrift government. In contrast, the German objective of budgetary parsimony was praised as virtuous and, accordingly, strict loan conditions for Greece were seen as wholly justified.

Surely, in the case of Greece it is easy to identify homemade causes of the crisis. However, there are also systemic reasons for the Greek crisis, which are related to Germany’s export success. Since 1999 German unit labour costs remained nearly constant, whereas the average of the European Currency Union rose about 15% and those of Greece, Portugal or Spain between 20 and 30%. Additionally, trade and current account deficits of these latter countries have increased in parallel to comparative unit labour costs, and disproportionally since the introduction of the Euro.

From a Post-Keynesian perspective this mercantilist strategy of perpetual trade or current account surpluses is a kind of beggar-thy-neighbour-policy. It aims at fostering the growth of one’s own economy and rate of employment at the expense of other countries. And given the fact that countries cannot sustain permanent deficits without rising indebtedness vis-à-vis foreign countries, such mercantilist strategies can force countries into insolvency. Moreover, such developments have internationally contractive effects on growth and can provoke economic and political instabilities. In the end, deflationary tendencies stemming from Germany and balance of payment and/or budgetary problems of deficit countries are two sides of the same coin.

The German model after the financial crisis
In sum, the German economic model was hit hard by the crisis but proved surprisingly resilient. Actually, its core, the willingness of all major stakeholders to work together in securing the export prowess of German industry, emerged from the test of the crisis stronger than ever. With the help of state subsidies, employers kept their long-term commitments to core workers, and in return, organisations representing skilled workers, i.e. work councils and trade unions, were willing to make concessions in terms of pay and working conditions. But whereas now some of those core workers (e.g. BMW) are receiving extra or ‘compensatory’ payments in return for their loyalty, temp workers and workers outside the export industry are bearing the brunt of the crisis as new levels of public indebtedness are leading to budgetary constraints whose first victims are again those on welfare.

While voices within and outside of Germany call for strengthening domestic consumption, the recent resurgence of exports seems to vindicate the export coalition. Therefore, it does not look very likely that the German economic model will be restructured in favour of less dependence on trade surpluses and further tensions within the euro zone are therefore highly likely.

---

Download this article as pdf

---

Stefan Beck worked as a research assistant at the University of Kassel. He is currently preparing his dissertation about mercantilism and the German economic model.

Christoph Scherrer is Professor for Globalization and Politics at University of Kassel, Germany. He is also executive director of the International Center for Development and Decent Work and a member of the steering committee of the Global Labour University.

---

References

• Abelshauser, W. (2009): Der Kulturkampf geht weiter; in: WSI Mitteilungen 12/2009: 692-694.
• Bogedan, C. et al. (2009): Betriebliche Beschäftigungssicherung in der Krise; Kurzauswertung der WSI-Betriebsrätebefragung 2009; Hans-Böckler-Stiftung.
• Herr, H. (2009): Vom regulierten Kapitalismus zur Instabilität; in: WSI Mitteilungen 12/2009: 635-642.
• Müller, K./Schmidt, R. (2010): Von der griechischen zur europäischen Krise; in: Prokla 159: 277-300.