Tuesday, November 12, 2013

A message from Germany: not my problem

Paul Krugman complains (again) that Germany's tough line towards the South fails to appreciate how much its own relative economic success in recent years is the flip side of the Mediterranean countries' failure. By refusing to allow a higher eurozone inflation rate, Germany is effectively denying the South the chance to realign its relative costs in the same way Germany was able to do in the first years of the Eurozone. As Krugman shows in his post, Germany's success in holding down its labour costs was spectacularly successful precisely because the South did not manage to achieve zero real wage growth, and therefore provided a ready market for German products (not to mention an outlet for German financial surpluses). Resolving the crisis requires Germany to return the favour.

I'm always puzzled, looking at things from the perspective of the UK and Southern Europe, how it can be domestically politically impossible to persuade Germans to spend money. After all, the easiest solution to the crisis has always been that Germans dipped into some of their trade surplus to enjoy the South's warm beaches and hospitality, or maybe even buy a few second homes on the shores of the Mediterranean. It looks like a win-win solution. Yet, the hair-shirted Prussians prefer to stick it all under the mattress, and invite Southern Europeans to do the same, even if this does actually shrink the economy and put German savings at risk.

This can be seen as a cultural or ideological problem. In many ways, the discourse of belt-tightening on the European level has a quasi-religious quality. We need to suffer, and those who have least should suffer particularly, since being poor they probably deserve it. The poor, Weber would say, lack a beruf (calling), whilst the parsimonious rich are blessed and will be rewarded in the afterlife. The crisis becomes a morality play. Easy answers, like inflation or fiscal stimulus, must be wrong, because the crisis is a clear sign we have sinned and must atone.

I can't help thinking that it would be easier to convince Germans to adopt a more constructive attitude if Southern Europeans didn't enjoy such an enviously pleasant climate and physical environment. Whilst Germans have to endure long cold winters, the South basks in sunshine  - no wonder they don't work so hard. Of course, as has been well documented by now, the average Southern European worker has a much longer working week than the average German, and savings rates are also actually quite high in the South:


The truly profligate are the Anglo countries, with clearly lower savings rates than continental and Southern Europe.

The morality tale of Southern Europe's decline doesn't really fit with the facts, but my guess is that it is simply easier to digest for Germans than the harsh truth, which is that European Monetary Union was designed and is being governed in line with German interests. In other words, the moralistic tone of the Eurozone policy discourse is a cultural problem founded on a very real set of material advantages.

EMU was an extension of the process of market integration in Europe, removing one of the last remaining barriers to trade - national currencies. By creating a single currency, competitive devaluations became impossible. The usual beneficiaries of such devaluations - the weaker currency nations of Southern Europe - were prepared to sacrifice this competitive advantage in exchange for the inflationary anchor provided by Germany's dominance of the new currency union. What they didn't perhaps anticipate was quite how exposed they would become to Germany's extraordinary capacity to control price and wage rises, and how little help they would get from the ECB, which shaped monetary policy around the needs of slow-growing Germany, leaving the fast-growing periphery to inflate itself into an uncompetitive real exchange rate. And now, the only way back for the South is a brutal internal devaluation which, as well as closing off the labour market to anyone below the age of 35, will make debt servicing next to impossible.

Despite recent optimism about financial flows returning to Spain, this process of internal devaluation is far from complete, and there are incipient signs of deflation across the South, hence the ECB's increasingly desperate attempts to use monetary stimulus to get the economy moving. Still Germany protests that all of this has nothing to do with them, and refuses to play any part in raising internal demand in the Eurozone. But politics has an awkward habit of raising its ugly head in these situations. There will be elections in Spain within 2 years, and almost certainly in Italy and Greece even sooner. The problem will not go away, and Catalan nationalists and left populists in Spain, the Five Stars movement in Italy, Golden Dawn and Syriza in Greece, are all waiting in the wings. Barry Eichengreen established that you can't run a gold standard in a democracy. Is Europe trying to test this theory to destruction?