Monday, September 30, 2013

German model ought to change

After the German elections , the big issue is whether Germany will change its economic model, and more importantly its plans for Europe. Until now, the country had a relatively confortable situation in terms of growth and employment compared to other EU countries. But even so, the economy has not returned to its pre-crisis levels. How can we say that this model has been successful?

Germany has pursued "beggar my neighbour policies" like in the 30s whereby it has imposed austerity policies to the rest of Europe. Export oriented policies have yielded a  large current account surplus (about 6% of its GDP) to the detriment of internal demand. Countries like Spain and Italy  have already narrowed their external deficits, but GDP has dropped, and the best case scenario will be a prolonged stagnation (which some economists reckon as the exit from the 'Great Recession' ). The truth is that the combination of increased productivity (due to wage cuts) and depressing demand has driven those countries to an external balance so that they can  repay their  short term debt to the international creditors.
As Martin Wolf (FT 25/09) put it,  "a large country with a huge structural current account surplus does not just export products. It also exports bankruptcy and unemployment, particularly if the counterpart capital consists of short term debt". The main problem is that vulnerable countries must improve their competitiveness, not only in terms of unit labour costs (which means achieving more or the same quantity of output  with less labour)  but also in structural terms, that is the accumulation of human and physical capital which is conducive to long term productivity gains. However, this cannot be achieved with current German policies, which on the contrary tend to increase the divergence between northern economies - anchored to the German economy- and the others which have difficulties to stay in the eurozone with low levels of competitiveness.

The solution is a European wide keynesian stimulus plan which is justified on economic and moral grounds. This has worked quite successfully during the last two great crises. During the great Depression, F. Roosevelt's New Deal, which  injected massive government spending and introduced several reforms between 1933 and 1936 (including for the financial sector) reactived the US economy and restored the level of confidence among US citizens which was then necessary for the economic recovery which came after the II World war. A similar mechanism happened after the failure of Lehman Brothers in September 2008:  a goverment stimulus plan worth 800 bn $, combined with the Federal Reserve's availability of liquidity for banks in trouble brought a certain amount of confidence to the marketplace. A policy of quantitative easing together with a low interest rate environment  further stimulated economic activities in the US. But all this happened when the private sector does not have the capacity or is reluctant to spend and in these two big crises government spending has rescued the world economy from two of its greatest disasters.

Yet government alone was not sufficient to eradicate the crisis, but has Germany learned anything from these two large scale experiments?  Europe has the means due to its economic size (more or less similar to the US)to launch a large scale programme of investments which could exploit the full potential of the internal market. It has the moral obligation to do so due to the intolerable mass of unemployment and distress that the austerity policies have generated with job losses, wage cuts and less services to the most vulnerable. Is this what we want?


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