Paying German workers more is a win-win for the euro
Imbalances in the euro zone need action from the core as well as the periphery
Most of us know that shedding flab after falling into flesh is not much fun. The same can be said for economies that lose their shape. Just as returning to fitness can be a long, hard slog for the corpulent, regaining competitiveness is tough on countries. Pain comes before gain in both cases.
The weighing scales of an economy’s external competitiveness is its balance of payments. An economy that pays more to the rest of the world than it earns from foreigners runs a deficit on the current account of its international balance of payments. (For clarity: all discussion of deficits and surpluses here relates to current accounts, not to governments’ budgetary balances).
From around 2002/03, current account deficits in many European economies ballooned. In some, they reached historic highs by 2008 or thereabouts.
In hindsight, this was among the most obvious signs that financiers were busy inflating a mega-bubble (deficits can only be run if foreign capital is made available to finance for them).
Although this had little to do with the euro – the biggest deficits were in non-euro countries – solving the competitiveness problem in a badly designed monetary union is proving highly problematic.
But the good news first.
One of the very few reasons to be encouraged by recent developments in the euro zone is the competitiveness gains being made in the periphery. The large declines in deficits illustrated in the graphic have come about not only because imports have fallen (the most painful part of regaining competitiveness) but also because exports have risen strongly in most countries. But they have not risen by enough to prevent deep recession across Europe’s Mediterranean underbelly. This is the problematic part.
As one country can only run a deficit if others runs a surplus, there are two sides to the rebalancing discussion within the euro zone. Given that Germany accounts for one-third of the euro zone economy, its current account balance matters. It matters all the more because its surplus stood at a massive €185 billion last year, more than the deficits of all other euro zone countries combined.
In the euro zone debate about how to recover from the effects of the burst bubble and put stable foundations under the single currency, Germany has come in for much criticism. Some of this criticism has been based on little more than prejudice and more has been unfair or unwarranted. But among the most deserved criticisms of German policy makers has been their unwillingness to take policy actions to shrink their current account surplus, which is still as big as it was before the crisis (see chart).
Returning to the personal fitness analogy may help explain why this is necessary. Just as it is bad to over-eat and under-exercise, so too is it unhealthy to under-eat and over-exercise. National economies are no different. Just as they can become uncompetitive, the can also become over-competitive.
Germany’s persistently large current account surplus is a sign of over-competitiveness. Its root cause is German workers not getting a fair share of the profits being generated by their country’s export success. Wage growth in Germany over more than a decade has been the lowest in the euro zone. And even if it has perked up a bit recently, there is plenty of scope for bigger pay increases.
While the German government can make a plausible case against fiscal stimulus – its public debt is very high and its population is shrinking – there is no case for not acting to push up wages.
The government could introduce a national minimum wage. It could also support trade unions in their pay talks with private sector employers, while signalling to business that tax on profits could rise if wages are not allowed to move towards their (higher) equilibrium.
German workers earning more will spend more, including on Mediterranean holidays and peripheral countries’ exports. Helping the peripherals grow by buying from them is better for everyone than bailing them out.
There are very few no-lose options in dealing with the euro crisis. Boosting demand in Germany by allowing wages to rise is one. It should be pursued.