Last week (February 14, 2019), Eurostat released its latest national accounts estimates – GDP up by 0.2% and employment up by 0.3% in the euro area – which confirmed that EU growth rates have declined significantly over the course of 2018. Moreover, the December-quarter data confirmed Italy is in official recession and Germany recorded zero growth (thereby avoiding the ‘technical recession’ category after contracting by 0.2 per cent in the September-quarter). Export expenditure accounts for nearly 50 per cent of Germany’s GDP – a massive proportion. It has adopted a growth strategy based on impoverishing its own residents through flat wages growth and a sustained proportion of low-paid, precarious jobs and setting its sail on sucking out expenditure from other nations (in the form of their imports). This has been particularly damaging to the Eurozone partners but also exposes Germany to the fluctuations in world export markets. Those markets are softening for various reasons (economic and political) and, as a result, German growth has hit the wall. The solution is simple – stimulate domestic demand, push for higher wages for workers, outlaw Minijobs, and start fixing the massively degraded public infrastructure that the austerity bent has starved. Likelihood of the German government adopting that sort of responsible policy. Zero to very low. There is the problem of the Eurozone from another angle. The main economy cannot play the game properly.



I considered the first release of the European national accounts data (from December) in this blog post – Nations heading south as austerity continues (February 6, 2019).

I also considered aspects of Germany policy strategies in this blog post – Germany – a most dangerous and ridiculous nation (December 27, 2017) – which also provides several links to related analysis that I have presented over the years.

A study of the German National Accounts provides for an interesting story. The following sequence of graphs provides the imagery. They are indexes (March-quarter 2000=100), except for the last two graphs (which are expressed as proportions of GDP).

The first graph shows the evolution of Real GDP and domestic demand (consumption and investment) from the March-quarter 1995 to the December-quarter 2018 for GDP and September-quarter 2018 for Domestic demand (latest available data).

They are indexed to 100 at the March-quarter 2000.

Since that time, GDP in Germany has grown by 27.2 per cent, whereas domestic demand has grown by just 20.9 per cent (in real terms).

There are two very interesting things about the graph apart from the divergence between total spending (GDP) and domestic-based spending (domestic demand).

First, you can see the suppression of domestic demand began soon after the inception of the euro – the Hartz devastation (see below).

Second, look what happened after 2011, as the fiscal austerity moved into top gear. While real GDP grew on the back of the growing exports, domestic demand fell between June 2011 and June 2013, further exacerbating the Eurozone crisis.

That evolution was the result of deliberate policy positions taken by the German government.

By deliberately constraining the standard of living of its citizens and undermining its own public and private infrastructure, the German government also damaged its EMU partners.

Remember that an export-based growth strategy requires a nation to feed of the spending of other nations and pushes those nations into external deficits, which require, among other things, fiscal deficits to support growth and domestic savings desires.

Imposing fiscal austerity in that context on the importing nations only exacerbates an already imbalanced situation, which Germany’s single-minded policy strategy created.

The next graph shows the evolution of consumption expenditure (public and household) over the same period.

Two things stand out:

1. The suppression of consumption expenditure both public and private in the first seven years after adopting the euro. This was tied in to the growing imbalance in the mix of expenditure driving growth in Germany (see below).

2. The on-going suppression of household consumption growth. While real GDP has grown by 27 per cent since the March-quarter 1995, household consumption expenditure has grown by just 17 per cent (very poor).

The next graph shows the German investment ratio (as a percent of GDP) over the same period.

It has declined from 23.3 per cent in the September-quarter 1999 (just before the euro adoption) to its current level of 20.9 per cent.

This decline has two implications:

1. Less expenditure is coming from capital formation, which affects the current growth rate.

2. The declining investment ratio impacts negatively on potential GDP, which means the productive capacity of the German economy is being undermined.

The next graph ties this altogether and shows the trade components of the Current Account balance as a share of GDP.

This is a very dramatic history.

Prior to the adoption of the euro, Germany was increasing its openness to world trade but more or less in proportion – exports and imports were rising as a share of total GDP.

But from the point Germany adopted the euro, it changed strategy entirely and began its export mania while suppressing import expenditure via suppression of domestic income growth. I will discuss the evolution of minijobs below.

German exports of goods and services has moved from being around 20 per cent of GDP in 1995 to 49.8 per cent of GDP in the third-quarter 2018.

That is a massive structural shift and comes at the expense of the material well-being of the German people who have endured an increase in precarious employment, flat wages growth, and largely flat consumption spending.

Throughout 2018, the export ‘miracle’ has faltered and that helps to explain the dramatic GDP slowdown. Clearly German exports are being negatively impacted by the US trade shenanigans and the slowdown of the Chinese and British economies.

Clearly, it looked beyond Europe for export growth, knowing that its enforcement of austerity within Europe, has seriously impaired its capacity to grow via intra-European exports.

All these trends can be tied together easily and related to the on-going malaise in Europe.

Germany’s ongoing violation of the EUs Macroeconomic Imbalance Procedure – as a result of it consistently exceeding the external deficit threshold of 6 per cent of GDP, has had ramifications through the Eurozone.

By dramatically reorienting its economic growth strategy away from a balance between domestic and external expenditure, through a combination of wages growth suppression, fiscal surpluses etc, Germany has been accumulating financial claims against the rest of the world.

How might this imbalance be resolved? There are a number of ways possible.

A most obvious solution would be for foreigners to borrow funds from the domestic residents. This would lead to a net accumulation of foreign claims (assets) held by residents in the surplus nation.

Another solution would be for non-residents to draw down local bank balances, which means that net liabilities to non-residents would decline.

Thus a nation running a current account surplus will be recording net private capital outflows and/or the central bank will be accumulating international reserves (foreign currency holdings) if it has been selling the nation’s currency to stabilise its exchange rate in the face of the surplus.

Current account deficit nations will record foreign capital inflows (for example, loans from surplus nations) and/or their central banks will be losing foreign reserves.

Large current account disparities emerged between nations in the 1980s as capital flows were deregulated and many currencies floated after the Bretton Woods system collapsed.

European nations such as Germany, the Netherlands and Switzerland were typically recording large and persistent current account surpluses and with a significant proportion of their trade being with other European nations, the imbalances grew within Europe as well as between Europe and elsewhere.

Think about the sectoral balances arithmetic. If a Member State achieve a balanced fiscal outcome and is sitting on the current account surplus threshold (6 per cent), then its private domestic sector will be saving overall 6 per cent of GDP.

Where will those savings go?

I have discussed how Germany maintained its external competitiveness once it could no longer manipulate the exchange rate in previous blogs.

Please read my blog posts:

1. Germany is not a model for Europe (March 2, 2015).

2. Germany should look at itself in the mirror (June 17, 2015).

The savings may go into the domestic economy if there are profitable opportunities to invest. But in Germany’s case, its whole strategy was based on suppressing domestic demand (Hartz reforms, wage suppression, mini-jobs etc), and so profitable investment opportunities were limited in the German economy.

As a result, German capital sought profits elsewhere.

The persistently large external surpluses which began long before the crisis (and 6 per cent is large) were the reason that so much debt was incurred in Spain and elsewhere. German investors pushed capital externally.

The combination of domestic demand suppression and huge external surpluses means that Germany’s outflow of capital is ridiculous.

The imblance in Germany then becomes an imbalance elsewhere and given the dominance of intra-European trade, those resulting imbalances make life precarious for the weaker European nations.

To resolve this problem (which is a massive imbalance between domestic saving and investment), Germany requires higher domestic demand and faster wages growth, both to boost the very modest consumption performance and to attract investment into the domestic market.

It also could stimulate public spending – say, to start the long process of restoring quality to its public infrastructure which has been seriously degraded by the austerity mentality of successive German governments.

But such a change would be at odds with the mercantile mindset that dominates the nation because it would reduce the competitive advantage that Germany enjoys over other nations that have treated their workers more equitably.

The Minijobs are now a permament feature of Germany

The official unemployment rate in Germany is low by any standards (other than full employment). In the September-quarter 2018, it was recorded at 3.8 per cent.

The following graph shows the evolution since the March-quarter 2005.

However, the reduction in official unemployment has really only been achieved by shifting the weak demand into precarious, low-paid positions.

Once the common currency emerged and Germany lost the ability to manipulate its exchange rate to its advantage (forget the rest), the next strategy it employed was to attack its own workers.

A reasonable argument can be made that Gerhard Schröder helped cause the Eurozone crisis. His government’s response to the restrictions that Germany encountered on entering the EMU are certainly part of the story and one of the least focused upon aspects.

Upon entering the EMU, Schröder was under immense political pressure to do something about the high unemployment in the East after reunification.

Without the capacity to manipulate the exchange rate, the Germans understood that they had to reduce domestic production costs and inflation rates relative to other nations, in order to retain competitiveness.

The Germans thus took the so-called ‘internal devaluation’ route well before the crisis; a move, which ultimately made the crisis worse for other Eurozone nations.

When Schröder unveiled his Government’s ‘Agenda 2010’ in 2003, it was clear that they were going to hack into income support systems and ensure that Germany’s export competitiveness endured despite abandoning its exchange rate flexibility.

It was dressed up in the language of flexibility and incentive, but was based on the mainstream view that mass unemployment was the result of a workforce rendered lazy by the welfare system, rather than the more obvious alternative, that it arose due to a shortage of jobs.

The so-called ‘Hartz reforms’ were a major plank of the strategy and resulted from a 2002 commission of enquiry, presided over by and named after Peter Hartz, a key Volkswagen executive.

The aim was clear, unemployment benefits had to be cut and job protections had to go. The recommendations were fully endorsed by the Schröder government and introduced in four tranches: Hartz I to IV, starting in January 2003.

The changes associated with Hartz I to Hartz III, took place over 2003 and 2004, while Hartz IV began in January 2005.

The changes were far reaching in terms of the existing labour market policy that had been stable for several decades.

The so-called supply-side focus saw unemployment as an individual problem and advocated that continued income support should be conditional on a raft of increasingly onerous activity tests and training schemes.

Further, governments abandoned their responsibility to reduce unemployment with properly targeted job creation schemes.

Public employment agencies were privatised spawning a new private sector ‘industry’ – the management of the unemployed!

The Hartz reforms accelerated the casualisation of the labour market and the precariousness of work increased. Hartz II introduced new types of employment, the ‘mini-job’ and the ‘midi-job’ and there was a sharp fall in regular employment as a consequence.

Mini-jobs provide marginal employment with no security or entitlements and allow workers to earn up to 450 euros per month without paying taxes, while the on-costs for employers are significantly lower. The no tax obligations also mean that the worker receives no social security protection or pension entitlements.

The neo-liberal interpretation of these changes is that Germany underwent a ‘jobwunder’, or jobs miracle.

However the speedy increase in employment that followed (and the decline in official unemployment) can also be viewed less optimistically.

The following graph charts the history of the mini-jobs since 2003.

In September 2018, there were 7.56 million ‘mini-jobs’, which represented 17.9 per cent of the labour force between 15 and 64 years of age.

The proportion has been fairly steady since late 2007 after a rapid increase in the earlier years of the scheme. However, it is starting to rise again, albeit slowly.

The rapid increase in mini-jobs meant an increasing (and sizeable) proportion of the German workforce were forced to work in precarious jobs with extremely low pay and were excluded from enjoying the benefits of national income growth and the chance to accumulate pension entitlements.

Profits win out over wages

The Government in cahoots with industry also engineered a massive redistribution of national income to profits and away from wages.

In general, German real wages (the purchasing power equivalent of the wages received by workers each week) failed to keep pace with growth in productivity (how much workers were producing each hour) and as a result there was a massive redistribution of national income to profits.

The following graph shows the – AMECO – (Annual Macroeconomic) database measure of Real Unit Labour Costs, provided by the European Commission.

RULC are the ratio of real wages to labour productivity and if they are falling it means that productivity growth is rising faster than real wages and redistributing national income towards profits.

So the RULC measure is equivalent to the share of wages in national income. If it falls, workers have a lower share in real GDP.

After Germany adopted the euro, there has been a 3.53 per cent swing to the profit share at the expense of workers.

The rise in the shares during the crisis signifies the fact that national GDP (output) was falling while total wages were not falling as fast or were relatively constant. As a consequence the ratio of the two rose.

Why does this matter? Until the early 2000s, real wages and labour productivity had typically moved together in Germany as they did in most advanced nations.

If real wages and labour productivity grow proportionately over time, the share of total national income that workers (wage earners) receive remains constant.

However, once the neo-liberal attacks on the capacity of workers to secure wage increases intensified in the 1980s in many nations and, later in Germany, a gap between the growth in real wages and productivity growth opened and widened.

This led to a major shift in national income shares away from workers towards profits.

The capitalist dilemma was that real wages typically had to grow in line with productivity to ensure that the goods produced were sold. If workers were producing more per hour over time, they had to be paid more per hour in real terms to ensure their purchasing power growth was sufficient to consume the extra production being pushed out into the markets.

How does economic growth sustain itself when labour productivity growth outstrips the growth in the real wage, especially as governments were trying to reduce their deficits and thus their contribution to total spending in their economies? How does the economy recycle the rising profit share to overcome the declining capacity of workers to consume?

The neo-liberals found a new way to solve the dilemma. The ‘solution’ was so-called ‘financial engineering’, which pushed ever-increasing debt onto households and firms in many nations.

The credit expansion sustained the workers’ purchasing power, but also delivered an interest bonus to capital, while real wages growth continued to be suppressed.

Households in particular, were enticed by lower interest rates and the vehement marketing strategies of the financial engineers. It seemed too good to be true and it was.

Germany adopted a particular version of this ‘solution’.

The funds to underwrite this credit explosion came from the increased profits that arose from the redistributed national income.

For some nations, such as Germany, the large export surpluses also provided the funds to loan out to other nations.

Germany didn’t experience the same credit explosion as other nations. The suppression of real wages growth in Germany and the growth in the (very) low-wage ‘mini-jobs’ meant that Germany severely stifled domestic spending.

Schröder’s austerity policies forced harsh domestic restraint onto German workers, which meant that Germany could only grow through widening external surpluses.

So the external strategy, which has caused irreparable harm to its Eurozone partners, has also impoverished its own population. The German approach, which is echoed in the basic design of the common currency and the fiscal and monetary rules that reinforce it, could never be a viable model for prosperity throughout Europe.

Conclusion

And now with the world export demand declining for various reasons, the vastly unbalanced German economy is faltering.

Germany has adopted the strategy that it can permanently game its Eurozone partners through its mercantilist approach.

The massive external trade surpluses, which then manifest as capital exports to its Eurozone partners, not only generate low returns for the investors but further complicate the debt dynamics within the union.

The German population do not win, nor do Germany’s partners.

And when the world export demand softens, the whole show becomes shaky again.

Another demonstration of the unviable nature of the common currency.

That is enough for today!

(c) Copyright 2019 William Mitchell. All Rights Reserved.