Learning lessons from Germany

Axel Weber, President of Bundesbank says:

In my following remarks, I will address these two aspects of the recent experiences within the euro area. First, the advantages of monetary union during the financial crisis. Second, the challenges that will have to be overcome in order to resolve the divergencies that have built up within the euro area. The current debate focuses on the differences in price competitiveness between EMU member states.

However, in my view losses in competitiveness are not the root of the problem but rather a symptom of underlying unsustainable structural developments in some member states. Accordingly, the marked gains in price competitiveness the German economy has experienced have been a result of necessary structural reforms that were finally addressed in 2003 when domestic problems such as high structural unemployment, rising social security contributions and repeated excessive public deficits became more and more pressing.

I will therefore take a closer look at this German experience trying to draw some conclusions for those countries that have lost competitiveness since the launch of the euro.

This is nicely put. After all the imbalances are a result of economic developments. The imbalances are not the cause but one of the many problems that follow.

He explains how Germany took tough decisions to improve competitiveness in 2003

This adjustment process is often perceived and portrayed as a significant improvement in price competitiveness due to ongoing wage moderation and major reforms on labour markets and in the social security system. However, this perception misses the point of what actually occurred in past years.

The price competitiveness of the German economy had indeed declined dramatically in the years 1990 to 1995. During the reunification process, a number of domestic imbalances had built up and became apparent as of the mid-1990s. The most prominent were an oversized construction sector and strong wage and price increases despite a decline in average labour productivity owing to the inclusion of the eastern German economy.

The German corporate sector reacted to this extremely unfavourable position on domestic and international markets by a painful, but eventually successful restructuring process including innovation, outsourcing, wage moderation as well as a balance sheet clean-up. It should be noted that these were market-based adjustments neither initiated nor managed by policy makers.

However, what actually forced the German government to undertake a set of major reforms was a couple of intensifying domestic problems which depressed growth and increasingly constrained policy makers’ scope of action. In the economic downturn following the burst of the “New Economy” bubble in the early 2000s, persistently high unemployment peaking at more than 5 million people in 2005 as well as overburdened social security systems led to high fiscal deficits and a protracted period of only meagre GDP growth.

Thus, adjustments in the areas of economic and social policy had become inevitable. Finally, in 2003, bold labour market reforms were introduced, which modernised the labour market structure and lowered the high employment threshold of economic growth. They were accompanied by fiscal consolidation and adjustments in the social security systems, in particular the pension system. These structural reforms have paved the way for further necessary market-based corrections, for example in wage setting and intra-plant working-time flexibility, to take place. They have been painful, but the economy was in much better shape afterwards. In my view, this is the core lesson that can be drawn from Germany’s experience.

He then comments on the Germany’s growth model – it was exports driven:

It is true that economic growth in Germany was unusually dependent on foreign trade during the last upswing between mid-2003 and early 2008, but we would be ill-advised to deduce from this experience the need for actively propping-up domestic demand, for example via encouraging higher negotiated wages. Rather, German exports were boosted by strong, but ultimately unsustainable global economic growth, whereas a pick-up in private demand once high unemployment started to decline was repeatedly burdened by exogenous forces. For example, the need to cut excessive public deficits required a more restrictive stance of fiscal policy and the rapid rise in energy prices in 2008 absorbed the sizeable pick-up in nominal disposable income as the upswing was about to broaden to the domestic economy. What is therefore often neglected is that Germany was able to serve as an important buffer for world demand at the height of the financial crisis via its still robust private consumption as well as large fiscal stimulus packages.

Looking ahead and bearing in mind the prospects for global economic growth as well as its regional breakdown, the German economy is unlikely to replicate the growth profile of the most recent upswing. In an external environment characterised by a less steep but hopefully healthier expansion, German enterprises will naturally have to focus more on the domestic market than before. Political coordination of this process which goes beyond the purpose of setting a framework for a market-induced, smooth reallocation of resources is neither necessary nor helpful.

 Interesting again. We mostly drive the wrong lessons.

One Response to “Learning lessons from Germany”

  1. Germany’s role in Euro – an alternative proposal « Mostly Economics Says:

    […] did all things right and other EMU economies did things wrong. Alex Weber, Bundesbank President showed how Germany reformed its economy after joining EMU. Then there was a paper which compared fiscal […]

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