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Tuesday, December 16, 2008

GERMANY, PAUL KRUGMAN, AND FISCAL STIMULI TO FIGHT EU RECESSION

Today's Buggy Topic

It can be found in a thread at Economist's View, one of the very best economic blogs on the web --- run by a talented economist, Mark Thoma of the University of Oregon . . . himself a moderate Keynesian in macroeconomic matters.  The topic concerns a stinging criticism by Paul Krugman, the recent Nobel Prize winner in economics, directed at Germany's resistance to the British-French-Spanish initiative --- and espoused by all other EU members as well --- to undertake twp simultaneous policies: 1) large independent expansions of fiscal spending in each member-state to fight the current recession and financial meltdown. and 2) coordinated fiscal expansion at the regional EU level itself. 

 

                                 INTRODUCTORY COMMENTS

Why Fiscal Stimuli Matter, Especially in the EU Eurozone

The Economist View thread started with the Krugman criticism, taken from the New  York Times on December 15th, followed by a lengthy set of angry exchanges by posters about Germany as the odd-man-out in the EU in fiscal expansion.  That opposition, very pronounced until last weekend --- and still intact, if slightly moderated since then --- has brought Germany into conflict with Britain, France, and essentially all the rest of the EU . . . a total of 26 member-states besides Germany, with 16 of them in the Eurozone itself. 

Why are fiscal stimuli so important in the EU? 

It's easy enough to explain.  In particular, important as such stimuli happen to be for the US and other non-European countries, they're doubly so in fighting the current recession in Europe . . . and for one stand-out reason: none of the eurozone countries --- including four giant economies: those of Germany, Italy, France, and Spain (which account for about 67% of the total EU GDP for 2008, roughly 12 trillion euros) --- have any control over interest rates, money supply, or exhange rates.  It's the EU Central Bank that controls these, and it's essentially independent of all member-governments.  

As for the remaining 11 member-states outside the eurozone --- three of them in West Europe (Britain and tiny Sweden and Denmark) and the rest new members in East Europe --- they are free to pursue their own interest rate and other monetary policies.  They are doing so already.  And free to depreciate or devalue their currencies against the euro?  In law, yes.  As a practical thing, though, any such policy would generate sharp conflict with all the Eurozone members and its Central Bank, and so it's essentially a non-starter.   

Well, What About the Eurozone Central Bank?  Won't It Pursue Expansionary Monetary Policies Like the Fed?

The answers: yes and no.

Almost always, to clarify briefly, since the start of the Eurozone in 1999, the European Central Bank has pursued more conservative interest rate policies than either the Federal Reserve or the Central Banks of Britain, Canada, Australia, and Japan . . . often, it should be added, wisely so.  But is it still wise?

Only recently, as it happens, the European Central Bank --- faced with all the bad news about the Eurozone countries slipping into recession (not least in Germany) --- has the European Central Bank moved to cut its short-term rates.  That was just last week in the run-up to the EU Summit meeting.  The Central Bank, to be specific, halved short-term interest rates to 2.5%.  It seems a lot, no?  Maybe so; it all depends on the standard of comparison and the European Bank's judgment of the gravity of the recessionary trends in the Eurozone.

Right now, anyway, that 2.5% short-term rate is still more than 10 times higher than the Federal Reserve's equivalent, and much higher, too, than the rates in Britain, Canada, Australia, and Japan.  

Hence the Significance of Fiscal-Stimuli in the EU

 

In effect, individually and collectively, the Eurozone members are left with only one policy for stimulating their economies in the face of their sinking economies: each one can try to pursue their own individual fiscal stimuli --- a mixture, say, of tax cuts and public works spending --- and, simultaneously, try to promote a coordinated EU-level expansion of fiscal spending.  

But note.  Some of the Eurozone countries have already exceeded the legal limit on deficit-spending of 3.0% of their individual GDP . . . in the case of France, for years now.  By contrast, German public opinion, the former German Central Bank (replaced by the European Central Bank in 1999), and generally German governments have always been wary of debt, both personal and deficits.  And so, on top of everything else, the current Angela Merkel Social-Democratic, Green, and Christian Democratic coalition-government has generally opposed  And that includes expansion, iff need be, that violates the Eurozone limits on government deficit spending --- 3.0% a year (actually some countries are and have been above that limit for years now, France above all).

Note the Underlined Term Above: Generally Opposed Deficit Spending

The fact is, for all of German finger-pointing and criticism of the fiscal profligacy of others in the last year or two, German central governmental deficits rose above the 3.0% legal Eurozone limit for a few years in the early and middle part of this decade too.  In fact it fell back below that limit only in 2006 (by a tick) and more so in 2007. 

The moral here?  It underscores the key point that Krugman was making in his criticism of the German resistance --- now slightly abridged --- to large fiscal stimuli, whether on the regional coordinated level or nation-wide.  That's because the individual expansions being carried out by, say, Britain outside the Eurozone and by France and Spain inside it, will be mutually reinforced if Germany --- the EU's biggest economy (about 20% of the EU's total GDP) --- were to follow suit. 

Focus momentarily on this percentage.  One country, the biggest in population in the EU --- 80 million and the world's biggest exporter --- has 20% of total EU GDP.  And if it continues to resist a vigorous expansion of government spending, the neighbors of Germany in the EU will not enjoy the mutually reinforcing effects of simultaneous fiscal stimuli.

And So Far, Then,  Germany Has Played a Delaying or Resistant Policy

Explaining why, as well as predicting what the German government will do, is the aim of the buggy long commentary posted at Economist's View.  Click here for the bugged out analysis.  And click right below here for the rest of the buggy commentary . . . lots of it.

Keep in mind one thing about the link.  It was originally posted this morning (December 16, 2008).  Professor Thoma then singled it out in a sidebar on the right side of the thread as something for all visitors to his site to look at.  And as you can see at this link, it elicited a couple of immediate replies.

For some reason, though, Professor Thoma then removed it in later web-views of that thread at his site . . . including the permanent link. Prof bug can't say why for sure, but probably he had second thoughts about the length of the buggy stuff.  Well, it's his site and his right, and there are no hard feelings on prof bug's side if that is the case.  Prof bug will, though, check in a day or two to see if the existing link still works (it has done so throughout most of the day). 

If it doesn't, he will then remove the link and post the entire buggy commentary here.

Oops!  

As it turned out on December 17th, 2008, Prof Thoma did remove the long buggy commentary, sending it--- who knows for sure? --- into the dark forbidding space in some cybernetic black hole beyond human reach.  Never mind.  Not to worry. 

Clever prof bug, by now thoroughly case-hardened to find some of his commentaries posted at other web sites cast out as toxic and sent packing to some sort of eerie interstellar garbage-dump, has learned to keep a copy on his own hard-drive . . . a kind of incandescently inspired insurance-policy against an ill-fated reception elsewhere.  You never know, right?  Can't be too careful these days, no?  And so what follows is that long commentary, saved from an electronic death in some dark and dismal interstellar graveyard where the gravitational field is so powerful no visible light can penetrate beyond its horizon.

 

AND SO, MEINE DAMEN UND HERREN, WE MOVE ON TO EXPLAIN AND ILLUMINATE         THE REASONS GERMANY HAS BEEN A FISCAL-SPOILSPORT IN THE EU AND MADE PAUL KRUGMAN UNHAPPY

1) Hey people! --- or should I say more elegantly John-and-Jane Q. Public?--- there's been a lot of shouting and exchanges of surly put-downs in these 115 posts up to now in this Economist's View thread, little else.  And so, right off the bat now, My Fellow Citizens, not to forget meine Damen und Herren from Mitteleuropa, a few facts about the Germany and its relations with others --- not just the US (or France or Britain or the EU Commission or poor Paul Krugman) --- might help to clarify and refocus the so-called  discussion that's been reeled out here so far with freaked-out rancor, little else. 

Who knows?  It may even tone down some of the venom and nationalist recriminations and enlighten one and all about the actual subjects at issue . . . the commentaries on which, up to now, have largely been on the level of testy Dick and Jane primer-stuff, nicht wahr?

Ha Ha! Time to fess up, prof bug's only been fooling around in the last paragraph

Fact is, these sweet, impeccably benign and courteous words about the buggy guy's fellow posters didn't really appear in the version that Prof Thoma originally singled out in his blog as particularly interesting for his visitors . . . only later, with cranky second-thoughts, to take out his ray-gun and use bursts of laser-force to send the sober, totally academic buggy stuff skyhooting into an intergalactic dumpster so far out in outer space that no telescope currently in use can even see it.  f

Fact two is, Mesdames et Messieurs, Señoras y Señores, und meine Damen und Herren, the bugged-out prof can't help it right now.  It's late in the afternoon, you see, and he needs to keep his spirits up before the sun disappears over the horizon and he can reinvigorate his dwindling mental energy with, guilt-free, a super-size glass of iced chardonnay.  From, needless to add, the renown vineyards of Santa Barbara County just over the 4000 foot Santa Ynez mountains just two miles behind the city . . . made famous, world-wide, by the film Sideways with the uncommonly talented Paul Giamatti of 2004 lore.  Click here for a good review in Food-and-Wine Magazine.

Actually, when you get down to it, the film was disappointing, no?  Among other things, it hardly captured the startling beauty of the Santa Ynez valley, full of vineyards and horse-ranches, with gorgeous Lake Cachuma plunked in the middle of it all and the steep coastal mountains on two sides . . . plus, let us not forget, the 8000-high peaks and ridge-line of the next mountain chain 20 miles to the east and south where the last North American condors live. 

None of this striking scenery showed up in the film, a masterpiece of botched cinematography.

2) Back now to the topics in need of clarity and enlightenment

Specifically, consider these five facts about the German economy:

  • Germany finally achieved good, solid, if not impressive GDP growth in 2006 and 2007 after, please note, about 12 years of stagnant growth that was rivaled only by Japan . . . the two countries racking up the worst GDP performance among industrial countries since the Great Depression.

  

  • The new return to decent growth --- about 2.3% annually in 2006 and 2007 --- rested almost exclusively on export-oriented growth . . . about 60% of domestic industrial output oriented toward such exports. (The manufacturing sector, along with construction, is about 32% of GDP . . . an extraordinary figure for a country with 80 million prosperous people and about 2.5 times higher than in the US or Britain (300 million and 65 million or so).

 

  • Note that the strong export surge testifies to the laudable efforts of mid-level and large exporting firms to restructure, upgrade, and reduce labor costs . . . the success here all the more impressive because it was carried out after 2002 under steady pressure from an overvalued euro: most of the time in the $1.40-$1.50 exchange rate. Only in late 2007 did German internal demand begin to play a role in the recovery.

 

  • In short, the German economy depends largely for growth on robust demand for its exports world-wide . . . whether from neighboring EU countries (in or out of the Eurozone), the US, Russia, Iran, the Middle East, and Asia.

  • Something else helps explain the righteous --- or, depending on your view, self-righteous --- attitude of the Merkel government and German public opinion.  The revival of the German economy, led by thrusting export growth, also reflected some tough market-oriented reforms of labor markets that started earlier in this decade in the Social-Democratic and Green-Party coalition-government and were intensified with the 2005 election of the wider coalition government headed by the Christian Democrats . . . with Angela Merkel the Chancellor and, it's worth noting here, generally far friendlier to the US than was the case of the previous government headed by the Social-Democratic Gerhard Schroeder. 


3) Against this background, what follows for German governmental interest in fiscal stimuli policies?


For one thing, to put it tersely, the German coalition government has little incentive compared to its neighbors in West Europe --- Britain, France, Spain, Italy, or even small Belgium, never mind some in desperate conditions in the eastern region of the EU --- to increase its federal deficit with a big German policy of fiscal stimuli. Why? Because, until recently, its government and big export firms --- tied closely to legions of suppliers all over the country --- thought they could let other countries, including the US and Germany's EU neighbors, resort to fiscal stimuli of aggregate demand and reap the benefits without increasing their own governmental deficits and national debt.  (Observe the underlined emphasis: it will be clarified momentarily.)
Enter, for another thing, an added motive: electoral this time

Next September, you see, general elections will occur; and until the last month or so, Chancellor Merkel and her fellow Christian Democrats --- watching, with glee, the spiraling internal fights among the Social Democrats in coalition with them and the Christian Democratic Party's main electoral rival  --- assumed they would sweep to victory in the elections and so be able to govern without relying on the Social Democrats.


4) Wait though! 

As it happens, these blithe assumptions --- 1) that Germany has recovered sustained GDP growth, 2)that there's no need for big fiscal stimuli in Germany itself, and that, pow! 3) the Christian Democrats would sweep to victory in September, applauded by a grateful German electorate (always antsy about personal and national debt)  --- have quickly begun to melt away.  And especially in the last couple of weeks.


For Germany, as it turned out with reports of GDP growth in the third quarter, entered recession earlier this year. In particular, it grew a -0.4% in the 2nd quarter and a -0.5% in the 3rd. No one knows what the current quarter's growth will be, except it will almost certainly be worse.

Meanwhile, the Bundesbank has predicted, along with the OECD, that German GDP will fall about 0.8% next year. That is likely to be way too optimistic.  The Deutsche Bank, which has a good economics division, predicts a decline of - 4.0%. 


5) What are the underlying causes of the swift decline of the German economy since March of 2008?

First and foremost, a country like Germany --- or (to a lesser extent) like China and Japan --- depends heavily on export-led growth as its main driving force of employment and domestic production.  In 2007, to clarify in passing, German GDP in PPP terms amounted to $3.320 trillion. And exports were $1.4 trillion . . . or just about 40% before taking into account imports.   
Net exports, of course, were lower: specifically, $279 billion. And here's the bad news: all of Germany's its main trade partners --- the US, Russia, the rest of the EU, China, and the Middle East oil-rich countries --- are all entering recession, some rapidly so.

Enter a clarifying point or two about GDP and export-led growth, and not just in Germany.  They should help illuminate, theoretically speaking, the current German dilemma, which has been slighted in the discussion so far.


Bluntly put, to focus on "net" exports as a contributing component to GDP misses the key point about export-led growth: through spillovers and linkages to the rest of the economy, exports growing at 9-10% a year --- when they constitute as in Germany or China around 40% of domestic production --- is too limiting. It ignores how such export-propellant removes the need of the German government to stimulate internal demand in a country of 80 million prosperous people. Much smaller countries in the EU like Holland (15 million) or Sweden (10 million) are, of course, even more dependent on exports; but they have no choice --- it's the only way for them to nurture and develop the economies of scale needed by their manufacturing industry. )


What follows?


Just this: Germany's ability to sustain steady year-to-year growth in GDP and in employment is largely at the mercy of vigorous economic growth around the world. And not just in the US or West Europe or Asia or the Middle East, you understand. As it happens, German exports to Russia have increased about 25% a year since 2005 and are now going to top somewhere over $80 billion this year.


On this last score, note something else: the significance of trade with Russia can't be grasped by dollar terms alone. Germany is Russia's main Western partner in not just trade, but foreign investment, and both have been growing rapidly. Over 4000 German firms are active in the Russian economy.- On the flip side, Germany is far more dependent on Russia pipelined gas and oil for its energy; in fact, hard to believe, it has no port facilities now for bringing in natural gas by sea from elsewhere.


 

6) Enter now center-stage the controversy sparked by the Krugman article

Leave aside the hurt or aggressive nationalist feelings on all sides --- American, French, British, Germany . . . what have you. It's all irrelevant.

In the EU, to get down to basics, the German government in the Merkel era has been doing nothing more than what Britain and France have done for decades: assert first and foremost the country's national interests as it defines and pursues them.

This is in contrast to the traditional German stance going back to the mid-1950s when the pioneer moves to create the current EU emerged.   For decades --- in part owing to German self-inhibition after WWII, and in part because of the the vigor and size of the German economy compared to the other major countries in the Western sectors of the EU (at any rate down to the 1990s) --- German governments of all political leanings played a highly conciliatory role. 

  

Take the creation of the Eurozone and Central Bank, decided on in the early 1990s. 

It was never popular in German opinion.  It was even strongly opposed at times.  What motivated German acquiescence in the French initiative behind the Eurozone was political.  In particular, what with German reunification in 1989 and the flurried alarms it caused in most of the rest of West Europe, the German government agreed to give up the German Mark (DM) for a regional currency and to substitute a European Central Bank for the German Central Bank,  and all essentially to reassure the rest of West Europe about the future of German power. 

Alas, for reasons that had nothing to do per se with the Eurozone (which came into existence only in 1999 anyway), German economy went into tailspin after 1991 and remained in stagnation for the next 14 years

In more concrete terms, the miserable growth performance of Germany between 1992 and 2006 was the worst in West Europe by far and was rivaled in the industrial world only by the Japanese stagnation, though without deflation. Note though.  Unlike the Japanese, eventually German governments did start in the early part of this decade to carry out market-oriented reforms: it freed up much of the labor market, it reduced unemployment benefits --- very toughly so, please note --- and prodded German export-oriented industry to carry out its impressive renovation.


7) By then --- in the current decade --- German politicians and top bureaucrats had decided, though, that they had no reason any longer to be the major conciliatory power in the EU.

Or for that matter in NATO, above all when it came to the behavior of the SDP-Green Coalition government that held power until 2005.  The SPD Chancellor, Gerhard Schroeder as  you might recall, won re-election in September 2002 largely on an anti-Bush, anti-American campaign over Iraq while, simultaneously, exploiting the growing resentments in Germany --- and elsewhere in Europe --- about the overarching thrust of Bush's assertive style and policies in foreign affairs.

Recall further here that the demagogy by Schroeder --- no other word for it in the run-up to the 2002 election --- then led Germany, much against the wishes of his Green Party Foreign Secretary --- to form a countervailing coalition with France and Russia against the American-British-Spanish-Italian-Dutch-Danish - and yes, East European NATO members over Iraq and the war that started there in the spring of 2003. Since 2005, however, Angela Merkel's Christian-Democrat/Social-Democrat government has been openly friendly with the Bush administration . . . almost as much, and even mores surprisingly so, as the behavior of President Sarkozy and his 2007 elected center-right government.

  

There are, though, some tensions that still mark Germany's odd-man-out behavior now and then in NATO, and not just with the USA --- but also Britain and France and other West European countries except notably Silvo Berlusconi's government.  These tensions concern mainly Russia.

Remember, it's been the biggest growth country for German exports and investments . . . those exports booming ahead at 20% a year since 2005 until the oil-price crash this summer and fall.  Enter the Russian invasion of Georgia (whose own government acted rashly last summer too).  The Merkel government did little more than utter some general statements about human rights.  Otherwise, even before the Russian invasion, German diplomacy had opposed US and other initiatives to move NATO more quickly to include Ukraine and Georgia as members. 

To an extent, too, Germany --- which is the major trading partner of Iran --- has tended to oppose tougher economic sanctions supported by France, Britain, the US, and others. In fact, though, it's largely Russian and Chinese resistance that is the principal obstacle here, not Germany.  Something else worth stressing here.  It's personal.  Angela Merkel and Sarkozy do not like one another, and that probably explains part of the cozier French relationship with George Brown's Britain . . . not just on foreign policy matters, but the critical issue of an EU coordinated expansion program.

 

8) So where are we?

Right here in the real world. Specifically, it's the economic realities on the ground --- not German nationalism per se, nor any of Chancellor Merkel's political calculations about the forthcoming elections next September --- that are currently driving German economic policymaking.

The Germany economy, to repeat --- heavily dependent on export-led growth --- has slipped into recession.  Its GDP and unemployment levels will, without large fiscal stimuli --- and expansion of credit-cards and other encouragements to stimulate domestic consumption --- likely suffer even more than some of its West European neighbors . . . considered by German opinion as profligate.   Just recently, for these reasons, the Merkel government adopted an initial (if small) domestic package of fiscal stimuli, but even more importantly, it has committed itself to create a larger one in January.

Nor is that all.  At the recent EU Summit meeting last weekend a $200 billion EU collective expansion program . . . itself not that large, but almost certainly only the start.

 

Wait though! 

As it happens, there do remain some core differences in economic policymaking that divide Germany from its big neighbors in both the Western and Eastern sectors of the EU, whether in or out of the Eurozone.

Namely? 

  • On the ideological front --- whether ideas, ideals, or preferences --- German politicians and policymakers of all political stripes would very likely prefer to see the country's economic well-being as largely dependent on its impressive export-performance and export-led growth.

  • Similarly, on the same ideological front, they will be reluctant to stimulate domestic demand, whether by means of tax cuts, fiscal stimuli, or credit-card and other forms of credit-expansion for German households except as a last resort. 

 

  • And they will continue to see Russia, with its vast energy and other resources --- including the prospects of about $500 billion infrastructural improvements targeted in that country for the next two decades or so --- as a huge boon for German exports, investments, and multinational activity.


9) But that's on the level of preferences, ideas, and hopes attached to them.

Plain and simply, the current economic realities in Germany and among its trade partners world-wide, not just in Europe, run counter to these preferences and hopes in even more basic ways than just mentioned. 

In particular, as German export markets dry up even more, the Merkel government not only will need a big fiscal rescue program --- just like its EU neighbors; on top of that, its economy's rapid decline into recession has already generated a growing backlash in German opinion about the government's tardy and reluctant interventionist policies --- not least an expansion of aggregate demand. Click here for the Spiegel's view (Der Spiegel a big influence on mainstream opinion in Germany)

Which brings us to the charge, embraced by the German media and public opinion, that others --- the Spanish, the Irish, the British, and above all the Americans --- are sinful wastrels, the empty-pocket scourges who underwent a huge housing boom . . . but not the careful, pocket-squeezing Germans themselves.

Oh?

Contrary to what a few posters here have said, the German economy might not have experienced the same level of unsustainable housing-booms that have marked the US, Britain, Ireland, Spain, and to a lesser extent France and Italy in this financially go-for-broke decade.  Even so, their banks are even more exposed to financial crisis than US banks, and by far . . . at any rate, if measured by the mix of troubled assets as liabilities compared to banking equity.

  

Want some evidence? Consider an article on all this, with a good diagram , that appeared in the NY Times on Oct 12, 2008  Be sure to click on the little image there; it will then open into a large graphic.  For those who aren't registered to access the NY Times, here's a table with a few countries and relevant data:

 

 Country

 Short-Term Bank
Liabilities as a %
of National Debt

Same Liabilities
as % of GDP 

Leverage Ratio:
Bank Assets /
Net Worth 

 Belgium

 367%

 285%

 33:1

 Switzerland

 1273%

 280%

 28:1

 Britain

 368%

 256%

 29:1

 Spain

 134%

 36%

 18:1

 Italy

 86%

 43%

 12:1

 France

 128%

 60%

 28:1

 Germany

 167%

 60%

 52:1

 USA

 43%

 15%

 12:1

 

As you can see, the German banks are in far worse shape than their American equivalents, though Britain's among the large EU countries are the most troubled.  French banks also are loaded with far more leverage than US banks. 

 

There's a lesson to be drawn here.  When you are told that the USA has been the source of financial meltdown globally, it's partly true --- at any rate, if this claim means that the low-interest rates maintained by the Federal Reserve in the early and mid-part of this decade encouraged the speculative explosion and greed-driven collapse of good credit-analysis that spread world-wide.  But again: only partly . . . the US as the catalyst.  What ensued globally --- not least in the EU --- shows that risky derivatives and other assets that are likely troubled were no better regulated in Europe or elsewhere than in the US.  What's more, European banks look like being even more reckless and risk-taking than their American counterparts.  

We can go further. 

Of the 15 European countries that apear in the NYT diagram --- 10 of them in the Eurozone --- only the banks in Poland and Norway turn out to  have been more cautious than those in the USA.  Norway is not in the EU.  Poland is in it, but not in the Eurozone.   (A surprise here is the leverage rate of Italian banks: the same as for their American equivalents.)  What's more, a detailed study in September 2008 showed that the leverage ratio --- assets to liabililties --- was 50% higher for the biggest 12 West European banks than for the biggest 12 American ones: more specifically, an average ratio of 30:1 vs. 20:1.

 

10) A pretty long analysis, no?

Much longer, to my surprise, than when I started out an hour or so ago (had to look up a fair number of figures and other data). 

Given all we've said, fa prediction now follows: fairly soon, say into the middle of the spring --- elections imminent in September --- the Merkel government will be pursuing expansionary policies that may differ somewhat from those in Britain or France or elsewhere in the EU, but stimulate aggregate demand one way or another and vigorously so will be very much on the agenda.

...............


Michael Gordon, AKA, the buggy professor

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