Friday, 15 August 2014

The Bundesbank is not demanding an increase in German demand

Yesterday's very bad news that growth has stopped in the the Eurozone reflects the lack of a realistic demand model: the ECB and much of the Eurocrat establishment see the key to growth as holding down worker wages in order to stimulate exports, but
  • exports are and will remain too small to be an engine of growth for the Eurozone, especially because
  • this strategy suppresses domestic demand, raising the amount of growth impulse needed.
So where is the demand going to come from?  As the Eurozone's largest economy, Germany has a huge influence on aggregate demand. That it has practised a policy of wage restriction makes recovery much harder throughout the currency block.

On this backdrop, it's worth evaluating the Bundesbank's recent intervention in the discussion on wages in Germany. To foreshadow my conclusions:

  • there is little evidence that the Bundesbank has embraced a demand-led growth model for Germany or the Eurozone
  • the Bundesbank's intervention focused on collectively bargained wages, but it's raising wages set outside collective bargaining that is the key issue

Emergence of the debate

In a meeting with union leaders and economists in July, the Bundesbank chief economist Jens Ulbrich told them (more background) that the time for wage restraint was over.  This was already creating something of a stir before Bundesbank chief Jens Weidmann (previously discussed) said a 3% raise for workers would be justified by a 1% increase in productivity and the ECB's 2% inflation goal (much higher than actual inflation in Germany).  

Weidmann's intervention raised something of a ruckus. Employers were not amused and even a man who had called for a German government far to the left of the one now in power wrung his hands about strengthening labour's bargaining position. From a different perspective, Francesco Saraceno hailed this as a big, positive change:
The call for wage increases in Germany signals, and it was about time, that even conservative German institutions are beginning to realize the obvious: there will be no rebalancing, and therefore no robust recovery, unless German domestic demand recovers. This means a fiscal expansion, as well as private expenditure recovery. Unsurprisingly, the Buba rules out the former, but it is nice to see that at least the latter has become an objective. Faster wage growth may not make a huge difference in quantitative terms, but it still marks an important change of attitude. This is a huge step away from the low-wage-high-productivity-export-led model that the Bundesbank and the German government have been preaching (and imposing to their partners).
A shift to promotion of German domestic demand would indeed be a welcome development (Dieter Wermuth makes a good case for it), but Weidmann's statement does not reflect such a shift.

The Bundesbank has not converted to a demand-stimulus model

Crucial context for understanding Weidmann's statement comes from his recent speech in Spain
In any case, deliberately weakening the competitiveness of Germany's export sector would harm, rather than benefit, the stressed countries' economies. We should bear in mind that German exports contain imported intermediate inputs from other euro-area countries amounting to 9 % of the overall added value. 
If Germany were to accept the economic advice to excessively boost its wages in order to stimulate domestic demand, it would harm employment in Germany and, as a consequence, the economic situation in the entire euro area as simulation results show. 
Despite this, it is clear that against the background of Germany's strong cyclical position and the tight labour market, wages will rise faster than in the rest of the euro area. We expect effective wages to rise more than 3 % this year and next year.
Note, first, the explicit rejection of the idea that German wage policy should be based on stimulus of domestic demand--a point he repeated almost word for word in the interview that set off the kerfluffle.

Note, second, the report of the 3% number as a prediction, rather than a goal. (In fact, Weidmann denied that the Bundesbank was making a suggestion about wage levels, something missed in a lot of the coverage.) If Weidmann really wanted to promote German demand to help the Eurozone, he could have pushed for a number above the trends. German Keynsian economist Peter Bofinger, for instance, called last year for a 5% increase in wages to promote Eurozone rebalancing.

This year's collectively bargained wage round is producing raises of just over 3% (though weighted ad personam, not ad valorem, apparently). So Weidmann's statement was hardly designed to move the trend.

So if increasing demand wasn't Weidmann's target, what was? There seems every reason to accept his own justification--namely, that he was trying to ensure that wage negotiations were based on inflation expectations in line with monetary policy, just as the Bundesbank did in the past. It's simply that this time the issue is inflation expectations are too low, rather than too high.  There's no sign that this is based on an underlying economic model in which demand is crucial.

Collectively bargained wages are not the key issue

Germany is famous for its highly co-ordinated wage setting mechanisms.  However, only half of German workers are covered by coordinated wage bargaining arrangements.  Furthermore, although collectively bargained wages in Germany lagged productivity before the crisis, they've done some catching up since (see chart).
Source: productivity from Eurostat, converted by me from GDP deflator to HICP deflator, whole-economy hourly compensation from OECD, bargained wages from Statistisches Bundesamt

The chart reveals that it's clearly the non-unionised workers that have been dragging German wage levels down. And Weidmann in fact has argued against recent measures to introduce a minimum wage in Germany. It's clear that he continues to view wages primarily as determinants of costs rather than determinants of demand.  

In sum, for all that we should welcome the Bundesbank's willingness to countenance wage rises, it's still a long way from backing the sort of demand-led policy that could turn the Eurozone's economic crisis around.  

Thursday, 7 August 2014

Draghi's duplicity on the relative importance of structural reform and demand for investment

Mario Draghi once again cited the importance of structural reform at yesterday's ECB press conference, suggesting weaknesses in structural reform (his examples had to do with the ease of opening businesses) explained weak investment. of the components of the low GDP figure for Italy is the significantly low level of private investment, while one would observe a rebound in private consumption. As far as private investment is concerned, one observes a very low figure, especially low figure of private investment. This isn’t unique in the euro area. The levels of private investment for the euro area as a whole is low, and certainly much lower than it is in other parts of the world, like in the United States. 
Then we ask ourselves why this is so. Now, certainly it’s not the cost of capital, because interest rates, nominal and real interest rates, have been low. And in some parts of the euro area they are negative, and have been negative for quite a long time.
So the answers are: one has to do with expected demand. But the second answer has to do with the reforms, uncertainty, the general uncertainty the lack of structural reforms produces a very powerful factor that discourages investment. 
There are stories of investors who would like to create, to build plants and equipment and create jobs, but it takes them months to get an authorisation to do so. There are stories of young people who tried to open their business, and it takes 8 to 9 months before they can do so. That has nothing to do with monetary policy. 
So it’s mostly the lack of structural reforms. I keep on saying the same thing, really – reforms in the labour market, in the product markets, in the competition, in the judiciary and so on and so forth. These would be the reforms which actually have and have shown to have a short-term benefit.
Ok, so here's a very simple test of that claim. If low investment mostly has to do with the lack of structural reform, rather than demand, we ought to see no significant variation in investment levels during periods of high versus low demand.  

Source: Eurostat, defining investment loosely as gross capital formation
To say low post-crisis investment is explained "mostly [by] the lack of structural reforms," is, not to put too fine a point on it, to lie. That arranging investment is harder than it should be is bad. But it's blatantly obvious that these difficulties were compatible with much higher levels of investment in the recent past.