4 Lectures on the €uropean crisis

1. 4 Lectures on the €uropean crisis • Lecture 2: Events

2. Lecture 2: the events • The events in Europe: emphimeral peripheral growth and the German mercantilism

3. The origin of the crisis in capitalism • Capitalism is based on the appropriation by the capitalist class of the social surplus. • The social surplus S is what is left of the social product P once wages N (necessities) have been paid: S = P - N • The open question is: who is going to buy S, what Marx called the ‘realization problem’. Part of S is bought by the capitalist themselves as luxury goods and part as investment goods, but this is not generally enough. • Rosa Luxemburg and Michale Kalecki argued that capitalism needs ‘external markets’. • Examples of external markets are: Government deficit spending; autonomous consumption financed by consumption credit; foreign markets (for a single economy, there are not foreign mkts for the world as a whole).

4. The origin of the crisis in capitalism (cont) • Kalecki’s idea was that capitalists anticipate, through the financial system that can create liquidity, the purchasing power to the external markets  banks finance consumers’ credit, the central bank finances gvt deficits, banks finance banks in foreign countries (chat in turn finance consumption or residential bubbles). • The problem is that consumers, States, foreign nations become indebted with banks (or banks in the periphery with banks in the core), in final with the capitalists themselves. • This is a lesser problem for States, as long as they retain their central bank (they are always solvent snce they can print money). Note that the European periphery has given up its central bank.

5. The origin of the crisis in capitalism (cont) • You may apply this model to the US crisis: consumers’ credit sustained aggregate demand and growth in the last 25 years or so, up until the model did not collapse (once too marginal consumers were involved) • You may apply this model to the European crisis where core-Europe financed consumers credit, and sometimes gvt deficit spending in the periphery up until the model did not collapse (once it was clear some countries were not solvent). The credit-debt relation within the EZ are the ‘European imbalances’ • Economic growth in the US drove economic growth in China where the US MNEs had transferred production to weaken the American workers’ bargaining power. • This generated the so-called ‘global imbalances’ (actually (CH-US).

6. Europe: this time was not different • The European crisis appears as the n-th “this time is different” episode: • financial liberalisation + fixed exchange rates  capital flows from the centre to the periphery  housing bubble  current account deficit and indebtness  “sudden stop” of capital inflows  default (?) • I personally find Reinhart and Rogoff (2009) a non well-organised account of the history of defaults, but the title really conveys the sense of this history. Seminal explanations Diaz-Alejandro, C. (1985) Good-bye financial repression, hello financial crash (excellent title also) and Frenkel & Rapetti CJE 2009

7. In a point F&R were not prescient (this is not a criticism!) • “[this paper ] argues that the factors that trigger the booming phase preceding a financial crisis are different in developed and developing countries. The conditions that have led to financial crises in developing countries typically arose from the implementation of macroeconomic policies, which created incentives that ended up generating the boom-and-bust cycles. On the contrary, in developed countries the elements that trigger the booming phase have developed endogenously within the domestic financial systems.” • Well, the EZ case shows that similar events may take place also among developed countries. But, indeed, also in the EZ a core and a periphery are distinguishable.

8. De Grauwe in 1998 was impressingly prescient • “Suppose a country, which we arbitrarily call Spain, experiences a boom which is stronger than in the rest of the euro-area. As a result of the boom, output and prices grow faster in Spain than in the other euro-countries. This also leads to a real estate boom and a general asset inflation in Spain. Since the ECB looks at euro-wide data, it cannot do anything to restrain the booming conditions in Spain. In fact the existence of a monetary union is likely to intensify the asset inflation in Spain. Unhindered by exchange risk vast amounts of capital are attracted from the rest of the euro-area. Spanish banks that still dominate the Spanish markets, are pulled into the game and increase their lending. They are driven by the high rates of return produced by ever increasing Spanish asset prices, and by the fact that in a monetary union, they can borrow funds at the same interest rate as banks in Germany, France etc. After the boom comes the bust. Asset prices collapse, creating a crisis in the Spanish banking system.” 1998!!!!! • We are living a De Grawe moment: http://politicaeconomiablog.blogspot.it/2012/05/de-grauwe-moment-impressively-prescient.html

9. The failure of the neoclassical explanation of international capital flows • The simple patterns of events financial <liberalisation + fixed exchange rates  capital flows from the centre to the periphery  housing bubble  current account deficit and indebtness  “sudden stop” of capital inflows  default> clearly suggests that external financial inflows do not finance domestic investment (or not necessarily), but consumption, mainly housing, bubbles. • This empirically disproves the neoclassical theory that capital flows from saving-rich/trade-surplus core-countries towards saving-deprived/trade-deficit peripheral-countries help the catching up of these countries. (Blanchard & Giavazzi 2002) • Saving do not determine investment neither in closed nor in open economies (the world is, after all, a closed economy)  the results of the capital theory controversy provide the rational for the empirical disproof). • Martin Wolf points out that peripheral countries have little space to invest in manufacturing/export capacity given fierce competition from mercantilist countries; so they invest in non-tradable sectors

10. The failure of the neoclassical interpretation and the Keynesian explanation • Moreover, foreign saving/trade surplus in the core are the result of the trade-deficit in the periphery: the story of the financial crisis validates the Keynesian story that financial credit precede (investment and) autonomous consumption, and that saving is an ex-post result. • Reinhart and Rogoff are indeed totally contradictory when they share Bernanke’s saving-glut hypothesis; how could China obtain a trade-surplus if the American household did not spend in the first place! • Blanchard and Giavazzi applied the neoclassical causality to explain capital flows in Europe as a result of a catching up process of the South (although they note that the saving rate in the periphery was falling, not investment rising). • The same argument we hear in Europe from Germany: German savings financed the peripheral profligacy. In actual, these savings are the result of a trade-deficit in the South financed by capital inflow. • Note that the situation has been made worse my the symmetric mercantilist policies adopted by Germany (on which more later on).

11. To sum up: the prevailing view is that the European crisis is a balance of payment crisis. A perfect kaleckian storm • Championed by Martin Wolf on the FT, this view is becoming dominant (with the exception of the German politicians and economists that continue to argue, for political reasons or ignorance, that this is a fiscal crisis). • So the model is perfectly Kaleckian-Luxemburg: capitalists in the core-country (and satellites) repress domestic wages and consumption and finance the “external markets”. • So they “realize” the domestic social surplus (S = P – N, where P is the social product and N the “necessities” to the workers) in the “external markets”. As known, S = P – N = X – M, profits are equal to net exports). • The only problem is that the periphery accumulates a foreign debt! A perfect Kaleckian storm

14. First explanation: diverging REERs

15. Second explanation: diverging ADs

16. Housing bubble

17. http://www.economonitor.com/blog/2011/12/which-graph-best-summarizes-the-eurozone-crisis/http://www.economonitor.com/blog/2011/12/which-graph-best-summarizes-the-eurozone-crisis/

19. An ECB fault? • The ECB monetary policy (one fist all, or what fits the core fits all) is often blamed for the crisis:

20. An ECB fault or a European policy fault? • Of course, I do not subscribe the Taylor’s Rule and the idea that monetary policy should have then been more restrictive, quite the opposite: it is the fiscal and wage policies in the core that had to be much more relaxed. • The figure above is indicative of the (interested) ‘benign neglect’ with which the effects of financial liberalisation and the mounting European imbalances have been looked at up to the crisis. • We must be clear about this: had monetary policy been more restrictive, given the German austerity stance, the EZ would have avoided the foreign imbalances but at the price of a generalised stagnation. • The results in terms of CA and net foreign position (or net International Investment Position)) unbalances we have seen above.

21. The specific Italian case • Italy is not a peripheral country and neither it saw massive capital inflows and an housing bubble. • The Italian public debt (PD)matured as a consequence of the EMS from 1979 (de te fabula narratur) and of the “divorce” bewteen the Treasury and the Bank of Italy in 1981. The high interest rates combined with an enduring and tollerated tax evasion determined the explosion of the debt. • During the EMU the lower interest rates permitted a reduction of the PD/GDP ratio from 120% to 105% expecially pursued by the centre-left governments. These policies and the loss of external competitiveness, led to the stagnation of the GDP and of productivity growth (I think a full account of the events has yet to be written). • In spite of the stagnation, the external account deteriorated. • This was due to the German policies (see below) but also on the persistent inflation gap with Germany • The inflation gap does not originate in the real wage dynamics (in fact real wages have declined over the last decades) but on the non-tradeble sector (that can fix prices). Anyway, Italy made an enormpus effort to reduce inflation to quasi-German levels, but you cannot beat Germany in its favourite game of having inflation always below competitors.

22. German mercantilism • Germany since Bretton Woods has always found fixed exchange rate arrangements perfectly suited to her mercantilist stance: since the time of Erhard the German strategy was to maintain the inflation rate a little below that of competitors to sustain exports while enjoying a strong currency, what has been named ‘Monetary Mercantilism’ (Holtfrerich)

23. Criticism to German (presumed) mercantilism is not new . Few examples* - The German stabilisation policies of the late 1940s/early 1950s were criticised by the American economists. - Also in the 1950s Germany preferred to blame the others: ‘inflationary policies’ abroad led to the German export upsurge and obliged her to ‘sterilise ‘imported inflation’ by pursuing a fiscal surplus. The surging of the German trade surplus led, after the American and French criticism, to the DM revaluation in 1961 - The case of the ‘locomotive theory’ is well-known: in the late 1970s chancellor Schmidt reluctantly accepted the idea that Germany had to pull the world economy along the US and Japan. The 2° oil shock came: he swore that never again Germany would have played the domestic expansion game.

24. At the origins of the German policy stance: monetary mercantilism?* • The pre-miracle German policy choices that shaped post-war Germany, in oarticular the centrality of price stability, have been denominated ‘monetary mercantilism’ by the historian Carl-Ludwig Holtfrerich. • Holtfrerich, as others (e.g. Bibow), denies that the obsessive objective of price stability by the Buba is due to the memory of the great hyperinflation of 1922. • Indeed, some economists maintain that this “memory” is a well fabricated invention by the Buba (memories are a social construct). An independent central bank is not even a German tradition (the opposite is true), and indeed Adenauer opposed it (he thought that a CB should be accountable!) • Why price stability then? Holtfrerich: “found the clue” in the early German policy decisions.

25. Monetary mercantilism (cont)* In the early 1950s “As protectionist tools could not be used…a different way of achieving mercantilism, namely export surpluses, had to be found. The solution was to keep domestic demand restrained by monetary and fiscal policies, thus keeping imports and domestic inflation low and freeing production resources for more exports. This strategy was contingent on a system of fixed exchange rates…The early Bretton Woods system…left countries the opportunity to gain in international competitiveness by realising relatively more price stability than abroad”. (The main Holtfrerich’s paper is published in a book edited by the Buba celebrating the 50° DM anniversary!) • Observe the combination of lower domestic inflation and fixed exchange rates! The same combination Germany obtained later through the EMS and the EMU!

26. Monetary mercantilism (cont)* • Monetary mercantilism was “conceived and planned” particularly by the president of the Bank deutsche Lander (the Buba was created in 1957) Wilhelm Vocke “as a long-term strategy for German monetary policy” : “keeping domestic affairs tight in order to strengthen exports”. Vocke was lucky: • 1) the Allies forced for an independent CB in 1949 when a Federal gvt was not existing yet; 2) Erhard endorsed Vocke’s policy; 3) the Korean war gave a big push to German exports and the opportunity to keep inflation lower than the competitors. • Erhard: “A great opportunity for the future of German exports has arisen out of the current situation. If, namely, through internal discipline we are able to maintain the price level to a greater extent than other countries, our exports strength will increase in the long run and our currency will become stronger and more healthy, both internally and with respect to the dollar”

27. Monetary mercantilism and Ordoliberismus* Price stability was also the obsessive policy target of Ordo-liberismus (or Freiburg school or social market economy), the dominant economic school in the reconstruction and miracle period. Price stability was associated by the ordo-liberals to the smooth functioning of the price mechanism. In practice, price stability is synonymous of wage and social discipline. • Wage and social order imply that exports, rather than wage consumption, become the natural debouche of the surplus (in the classical-marxian sense). Indeed, income distribution has never been particularly favourable to labour in Germany. • An export-oriented economy becomes in turn a powerful political instrument to obtain labour consent and discipline (reinforced by the German trade unions pursue of co-determination rather than strong wage claims why German trade unions have been so docile in the post-WW period is not clear to me yet).

28. The German model* • The success of the model in leading to improved standards of life (although income distribution, not surprisingly, has never been particularly fair in Germany) and the traditional paternalist Bismarkian welfare state did the rest. • Erhard, declared in 1953: “Foreign trade is quite simply the core and premise of our economic and social order”. • This declaration seems to allude to an export-led model as a way to enforce social order, and to social order as a way to sustain export-led growth: Social order export led growth Price stability

29. The pillars of the German model and why they do not want to give it up • The three institutions pillars of “monetary mercantilism”: neo-corporativism, mercantilist micro, meso and macro institutions and policies, and …the Bundesbank. • The former implied a direct involvement of the labour movement both at the micro and the macro level in the maintenance of a competitive system, particularly in the export sector. • At the micro-level Germany has a excellent training, educational and R&D system; at the meso-level the reliance on export-led growth creates an ideological climate that induce cooperation and discipline (Crouch 2008); at the macro level the system keep wage-growth below or in line with productivity growth. The government domestic and foreign policies have the promotion of German export as the priority. Paternalism is a traditional attitude of the German government; the sense of the national community, traditions and nature (heimat) is the main component of the “German ideology”. This perfectly suit the mercantilist tradition (Heckscher), particularly in its German version (Cameralism, Historical School) • This model has brought welfare and order in Germany: would you easiliy give it up?

30. Arsenic and Buba • But, of course, as Voltaire said: “Incantations will destroy a flock of sheep if administered with a certain quantity of arsenic” • Just in case, the watchdog role of the model was assumed by the Bundesbank in a unique wage bargaining process directly involving the central bank and the leading trade union IG-metall (Franzese and Hall 2000: 182-83). • This role of the Bundesbank as the watchdog of the German mercantilist model is very important to understand the German opposition to the reform of the ECB from its present “monetarist” constitution.

31. The Buba and the labour market* • A ‘credible’ CB was a central element of the German economic policy, where by credibility is meant that the trade unions considered the German CB commitment to fight inflation at any cost as convincing. • According to Franzese and Hall the centralised wage bargaining in Germany, led by the IG-Metall, made a peculiar interaction between the German CB and the trade unions possible: “The highly public pas de deux between the Bundesbank and the principal wage bargainers, which occurs at the time of every wage round in Germany, is a prominent feature of politics. The bank often issues pointed comments on the initial wage demands made by the union involved in the leading settlement, accompanied by detailed commentary about the state of the economy and warnings about the policy consequences of overly inflationary wage settlements. ... this kind of dialogue between wage bargainers and the central bank is completely absent from U.S. economic politics. … The Federal Reserve and the Bundesbank speak differently because they have audiences with different institutional structures”. …

32. Corporative social-democracy and mercantilism • Interestingly, the Bundesbank’s credibility was reinforced by the export-led model, given the concentration of the strongest trade union in the export sectors: “The German case also suggests that the effectiveness of such signalling mechanisms may be enhanced when the export sector is large and plays a pivotal role in wage bargaining (…). The metalworking sector, which produces the lead bargain in most years, has a high export concentration. In itself, this induces lower settlements because wage bargainers in export sectors are especially concerned to maintain unit labor costs at internationally competitive levels. Actors in such sectors are also especially sensitive to signals from the central bank, however, because the restrictive monetary policies that the bank wields not only depress the level of economic activity but also tend to appreciate the exchange rate, thereby threatening export sectors especially severely by rendering their products more expensive in world markets.” The direct involvement of the German CB in wage bargaining has been inherited by the ECB. Just recall again the two infamous rate increases in July 2008 and April 2011. • Is it a case that most (all?) northern corporative social-democracies are export-led economies (Colin Crouch)? This might be due to the smallness of those countries, but this is not the case of Germany.

33. Corporative social-democracy and mercantilism • Interestingly, the Bundesbank’s credibility was reinforced by the export-led model, given the concentration of the strongest trade union in the export sectors: “The German case also suggests that the effectiveness of such signalling mechanisms may be enhanced when the export sector is large and plays a pivotal role in wage bargaining (…). The metalworking sector, which produces the lead bargain in most years, has a high export concentration. In itself, this induces lower settlements because wage bargainers in export sectors are especially concerned to maintain unit labor costs at internationally competitive levels. Actors in such sectors are also especially sensitive to signals from the central bank, however, because the restrictive monetary policies that the bank wields not only depress the level of economic activity but also tend to appreciate the exchange rate, thereby threatening export sectors especially severely by rendering their products more expensive in world markets.” The direct involvement of the German CB in wage bargaining has been inherited by the ECB. Just recall again the two infamous rate increases in July 2008 and April 2011. • Is it a case that most (all?) northern corporative social-democracies are export-led economies (Colin Crouch)? This might be due to the smallness of those countries, but this is not the case of Germany.

34. Social-democratic mercantilism* • As seen, export led-growth is also functional to secure labour acquiescence and discipline, solving therefore the second Kaleckian concern about the inconsistency of full employment and capitalism. • Germany appears as a high-productivity/low wage economy. This is a classic definition of a mercantile country. • The model, in the German case, is self sustained in the sense that it brings about social and distribution discipline (associated to decent standards of living), that in turn supports the model. • The question is the international sustainability of the model, but perhaps Germans see themselves as a small player at the global level so that they expect the world to tolerate this policy. But they have to solve the European situation first. • There is no reason why Germans (of any social class) would like to abandon the model, so be politically realist and do not talk of European solidarity.* • *See my The European crisis: political and institutional failures or method in the madness? In www.networkideas.org, re-published by www.irishleftreview.org

35. References • Cesaratto S. (2013). Controversial and Novel features of the Eurozone Crisis as a Balance of Payment Crisis, in Febrero E. et al., editors, Post Keynesian Views of the Economic Crisis and its Remedies, Routledge, 2013. Working paper: http://www.econ-pol.unisi.it/dipartimento/it/node/1649. • Cesaratto S., Stirati A. (2011) Germany in the European and Global Crises, International Journal of Political Economy, vol. 39, no. 4, Winter 2010–11, pp.56–87; working paper version: http://www.econ-pol.unisi.it/dipartimento/it/node/1267 • Cesaratto S. (2011), Europe, German Mercantilism and the Current Crisis, Quaderni del dipartimento di economia politica, in Brancaccio E., Fontana G. (a cura di), The Global Economic Crisis. New Perspectives on the Critique of Economic Theory and Policy, Routledge, London. Working paper version Quaderni del Dipartimento di Economia politica,, n. 595 (www.econ-pol.unisi.it/dipartimento/it/quaderni)