August 07, 2002

The German Economy Remains Stuck

Actually, the links between the German and the American economy are not that strong--save for the fiber-optic and satellite communications links that transmit shocks of business and investor confidence from one country to the other. There is no fundamental reason for the U.S. and German business cycles to be linked. But they are.

I keep on expecting the kind of virtuous circle of fast productivity growth and falling unemployment that the U.S. saw in the 1990s to emerge on the European continent. Prime Minister Schroeder thought his first term would see such a virtuous circle emerge. He has been wrong.


Germany: Schroeder's Millstone

...Germany's economic fortunes are closely linked with those of the rest of the world and with the United States in particular. As America slipped into recession last year, so did Germany. Unlike the United States, however, Germany has not enjoyed much of a recovery, even a weak one. Europe's largest economy is now barely growing. The widely-reported headline figure for unemployment--before seasonal adjustments have been made--is now above 4m, within a whisper of the level Mr Schroeder inherited from Helmut Kohl four years ago. At 9.7%, the rate is one of the highest in the euro area, and substantially above unemployment in Britain or America.... What is now obvious to German voters is that Mr Schroeder has failed to deliver the more dynamic economy he promised. He has also managed to upset both the unions--the SPD's traditional supporters, who feel he hasn't done enough for their members--and employers, who argue he has not done enough for them, and has failed to tackle the problem of over-regulation which has long hampered German competitiveness. A series of high-profile strikes earlier this year, the first large-scale walkouts for many years, did enormous political damage to Mr Schroeder's government, although it was not itself directly involved in them...


Schröder’s millstone
Aug 7th 2002
From The Economist Global Agenda


Yet more gloomy economic figures released in Germany this week will make Gerhard Schröder's uphill battle for re-election, which he launched on Monday, more difficult


GERHARD SCHRÖDER kicked off his general-election campaign this week at the head of a dispirited party with many people in Germany convinced that he will not win re-election as chancellor when voters go to the polls on September 22nd. No one denies that he has a battle ahead of him. The ruling coalition, which comprises Mr Schröder’s Social Democratic Party (SPD) and the Green Party led by foreign minister Joschka Fischer, is trailing in the opinion polls. And then on Wednesday August 7th came the one thing Mr Schröder fears the most—bad economic news. Newly published government figures show another rise in unemployment and an unexpectedly large drop in manufacturing orders.

The jobless figures pose a particular problem for Mr Schröder. In the 1998 election, he promised to cut unemployment, arguing that, if his government failed to do so, it would not deserve to be re-elected. Bold words and, with hindsight, unwise ones. Unemployment did fall in the early part of Mr Schröder’s term. But as the chancellor now realises, Germany’s economic fortunes are closely linked with those of the rest of the world and with the United States in particular. As America slipped into recession last year, so did Germany. Unlike the United States, however, Germany has not enjoyed much of a recovery, even a weak one. Europe’s largest economy is now barely growing. The widely-reported headline figure for unemployment—before seasonal adjustments have been made—is now above 4m, within a whisper of the level Mr Schröder inherited from Helmut Kohl four years ago. At 9.7%, the rate is one of the highest in the euro area, and substantially above unemployment in Britain or America.

The German finance ministry tried to put the best possible gloss on the very large drop in manufacturing orders, which were down by 3.2% in June compared with May—more than double the fall predicted by economists. Officials pointed to the fact that the rise in orders had been unusually high in May. In fact, when the three-month figures are analysed, the picture looks less alarming. But the level of overseas orders is especially important for German manufacturers: any prolonged downturn in America, for example, would be painful. And the ordinary voter is not going to notice anything other than headline totals reported by the media.

What is now obvious to German voters is that Mr Schröder has failed to deliver the more dynamic economy he promised. He has also managed to upset both the unions—the SPD’s traditional supporters, who feel he hasn’t done enough for their members—and employers, who argue he has not done enough for them, and has failed to tackle the problem of over-regulation which has long hampered German competitiveness. A series of high-profile strikes earlier this year, the first large-scale walkouts for many years, did enormous political damage to Mr Schröder’s government, although it was not itself directly involved in them.

The government has also failed to tackle the problem of the gap between the relatively better-off West Germany and the depressed former East Germany. Unemployment in the East is around 20%. The slight improvement in the eastern provinces which was revealed in the latest figures is unlikely to impress many voters. Recognising that it needs to do more in the East, Mr Schröder’s campaign managers have decided to focus particular efforts there, with an emphasis on job-creation programmes and public-works projects a key element of their electoral agenda.

Mr Schröder’s opponent, Edmund Stoiber, prime minister of Bavaria and candidate of the CDU-CSU coalition, has sought to exploit the chancellor’s vulnerability on the economy. Mr Stoiber, who some characterise as grey and boring, makes the most of his reputation as an efficient economic manager—Bavaria is the most successful and prosperous region in Germany. He aims to persuade voters that what he has done in Bavaria he can do for Germany as a whole.

Yet Mr Stoiber’s personal ratings trail behind that of Mr Schröder, and the chancellor’s popularity is one reason why he may yet, like all previous post-war German chancellors, win a second term. The speech which Mr Schröder made to launch his election campaign was confident and assertive. He criticised the failures of big business, and defended German-style capitalism against demands for faster deregulation by citing the example of ordinary Americans deprived of their pensions while corporate bosses had made off with millions. “That is not the German way,” he proclaimed.

AP/ AP
AP/ AP

Schröder v Stoiber

The chancellor has also gone on the offensive on foreign policy, insisting that Germany should not be afraid of adopting its own position on international affairs. The first post-war chancellor to send German troops on active duty overseas—during the Kosovo crisis—Mr Schröder made it clear he did not support American policy on Iraq, disparagingly referring to new adventures abroad. Mr Stoiber’s more supportive approach to America is unlikely to be as popular in Germany.

In the end, though, with many ordinary Germans anxious about jobs and uncertain about the future, the economy is likely to remain the main battleground, not foreign policy. The gloomy economic data released this week, just as the election campaign begins, suggest that Mr Schröder faces a difficult task persuading German voters that he can deliver more in the next four years than he has in the last four.


Posted by DeLong at August 7, 2002 07:56 PM | TrackBack

Comments

Of course the current economic slump does not help to get Schroeder reelected. But in my opionion more and more voters in Germany are beginning to realise the Government's limited ability to manage business cycles and are therefore more concerned with long-term reforms in the labour market's incentive structure. So Schroeder's main problem is not frictionally rising unemployment but his shakiness about the fundamental direction of his economic policy: This week the Social Democrats (SPD) began their official campaign, obviously focused on their tradiational core voters, with a promise to retain the "German way" of organising the labour market. This follows suit on a rather unsuccessful attempt (as far as polls are concerned) to gain points among the reformist voters who helped him into office back in 1998 by proposing to pursue the implementation of serious changes to the incentive structure of the German labour market.

The deal he tried to cut was - back me again and then I'll be in a better position to keep the Unions and the SPD's left in check than a conservative-liberal coalition (important in Germany's consensus democracy!), so this time I could actually implement the change you (and I) want. While this calculation may be right if - and it certainly looks as if - Schroeder himself is the only argument that could keep the SPD in office, many voters seem to have lost their faith in his ability to deliver. After all, they signed precisely that deal in 1998 and the only changes the SPD made to labour market regulation, even after the departure of my-heart-beats-on-the-left finance minister Oskar Lafontaine, made it even more rigid than before.

But Schroeder's plan could still become reality - especially if the SPD has to cut a deal with the openly neoliberal Liberals (FDP) after the election instead of their current coalition partner, the Greens. Such a deal seems more and more likely should the Social Democrats get more votes than the Conservatives. Currently they trail the Conservatives by about 5% points, the give and take depending on the polling institute. With the Greens trailing about 4% behind the Liberals (10%+) and the electoral outlook of the former communists (PDS) (about 4%) getting gloomier by the hour, the 5% threshold might help the Liberals to again assume a position they held until 1983 - to become the makers or breakers of German governments. I would certainly miss Joschka Fischer and would dearly deplore the lack of social progressiveness in the current Liberal leadership but as things stand today I figure a coalition of Social Democrats and Liberals would be the best deal Germany could get this time. And given the current polls, I think there is fair chance that such a coalition can become reality.

Posted by: Tobias Schwarz on August 7, 2002 09:05 PM

> I keep on expecting the kind of virtuous circle of fast

> productivity growth and falling unemployment that the

> U.S. saw in the 1990s to emerge on the European continent.

Why? Unlike the Fed, and much like the late Bundesbank, the ECB is pursuing a restrictive anti-inflation, don't-care-about-growth policy.

In addition to this, we have an abundance of pointless regulation that is democratically stable because it protects majorities against minorities: the majority of jobhoders against the minority of employers and jobless; the majority of house renters against the minority of house owners (house ownership is much rarer here than in the US); last not least, here in Germany, it protects the majority of craftsmen within the guilds against the minority of craftsmen outside said them, even though they could provide the same services for less money. You get the picture.

With persistently high interest rates and persistently over-regulated markets, why on earth would you expect a virtuous cycle of productivity growth and falling unemployment on our side of the Atlantic?

Posted by: Thomas Blankenhorn on August 8, 2002 08:26 AM

Concern about the value of the Euro appears to have led the central bank to keep rates at a higher level than necessary. Curious how central banks will limit economic growth for the sake of currency strength. Hong Kong with a currency tied to the dollar has been suffering since the beginning of 1998, there is significant deflation. Should the dollar peg be adjusted?

What I find confusing is that the Netherlands has seemingly worked out a ground for labor market flexibility that has not undercut strong social safety protections.

Posted by: on August 8, 2002 09:46 AM

There is no need that a slowing in Germany should adversely affect America. But add to Germany, a slowing in England, Australia, Japan, Brazil, Hong Kong, etc. and there is no apparent engine of growth for the world economy other than America. We may be looking at global weakness as in 1998, with America unable to spark a general growth spurt. Steve Roach has been pointing out that there is now deflation in Japan, Hong Kong, and China.

Posted by: Arthur on August 8, 2002 11:53 AM

-->Thomas Blankehorn, you write: "persistently over-regulated markets, why on earth would you expect a virtuous cycle of productivity growth and falling unemployment on our side of the Atlantic?". Well, I do not see in what way Germany´s "over-regulated" market is the problem?

Compared to the US more or less the whole Euro-zone is over-regulated, "despite" this the unemployment in the Euro-zone is constantly decreasing, while it goes the other way in the US. My knowledge concerning the German problem is not particularly extensive, but I find the classical phrase of blaming "over-regulated" markets to be quite false.

The more successful European countries regarding employment and so on, are actually characterized by extremely tough regulation and market intervention, especially in the northern parts. One big problem in central and southern Europe I would say is for example the very poor co-ordination between the unions and employers, which creates bigger insider-dilemmas.

Posted by: Mikael Svensson on August 8, 2002 03:22 PM

This article, and the comments that have followed, are silly to the extent to which they suggest that German "failure" is evidence in favor of their neoclassical worldview.

1) If government regulation was the problem, how come the equally regulated West German economy's unemployment is indistinguishable from that in the US?

Maybe people foolishly believe that enough time has passed since unification that East Germany is no excuse for German unemployment, an argument that I believe ignores a) WWII (think: Slaughter House 5/Dresden firebombing) without a Marshall Plan (and perhaps the opposite), b) 45 years of Soviet brutality, c) that no country has ever ascended to first world status in the short period in which German unification has been a fact (cf. Russia, which has seen it's GDP halve during the same time period), d) that no country has EVER ascended economically with free trade (except maybe late 19th Century Japan; for ample discussion, see David Landes remarkable The Wealth and Poverty of Nations), e) that East Germany was industrialized with ancient, uncompetitive factories, a horrible base from which to grow, f) and that for comparable reasons, the US doesn't, it seems, include Puerto Rico in its unemployment figure calculations (the closest analogy).

2) Dean Baker, Co-Director of the Center for Economic and Policy Research (a liberal, respected think tank) and a Michigan educated economist, writes, "Germany uses a somewhat different measure of unemployment than does the United States. By the U.S. measure, unemployment in Germany as a whole is approximately 8 percent. In the area of former West Germany, the unemployment rate is slightly over 6 percent, almost the same as in the United States." http://www.cepr.net/Economic_Reporting_Review/May_6_02.htm

(I adopted this from http://www.hauserreport.com/oldfights/2002_07_10_oldfights.html#85237357)

Posted by: Jeff Hauser on August 8, 2002 05:01 PM

Michael Svensson:

You said:

> Compared to the US more or less the whole Euro-zone

> is over-regulated,

That's correct. And this is a major reason why the Euro-zone as a whole is experiencing higher average unemployment than the US.

As for the differences between EU countries, you can look at the "International Labor Statistics" page Mr. de Long links to on his page for "useful materials to teach macro".

http://www.bls.gov/fls/

If you take a sharp look at the statistics, you'll see that the economies with improving unemployment figures tend to be those who either have liberalized their labor markets to somewhat (like the Netherlands) or those whose economies are booming because the Euro brought them lower interest rates (like Ireland, Spain and Portugal).

Germany loses on both accounts. Germany's labor market has experienced more, not less regulation over the last years, and the Euro has made interest rates higher because Germany now shares the risk premium that had previously been paid by countries like Italy, Greece, etc.

Just my 2 € - cents

Posted by: Thomas Blankenhorn on August 9, 2002 01:02 AM

Michael Svensson:

You said:

> Compared to the US more or less the whole Euro-zone

> is over-regulated,

That's correct. And this is a major reason why the Euro-zone as a whole is experiencing higher average unemployment than the US.

As for the differences between EU countries, you can look at the "International Labor Statistics" page Mr. de Long links to on his page for "useful materials to teach macro".

http://www.bls.gov/fls/

If you take a sharp look at the statistics, you'll see that the economies with improving unemployment figures tend to be those who either have liberalized their labor markets to somewhat (like the Netherlands) or those whose economies are booming because the Euro brought them lower interest rates (like Ireland, Spain and Portugal).

Germany loses on both accounts. Germany's labor market has experienced more, not less regulation over the last years, and the Euro has made interest rates higher because Germany now shares the risk premium that had previously been paid by countries like Italy, Greece, etc.

Just my 2 € - cents

Posted by: Thomas Blankenhorn on August 9, 2002 01:02 AM

Out of interest, how would one use a theory of regulation as the major determinant of unemployment and productivity to explain the gap between the UK and the USA?

Posted by: Daniel Davies on August 9, 2002 04:33 AM

Daniel Davies poses an interesting problem. I can not answer the question but wonder whether the UK may have more poorly integrated its labor force through educational efforts than America....

Brad has commented on the failure of British education a century ago to provide promising opportunites to lower class children. America has of course had problems integrating education, but immigrant children had fine opportunities by the second generation and African-American and Latino children have slowly but increasingly been offered higher quality educations. We may have a considerably more open education system than England.

Posted by: on August 9, 2002 08:24 AM

Paul Krugman has a most important column today on South America - the problem may be that there is something wrong with the open-economy development model for countries such as Brazil and Mexico - also - the impossible problem for Argentina was keeping the currency peg though even adjusting the peg would not have solved the inequality problem....

Inequality in Brazil, Mexico, Argentina may not be touched by merely opening markets - where then does that leave us?

Posted by: Anne on August 9, 2002 09:39 AM

I'm unconvinced by educational egalitarianism as a determinant of the US/UK productivity gap; in terms of mathematical ability, etc, the gap isn't really all that large. I *do* think that this is a big part of the problem in Latin America; the IMF et al have treated inequality as a separate problem when in fact inequality *is* the problem; most Latin American countries just don't provide an adequate education to vast swathes of their population.

I agree with Anne that Krugman's column is incredibly important; I'm inclined to take back about 80% of the nasty things I've said about him over the years (he still remains on the hook for typing on a laptop computer during a dinner though).

The question it raised in my mind is where does the case of Brazil leave the "eternal triangle" (Krugman's argument that you could have any two of 1) a non-deflationary monetary policy 2) open capital markets 3) a fixed exchange rate, but not all three). Brazil went for the orthodox combination of 1) and 3) and is getting it in the neck ... so what's wrong with the model?

Posted by: Daniel Davies on August 9, 2002 10:11 AM

Questions:

Since the UK has a labor market flexibility that has allowed for unemployment below 4%, why have productivity and gdp growth lagged behind America's the past decade? If general education is not a reason, has there been much less penetration of technology? If technology penetration is less, then what competitive lags are at work?

Brazil has opened capital markets and followed a non-deflationary monetary policy. Government spending was not profligate. [Remember there are needs such as broad scale health care that are costly but essential and that Brazil has done well in satisfying.] Where does the problem with development lie? How could it be that per-capita income in Brazil as well as Mexico has grown so little since 1980? How is the inequality lessened? From where is a model to be borrowed?

Posted by: Anne on August 9, 2002 10:58 AM

Much of Germany's troubles come down to a simple Keynesian shortage of demand, with the blame firmly on the shoulders of the ECB. It's 2% inflation ceiling is simply too low, and requires Europe to consistently run with much more economic slack than the US for a trivial inflation advantage. Exactly how has the US economy suffered by being willing to live with infaltion in excess of 2% in the 1990s? Moreover, the Fed long ago realized that money growth rates are too unstable, and too vulnerable to meaningless asset shifts between various categories of "money", to be useful as the guidepost for monetary policy. At least the ECB hasn't been so rash as to start tightening this year as its beloved M3 ran above target.

Posted by: Avery Shenfeld on August 9, 2002 02:12 PM

Anne: I have absolutely no answer to either of your excellent questions, which is why I am going to ask Brad once again to write an article on Brazil (I hope he won't mind my mentioning that in private email, he turned down my previous request on the grounds of not knowing enough about the specifics, but I'm hoping for a Krugmanesque application-of-general-principles article)

Posted by: dsquared on August 9, 2002 02:22 PM

David and Anne, I was disappointed with Krugman's article today. Knocking the "Washington Consensus" with Argentina, Mexico, and Brazil is rich. So why isn't Chile suffering woes? Probably because they are the only Latin economy approaching the Washington consensus. I think you'll both find the answers to your questions if you look at what Chile has that the others don't.

Jeff, you should also take a look at Chile in regard to Landes not so remarkable "The Wealth and Poverty of Nations". It is all of the things that Landes says they cannot be.

Posted by: on August 9, 2002 02:25 PM

I confess to knowing little about Chile -- why do you think it disproves Landes, whose model DOES account for the possibility of change? And what differences viz. every other erstwhile poster country for neoclassicism does Chile possess?

Posted by: Jeff Hauser on August 9, 2002 03:55 PM

http://poverty.worldbank.org/library/view/11513

Chile: Poverty and Income Distribution in a High Growth Economy. The Case of Chile 1987-98

World Bank

Chile remains one of the outstanding countries in Latin America in terms of its record in reducing poverty. A combination of strong growth and well directed social programs have combined to reduce the poverty rate in half during a period of just eleven years. This study shows that previously noted trends in falling poverty, in terms of incidence, depth and severity, continued into 1998. As a result, only 17% of the population now lives in poverty (compared to 40% in 1987), while those living in extreme poverty are barely 4% of the population.

This report focuses on updating the situation between 1994 (the previous Bank report) and 1998. The analysis shows that there was unambiguously less poverty between 1994 and 1998 than in all earlier years, whether poverty is measured by the headcount, the poverty deficit or by any of the most sensitive poverty indices. The reductions in poverty observed between 1994 and 1998 are observed at all levels of income, in including those in the very extreme tail of the distribution.

Bibliography: Chile: Poverty and Income Distribution in a High Growth Economy. The Case of Chile 1987-98 (In Two Volumes), Report No. 22037-CH, August 30, 2001, Poverty Reduction and Economic Management Sector Unit, Latin America and the Caribbean Region, Document of the World Bank.

Posted by: Anne on August 10, 2002 02:18 PM

Will read the World Bank report on Chile and consider implications. Will consider how vulnerable Chile may be to changes in international capital flows. Fine idea.

Posted by: Anne on August 10, 2002 02:30 PM

The World Bank poverty report on Chile shows the promise of an open economy combined with targeted poverty reduction programs through 1998. Chile grew rapidly through the 90's. Offered quite a number of targeted poverty reduction programs, especially broader educational opportunities. The result was that though income inequality did not lessen through 1998, there was considerable progress for the poor. The Asian crisis left Chile with unemployment above 10%, and I have not covered the economic record since the Asian crisis or the Argentine crisis. Interesting possibility....

Posted by: on August 11, 2002 10:06 AM

Chile cannot be considered a "poster child for the Washington consensus" as it has quite rigourous capital controls. It has deregulated and privatised its economy, but that's not the Washington consensus. If the WC is to mean anything, it has to refer to the specific version of the neoliberal agenda pushed by the Bretton Woods institutions, and that version contained a specific piece of policy advice on the timing of capital market liberalisation, one which, IMO, has proved _absolutely_disastrous_.

Posted by: Daniel Davies on August 11, 2002 11:48 PM

Thanks DD - as always....

Just found the same about Chile. Chile has used capital flow controls to cushion itself through the Asian crisis of 1998 and in the wake of the Argentine crisis. This seems more in line with the defense used by Malaysia and Taiwan in 1998. Taiwan is now "open." Korea was forced to open after the IMF loan agreement of 1998.

South Africa by the way is also open.

More thought needed.

Posted by: on August 12, 2002 07:44 AM

Daniel, Chile limits foreign direct investment to long term investment vehicles. It is not a normal capital control per se. You can invest all you want and take out all you want. You just have to have it in Chile for a certain period of time. I believe the minimum time period is two years? It is very different than the controls used by Malaysia. FDI isn't leaving Chile because Chile's fundamentals are good. Chile's controls would just make it take a while should people decide to abandon ship.

The great thing about the "Washington Consensus" is that it can be defined however an author wants. Chile is a neo-liberal economy that has outperformed all of its contemporaries. Its ongoing economic policies are much closer to those prescribed by the standard IMF rescue package than any of the others listed in Krugman's article. It is therefore closer to the Washington Consensus.

Anne, the Soviets had a great education system. Investing in education is extremely benefitial to a national economy but it hardly ensures growth. Other investments can have equal returns. You are caught up in one investment choice among many.

Posted by: on August 15, 2002 02:34 PM
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