December 11, 2011

Class War: Low Wages and Beggar Thy Neighbor

Dr. Heiner Flassbeck: The words "class war" maybe unfashionable, but it is still a battle between labor and capital
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Dr. Heiner Flassbeck graduated in April 1976 in economics from Saarland University, Germany, concentrating on money and credit, business cycle theory and general philosophy of science; obtained a Ph.D. in Economics from the Free University, Berlin, Germany in July 1987. 2005 he was appointed honorary professor at the University of Hamburg.

Employment started at the German Council of Economic Experts, Wiesbaden between 1976 and 1980, followed by the Federal Ministry of Economics, Bonn until January 1986; chief macroeconomist in the German Institute for Economic Research (DIW) in Berlin between 1988 and 1998, and State Secretary (Vice Minister) from October 1998 to April 1999 at the Federal Ministry of Finance, Bonn, responsible for international affairs, the EU and IMF.

Worked at UNCTAD since 2000; from 2003 to December 2012 he was Director of the Division on Globalisation and Development Strategies. He was the principal author of the team preparing UNCTAD's Trade and Development Report, with specialization in macroeconomics, exchange rate policies, and international finance. Since January 2013 he is Director of Flassbeck-Economics, a consultancy for global macroeconomic questions ( Co-authored ACT NOW! The Global Manifesto for Economic Policy published in 2013 in Germany.


Class War: Low Wages and Beggar Thy NeighborDR. HEINER FLASSBECK, DIRECTOR, GLOBALIZATION AND DEVELOPMENT STRATEGIES, UNCTAD: I'm going to go straight into the core of the matter and touch some of the things that have been mentioned this morning by passing, but not going into it so much. The question that we have been asked is why these problems in the eurozone, and I think there we have to go a bit deeper into economics. Why this problem in the eurozone? And let me first say what many people do not understand, why we do have a currency union in the eurozone or in Europe. This is one of the core questions that we have to answer before we come to why we have a problem in that eurozone, in that monetary union, in the eurozone. We have to answer the question, was there a rationale for going into a currency union. And I think, yes, it is. Some people say it was purely for political reasons and so there was no economic rationale. I think that's wrong. What happened before we went into the eurozone, so into the monetary union, was that we had a strange arrangement in monetary affairs in Europe, which was an arrangement where many countries absolutely fixed the exchange rate to Germany, to the D-mark. The D-mark was clearly the anchor of that system. So they fixed the exchange rate. Austria, for example, [incompr.] fixed its exchange rate forever. It had never changed its exchange rate after the Bretton Woods system collapsed. So, immediately, the Austrian schilling was pegged to the D-mark and never changed. And many other countries followed, for the very simple reason that they didn't want to have, let me say, be blunt--and my French colleague will not fully agree, but let me say it like that--they didn't want to have high inflation anymore. They wanted to be as successful as Germany, not only in terms of inflation, but also in terms of inflation. And inflation was, so to say, the medium, the means by which they thought they could get as successful as Germany. And in this arrangement, only one thing is really a bad institution or is a bad setting, so to say, namely, that you have--in such an arrangement that could go on forever, you have all the advantages of trade, you have to exchange money. But what's the matter if I go to Austria and change my D-marks into schillings and back to--at a fixed rate? It's nothing. So that is not important. Important is, in such an arrangement, that you have monetary policy that is monetary policy of the anchor country and nothing else. It is monetary policy of the anchor country. And you want to go a step further, you want to go step further, so not stay with the Argentinian arrangement, where you have fixed your exchange rate unilaterally to the dollar--then your monetary policy is American monetary policy, but you have no influence on that policy. If you want to go a step further, then you have to go into something like a monetary union, because this gives you only the seat, the seat in Frankfurt. Who mentioned the seat in Frankfurt? At least you have a seat. Whether it's used or not is a different question, but you have a seat. And this was a big achievement. It was a big achievement to jump from an anchor, purely anchored system, vis-a-vis the D-mark, into the eurozone, because that gave Austria and the other countries a seat and a voice in the system. And that's an achievement. And there's no way back, no simple way back, to, say, do it with flexible exchange rate and such things--I don't want to say nonsense, but it is nonsense in my view. And if you look around the world, you see how badly flexible exchange rate work and how much distortions they create. And we have--just in the G-20 this year, we had a long debate about that. I do not want to go into that. So what happened? Why did it go so wrong? What is so--monetary union is a union of countries that want to have the same inflation rate, but not only for one moment of time, but forever. That's the critical thing, hmm? They want the same inflation rate not only for the year 1997, when there was a criterion that you should reach, so to say, the German inflation rate of 2 percent, but forever. And this is the critical thing. And there we look briefly into the matter and we see--. So what happened is very simple. Namely, what we have is we have different inflation performances in this currency union. We have Southern Europe. And, by the way, it's not a big problem, huh? The problem in Europe has nothing to do--well, nothing is an exaggeration, but close to nothing with Greece. Greece is just one of the countries in this blue line. And this blue line, the countries in Southern Europe, including Italy--and you see the name Greece, Italy, Portugal, and Spain. These countries had inflation performance in the last ten years--this is all from '99, from the beginning of the currency union--of something like 2.6 percent. That's not bad, huh? If you have 2.6 percent, it's not an accelerating inflation or a big problem. You see, one country got it absolutely right, if you take the target that we had in this monetary union. [incompr.] the target was exactly 2 percent. It was the German target. The old German target was the target for everyone in Europe, and there was one country that got it right, namely, France. Hm? France was very much criticized, but France was the only country that got it right. They were exactly on the target. And the whole of the European Monetary Union was also on the target. You see? The EMU as a whole was absolutely on the target. But one country got it absolutely wrong, more wrong than anyone else. One country got it more wrong than anyone else. And that country was not Greece. It was Germany. That country is Germany. They got it more wrong--the deviation of Germany from the inflation target, if you look at the end in 2010, is bigger than the Greece deviation from the target. So what did we have? We had an arrangement, we had an institutional arrangement that said you should reach an inflation target of 2 percent, and the country that most violated this arrangement--. It was a common arrangement. Everybody agreed about 2 percent, not below 2 percent, but 2 percent, for many reasons that I do not want to go into. All the country agreed to it, to the 2 percent. But Germany deviated more than anyone else. And if you deviate downwards, it's as bad as if you deviate upwards, because there is no rule to say the one is worse than the other. What you only--the only argument that we have is that deflation is worse than inflation, so it was--it's even worse. Behind this was the inflation target. I don't want to explain this further, but it could be shown very clearly. Behind this were deviations in what is called unit labor cost. And unit labor cost is the deviation of your nominal wages to your productivity, to the national productivity. So what is asked for: that you have nominal wages that rise in line with productivity plus 2 percent in all countries. That's a very simple rule. And I was--when I was deputy finance minister in Germany, which I was for a short time, I tried to impose that rule on all European countries. And we even created an institution, which was called Macroeconomic Dialog, to do exactly that, namely, to give countries guidance in imposing such a rule. Again, the only country that got it right was France. In France, wages were rising--at least, they were rising. Maybe just statistics that were wrong, but as far as we believe in statistics, France got it right and the real wages were rising with productivity. That's the rule: your real wages should rise with your own productivity, not with the productivity of Germany or something like that. That's nonsense. With your own productivity. So you have to live according to your means, not above your means, but not below your means. You should live according to your means. That is in the core of the matter what a currency union asks. And that's not very much, hm? That's not such a big thing, to get that every country adjusts, given the inflation target, to its own means. That you have to do anyway. In the end, you have nothing else but your means. You have your productivity and nothing else. So the United States have to adjust to their means. The only question is how they distribute their means. That's a different question I come to a bit later. So what happened and why was this now? Why did this happen? Was it, so to say, an idea by Germany to say, now we have the currency union, now we can exploit, so to say, our new--not our--it was not German traditional policies, but new belt-tightening policies to gain market shares in Europe? Well, some people may have thought like that. I think in the German industry community there were surely some people who were in favor of the monetary union because they thought this is right. But the most--for most of the people, including most of the people in the government, this was not the crucial point. The crucial point was quite different and totally independent of the euro. And so far this is the tragic and--the tragedy of the situation, that Greece is now collateral damage of the euro. But the euro itself is collateral damage of something bigger, of a much bigger fight that took place in Germany and that's taking place every day elsewhere. What is that bigger fight? Well, the bigger fight was that at the same time, or a bit, even, before the euro was installed officially, the German government, including the Social Democrats and including the German unions, which were at that time still quite strong, decided to go for a unique historical experiment, for a unique historical experiment. And that experiment was called: we cut the wages, we do not raise real wages in line with productivity anymore, as we have done 40 years before, to bring down our unemployment rate. This coincided with the euro. I can tell you I was in the first red-green Social Democratic Green government, and although I was fired rather soon, when my minister, Oscar Lafontaine, left, but even at that time, nobody--nobody--in the German government thought about killing the euro or something like that. Nobody thought about killing the euro. But they all thought to bring down German unemployment, because Germany was really in the worst situation of all countries. It had the lowest growth rate. It had the highest unemployment. Unemployment was rising. And so they took a desperate measure to bring down the unemployment. Unfortunately, the whole experiment failed or--well, it did not fully fail, but it failed to a certain extent. And this is extremely important to understand. It's extremely important to understand, for economists in particular, what happened there. What happened was that two mechanisms came into play. The first mechanism was that due to German wage cutting, with given productivity--productivity went on rather unchanged--with given productivity, Germany started into a beggar-thy-neighbor experiment. And this is what you see here. All products that were at EUR 100 in 1999 are now--have now a cost or a price of EUR 107 in Germany and EUR 133 in Southern Europe, and EUR 117 in France or EUR 120 in France--oh, a bit more than EUR 120. By the way, that's why France has positioned itself on the wrong side. That is the main mistake of Mr. Sarkozy. He has never understood where he should have sided. He should have sided with the Southern Europeans, because he is as much in trouble as the Southern Europeans, because if the French products all cost EUR 125 and the German cost EUR 105, forget about France. It will be wiped out, as the others (it takes only a bit longer), if we do not change fundamentally this system. If this system is not changed, you can be absolutely sure--I do not want to go into showing you the figures of the trade flows--it can be shown crystal clear that this system sooner or later wipes out the export industry of all the countries that are north of Germany, all the countries that are north of Germany. And so far this is absolutely unsustainable. But, again, coming back to why was it--what was the second channel, so the first channel that Germany relied on, namely, the channel through export, was absolutely successful, and this everybody could have told. I mean, every good, let me say, Keynesian or Kaletskian or such kind of economist could have told you that this is one channel that would happen. If you have one big country that tightens its belt dramatically, forces wages to remain below productivity, and there is no reaction on the currency side, there is no appreciation of the currency of that country, [it] would be a winner in the competition of nations and would gain huge current account surpluses. There's no doubt about it. But the other channel--and this is the critical thing--. Unfortunately, I do not have the--I only have the trade imbalances; I do not have the other chart here. The other channel, namely the channel that was mainly thought to be the important channel for the good-willing part of the German people, who thought we are going for this unique experiment of wage cutting, the other channel did not work out at all, and that was the neoclassical nexus, that you cut real wages, and through the cutting of real wages you change the production structure, you reduce productivity, and through the reduction of productivity you employ more people, you work more labor-intensive than before. This did not work out at all, and it can be shown that it didn't work out at all, because what happened at the same time when German exports exploded, German domestic demand was absolutely flat. It remained absolutely flat over the last 15 years. So the exchange of wages against the trade-off of wages against domestic demand never happened. It was just a beggar-thy-neighbor strategy and nothing else. And this is the crucial thing to understand, because here we come to the question [of] how this can be settled. I do not want to go into that. My time is over in a minute. But the point is, if you go for such a strategy and you do not have the neighbors that are, so to say, accepting your economic imperialism--for a time, at least, till they are bankrupt--and that is where we are now--till they are close to bankruptcy, then you have no chance to go for such a strategy. And that is the important thing behind this, because what we have, the big battle that we have in this world is not between Germany and the other Europeans, is not between South and North, China and Germany, or so. The big battle is still, believe it or not, the battle between labor and capital. This is still the big battle. I know it's fashionable in the United States to a priori dismiss arguments by calling them a class warfare argument, hm? Republicans like that very much, to say this is class warfare. I tell you, what happens in this world is class warfare, because what we have--look at the United States, my last sentence. What happens in the United States right now? For the first time, if you look at U.S. statistics carefully, for the first time in history, in the modern history since the Second World War, we have two years, we are two years in a recovery, and in the United States the wages, the nominal wages, the nominal wages are rising by absolutely zero. They're not rising at all. We have for the first time not only a jobless recovery--that's a normal thing. For the first time, we have in the United States a wageless recovery. Wageless recovery. And that is exactly what Germany did 15 years ago, wageless recovery. And I can tell you how this experiment will going to end, because in the United States there is no market that they can occupy, there are no markets and no partners that they can exploit, there is no currency union that they can use. The experiment will end in disaster. It will end in disaster because if you do not have a regime that allows the systematic participation of workers in the productivity increase--and this happens for the first time in the United States [incompr.] not at all there. And this is what the people are talking about when they talk about 99 percent. But it's worse than ever. It was worse already ten years ago, but now it is worse than ever. And if you have such a regime, capitalism hits a wall, it hits dramatically a wall, because no economy can grow successfully if the people only have to rely on bubbles that sooner or later burst to consume, and if they do not, can expect that they will participate in the success of all. Thank you very much.

End of Transcript

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