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Dr. Heiner Flassbeck (Director, Division on Globalization and Development Strategies, UNCTAD): German policy of low wages and beggar thy neighbor is root of euro crisis

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. On December 8 and 9, the leaders of the European Union met in Paris, tried to hammer out an agreement that would solve the euro crisis. Well, they came to some kind of agreement, but it’s questionable how much did they actually solve and were they in fact even addressing the right problem. Now joining us to unpack all of this is Heiner Flassbeck. Mr. Flassbeck served since 2006 as director of the Division on Globalization and Development Strategies of the United Nations Conference on Trade and Development, and he was the vice minister from October 1998 to April 1999 at the Federal Ministry of Finance in Bonn, responsible for international affairs, the European Union, and IMF. Heiner’s joining us from Geneva. Thanks for joining us. Now, let’s start with what exactly was the agreement the European leaders came to and did they actually solve anything.

DR. HEINER FLASSBECK, DIRECTOR, DIVISION ON GLOBALIZATION AND DEVELOPMENT STRATEGIES, UNCTAD: Well, there’s agreement. First of all, this is about more austerity for Europe. It’s an agreement that more or less all the countries in the eurozone and some others are going for more austerity, are going to cut down public expenditure, and that they are going to try to improve what they call–improve the competitiveness. But that means wage cuts, further wage cuts.

JAY: You mentioned wage cuts and the whole issue of wages. I did little exercise. I took the documents of the Toronto G-20, I did the same thing with the G-20 documents from Cannes and Paris, and I can’t find the use of the word wages in those documents. The whole issue of wages and their connection to the root causes of this crisis is not talked about very much. What do you make of it?

FLASSBECK: Well, I think the root of this crisis is not a violation of rules of fiscal discipline, of degrees of public debt in the eurozone, different degrees of public debt. What I think is the core of the issue is a divergence of wage development. Unit labor costs have diverged dramatically in the last ten years. They did not follow the commonly agreed inflation target in Europe. They–on the one hand, Southern Europe went beyond this inflation target of 2 percent, but more so Germany went below this target by a very wide margin. And this has led to an overall gap in competitiveness inside the eurozone, where you cannot depreciate or appreciate any more, of something like 25 percent between Germany and Southern Europe and 20 percent between Germany and France.

JAY: Well, you pointed out, in one of the talks I saw that you gave, that controlling inflation really is the raison d’etre of the European Monetary Union. It’s all about controlling inflation and hitting this 2 percent inflation target. But you’ve also said that going below this 2 percent target is as dangerous as going over it. AOnd that’s what Germany did–they went below it. But that essentially meant cutting wages or freezing wages. Is that not what it meant, an attack on wages?

FLASSBECK: Yeah, it was a dramatic pressure, political pressure on the unions, on wage agreements that we had never before in Germany. First of all, it started at the end of the ’90s with the tripartite agreement putting government, unions, and employer associations–. But then, on top of that, the red-green, paradoxically, the red-green government put another big pound of pressure on the unions by restricting the possibility to negotiate certain wages for low skill by reducing unemployment contributions and so on. So in that way, wage flexibility has increased dramatically. It was part of the program that everybody called labor–increase your labor market flexibility. And that is exactly what is asked for now from the other Europeans.

JAY: The reason the red-green government did this is they thought this would reduce unemployment. Was that the idea?

FLASSBECK: That was the idea. They had clearly what we call as economists a neoclassical approach. They tried to improve employment by wage cutting and pressure on the wage negotiations. But it dramatically failed; in terms of the domestic market, it dramatically failed. The only thing what happened and that could be expected [incompr.] all reasonable economists would have expected that if you go into a currency union at the same time and the other countries do have no chance to depreciate their currency, well, the end is that you beggar your neighbors. And that is exactly what happened. And so we have huge current account surpluses in Germany and huge current account deficits in the other countries. The unfortunate thing is that we cannot correct it anymore by exchange rate changes.

JAY: And this greatly benefits benefited Germany, at least the German elite, as Germany was competing neck-to-neck with China for being the world’s leading exporter. And, of course, most of those German exports went, actually, within the European Union.

FLASSBECK: Yeah, as I said, overall it failed. It benefited only the export industry, that’s right, and a certain kind of elite–that’s right also. But overall German growth was weak over the time. Germany in the first ten years in the eurozone was the worst country in terms of growth and in terms of employment. But only–if you do something like that, you know the increase, the improvement in competitiveness accumulates over time. So you start with, say, a difference of 2 percent, and after ten years you have, as I said, 25 percent. So under these conditions you have 25 percent premium over your competitors, over the other countries. Then the increases, the benefits that you get in the export industry are accelerating. And this is why Germany at the end was extremely strong and the others extremely weak.

JAY: On Thursday, President Obama said that European crisis wasn’t so difficult to solve. He said there’s plenty of wealth in Europe; if they want to, they can solve it. Now, of course, you could say the same thing about the United States. They’re up in arms about a deficit and debt in the United States. And one could say there’s plenty of wealth here; if they wanted to get rid of the debt, they could solve it. But there’s no political will to do so. But, at any rate, what he’s saying also applies to Europe. They don’t seem to want to go where the money is. And let’s assume that this doesn’t change and the wealth stays in very few hands and they keep pushing austerity policies. Then where does this lead? Are we into a decade of recession or more?

FLASSBECK: I think the most probable outcome that we are facing now, not only in Europe, but in–as you said, in the United States and in Japan, is something like the Japanese two lost decades that started at the beginning of the ’90s, because we’re heading for deflation, clearly, deflation in Europe and stagnation, because wages are not rising anymore. Wages are cut in the South. In Germany they’re not rising very much. That leads immediately to faltering domestic demand. On the export side, we cannot expect very much from, as I said, the United States and Japan. China cannot do it alone. So we’re really in a trap, in a trap that will not be–you will not be able to escape if you do not [have] radical changes in overall policy in Europe and, maybe, in the United States.

JAY: Now, what you’re saying is not like some state secret. This austerity policies are going to lead to a deeper recession, and the European leaders have to know this. I mean, you can see this even in the business press. I was seeing today in the Canadian business press some of the more conservative columnists are actually calling for stimulus in Europe. So the European financiers, the politicians, they know this is leading into a recession, but they’re going there anyway. How does this benefit them?

FLASSBECK: Well, it’s not benefiting, and I think they really do not understand. Some may understand, but the majority of the political leaders, I think, really do not understand. In Germany, to be frank, people are talking all the time about the Swabian housewife, which means you do not spend too much, you’re saving a lot of your income, and this is the model for our policy. So they really take a micro model for the macroeconomy and they do not understand that the macroeconomy is functioning in a totally different way. So it’s not just about who benefits or not. It’s–the core of it, in my view, is economists, the majority of economists, the mainstream in economics, strongly believes still that saving is a good thing. They do not understand the kind of Keynesian restriction or the Keynesian arguments against the saving approach. And even more important is that all good economists, so to say, on earth believe that wage flexibility is a good thing, and they do not understand fully that wage flexibility, first of all, leads to falling demand and not in the first round [incompr.] to rising employment. So you have a demand restriction, you have a demand constraint, and that demand constraint will be very difficult to overcome. I mean, look at the discussion in the United States. It’s quite similar to the European discussion. The people really do not take care of the very low wages of the family income expectation that are, as far as I see, at the lowest level in United States ever. And to overcome this you need a huge fiscal stimulus, and even that may not be possible. And this is exactly an analogy to the Japanese–beginning of the Japanese two lost decades.

JAY: If the underlying issue is wages, then doesn’t there need to be something done about raising wages, not just government stimulus?

FLASSBECK: I think you need a mixture, you need a reasonable mixture. You need stimulus from the government side. But given the political opposition against further stimuli, you need in addition something like incomes policy, or at least more freedom to unite for the workers to do what is necessary. But, you see, the point is, in the United States, if unemployment is high–and that was the case at the beginning of this century in Germany also–if unemployment is high, it’s very difficult to negotiate for higher wages. Then the government has to give a strong signal, either through minimum wages or other instruments, say, wages in the public sector or so, to make clear that people can expect that they have their part in the productivity increase in the future. We have a totally new situation, I think, in the capitalist system that we have never seen in 30, 40 years before, namely that we really have an age of diminished expectations, so to say, of the average people. And these diminished expectations, so to say, naturally lead to a stagnative mood, and we have to overcome that by a very heterodox, unorthodox instrument. Just monetary policy does not work anymore. Fiscal policy is politically blocked. So you need to think hard about other instruments.

JAY: Last time we were in a moment like this, if you look historically at the 20th century, a moment like this led to quite tragic consequences. How dangerous are things now?

FLASSBECK: I think it’s extremely dangerous. We should not take democracy as something natural or given. If you look at Southern Europe, people are on the streets every day. The riots are getting harder to fight and the governments really do not know what to do anymore. So if you put people into such a situation where they’re really desperate about the outlook, where they’re desperate about their kids’ future and so on, then people are doing things that might look quite unreasonable. But it’s just the result of their desperation. And so far, I think G-20 could be the forum to act, but in a more rigorous and a totally different way. I have been following G-20 in the last year, and it was, unfortunately, a very bureaucratic affair. I would hope that the leaders come together one more time, and to see that they need a bigger approach, a broader approach, and they have to face not only some minor economic question, but they’re facing a big, challenging century, a question of a century, in terms of overall politics.

JAY: When you look at the documents of the G-20 in Toronto and in Cannes, they’re completely committed to austerity measures. Some kind of actual measures to spur growth are not really even being discussed with any seriousness. They seem committed that the real issue is making sure the bondholders get repaid and the bondholders are satisfied, and that seems to be as far as they’ll go. They seem to be reconciled to years of recession.

FLASSBECK: I think they have to realize that the bondholders are not so stupid. If you look at the much-criticized–in Europe, much-criticized opinion from Standard & Poor’s this week about the rating of Europe as a whole, the eurozone as a whole, then Standard & Poor’s has said something quite reasonable. They said just austerity is not enough, so if you just go for austerity, then we have to downgrade you, because the overall situation is deteriorating. And what was not clearly in the cards last year in the negotiation of the G-20 was this dramatic development in the real economy. And this has changed the situation. So this should be a wake-up call for everyone to go more serious than ever into negotiations about who could stimulate and who has to do some austerity, even at this very critical circumstances. So there was a fruitful discussion at the beginning of last year, but it faded away and it didn’t have the political momentum. So I very much hope that we will have some political leaders somewhere in the world who understand how serious the situation really is.

JAY: Thanks very much for joining us. And thank you for joining us on The Real News Network. And don’t forget the donate buttons. We’re in the midst of our end of 2011 fundraising campaign, and if you don’t click that, we can’t do this.

End of Transcript

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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.