On the role of Germany in the Eurozone crisis: Development planning matters

I have just gone through a recent article by Servaas Storm who answers Peter Bofinger in the debate on the role of Germany in the Eurozone crisis. It is a continuation of the debate raised by Storm that I and others have questioned here. However, in his most recent article Storm raises a point that reminds me on an argument I have developed according to the situation in Greece and other southern European countries.

Storm argues:

“We should stop talking about wage increases in Germany or wage cutting in Southern Europe as being relevant to the real life-and-death challenge facing the Eurozone and face up to more difficult task of how to plan and finance a viable recovery strategy. I fear it is already almost too late.”

Whereas I do not agree on his opinion that “we should stop talking about wage increases in Germany or wage cutting in Southern Europe as being relevant” or as I argued about a cost and inflation neutral development of wages as decisive for a balanced development or even the surviving of the European Monetary Union (see here and the article of Harvard-economist Simon Wren-Lewis here), I do agree on what Storm calls “plan and finance a viable recovery strategy”. I do agree in so far as in my point of view countries like Greece need a “comprehensive development planning” as I called it in several articles (see e.g. here and here).

Click here to get to the analysis of industry in Greece.

After I had analysed in July 2015 the development of industry in Greece, I concluded amongst others:

“…What can be concluded from these developments? First, Greece has industry. Second, it seems to be dominated by light industry. However the structure, development and potential of the industries in this category have to be studied more carefully. For example, the share of textile fibres, yarn, fabrics and clothing in this category has fallen from 70 per cent in 1995 to 37 per cent in 2014. The main decrease took place between 2003 and 2008. However, the main loss in absolute terms first occurred already between 1995 to 2002, then turnover steeply increased again to the former level of 1995 only to decrease again until 2007. After a short recovery in 2008 turnover has steadily decreased again until today. Third, manufacturing in Greece seems to comprise a wide range of industries, also in capital goods. To draw further conclusions this must be studied more detailed, too. Fourth, industry in Greece seems to be heavily dependent on imports. The dependence on imports in the manufacturing sector is supposed to be higher than that of the economy as a whole. In both cases import dependence seems to be very high. But the generally high trade deficit at the same time signals a potential to produce at least a certain and increasing share of imported products domestically.

This brings me back to the argument I already developed in former articles: Greece needs a comprehensive development planning. That means to carefully study the development and state of already existing industries (and, of course, agriculture, too) and potential new ones. Then it will be decisive to develop a master plan how to develop all together. Again, I refer in this context to the development planning in Malaysia and their five year plans reading like a textbook in development economics and worked out very well. Other even smaller countries like Singapore perhaps could serve at least partly as a model, too. I don´t know whether Greece ever had a comprehensive development planning. I suppose not. The present unprecedented crisis could be an incentive, a chance, to do so. Such a development planning would, of course, not be about four or five points ´plans´ like Varoufakis for example so far has presented…”

This view is completely missed in the special report on the “Consequences of the Greek Crisis for a More Stable Euro Area” by the German Council of Economic Experts published in July 2015, too (see here complete report in German language, press realease in English and a critique here).

Analysing Portugal´s development in October 2015 I came somehow to the same conclusion: “Similar to Greece Portugal would need a comprehensive development planning to get a sustainable growth perspective.”

So I think as far as this issue is concerned Storm raised an important argument.

And even concerning the debate on unit labour costs he gave new input worth to discuss further:

“This whole discussion about the deeper causes of changes in relative unit labor cost does distract from the equally important issue of the extent to which unit labor cost matter for exports, imports and the trade balance. This is not a trivial issue, because as argued by Felipe and Kumar (2011), Gaulier and Vicard (2012), Wyplosz (2013), Gabrisch and Staehr (2014), Schröder (2015), Storm and Naastepad (2015) and many others, there are good theoretical and empirical reasons to qualify the importance of relative unit labor costs for trade. First, unit labor cost elasticities of export/imports tend to be much smaller (in absolute size) than the corresponding price elasticities, due to the fact that (a) wage costs constitute only about 22% of total production costs; and (b) higher wage costs are only partly shifted onto higher prices. Secondly, there is clear evidence that in countries like Spain the trade deficit increased because of faster import growth, while export growth stayed constant; if this is so, the question is why (higher) relative unit labor cost would one-sidedly impact imports and not exports.

Thirdly, if one wants to identify the impact of labor costs on trade, one should filter out other influences on trade and most prominently the impact of income and demand growth. But doing so will show that world income growth already completely explains export growth and domestic income growth fully explains import growth for most economies concerned. Put differently, the income effect is mostly found to overwhelm any cost-competitiveness impact, especially in the longer run (see Schröder 2015 for elaboration). What is finally important to acknowledge is that in the crisis economies, unit labor costs started to increase only following a preceding deterioration in the trade account (Gabrisch and Staehr 2014). This indicates that rising unit labor costs were the consequence, rather than the cause, of the growing imbalances. I concur with Felipe and Kumar (2011), Wyplosz (2013) and Schröder (2015) that it is a myth that the Eurozone imbalances were driven by (exogenous) losses or gains in cost competitiveness.”

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