Several years after the outbreak of the Eurozone crisis a “consensus diagnosis” is beginning to emerge, as was made clear by a group of economists associated with CEPR (see “Rebooting the Eurozone”, published in VoxEU on 20 November 2015). The consensus puts considerable emphasis on nominal unit labour costs, particularly their divergence among EMU members, in good part due to extraordinary German wage moderation. It is interesting to note that back in 2010 only a few voices associated the Eurozone crisis with divergences in nominal unit labour costs, for instance Lapavitsas and Flassbeck.

Servaas Storm’s recent contributions have kindled a brief but intense debate on nominal unit labour costs, including pieces by Bofinger, Lapavitsas, Flassbeck and others. The focus has been on German wage moderation and its role in inducing the profound imbalances prior to the crisis. Much of this debate has occurred on the website of the Institute for New Economic Thinking (INET) in 2016, and is now reproduced on the EReNSEP website.

What is missing in Flassbeck & Lapavitsas

Heiner Flassbeck and Costas Lapavitsas have extended their discussion of my earlier essays on the fundamental economics of the Eurozone crisis. This time their focus is my rejection of their claim that “capital flows, credit and banks were not the primary causes of the crisis; that honor belongs to divergences in [labor cost] competitiveness.” I feel this second response is not helping their cause. They continue to talk past the empirical realities, in particular the econometric findings discussed in in my earlier note, that so overwhelmingly contradict their claims. I would like to try one more time to point out what is missing in Flassbeck and Lapavitsas’ analysis, but will try to avoid repeating myself.

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Confusion is no response to economic orthodoxy

For several years after the outbreak of the Eurozone crisis the dominant narrative blamed peripheral ‘profligacy’ and ‘inefficiency’ in running the economy and the state. The benchmark was putative German parsimony, hard work and efficiency. This perception, which became thoroughly entrenched in German policy making, drove the bailout programmes as well as the spread of austerity across much of Europe. Apparently, the rest of Europe had to go through a tough period of adjustment, following which there would be growth and prosperity.

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How to make a mess of a Monetary Union, and of analyzing it too

Servaas Storm means well. He is alarmed that the eurozone’s official strategy of “internal devaluation” might do more harm than good by unnecessarily forcing countries that have lost their competitiveness into deflation. This is a very real concern indeed and Storm should be applauded for raging against the colossal folly that is wrecking Europe. Unfortunately, Storm goes astray in seemingly dismissing any role for unit labor cost competitiveness and German wage moderation in causing the still unresolved eurozone crisis in the first place.

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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.

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Rejoinder to Flassbeck and Lapavitsas

In response to my critical analysis of German wage moderation and the Eurozone crisis, Heiner Flassbeck and Costas Lapavitsas spell out their version of what is roughly the neoclassical textbook model of a currency union. Their main point is that there would not have been large unsustainable current account imbalances within the Eurozone, and consequently no sovereign debt crisis in the deficit countries, if all member states had kept their nominal wage growth equal to labor productivity growth plus 2% (the inflation target). Professor Wren-Lewis (2016) has been making the same point.

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Wage moderation and productivity in Europe

Recently, our analysis has been questioned by Servaas Storm who has claimed that it is untenable to blame neo-mercantilist Germany for driving a wedge into the Eurozone. It is shown below that Storm’s critique has a certain aplomb, but lacks substance.

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German exports and the Eurozone

I have argued that the low level of German wage increases before the financial crisis were a significant destabilising influence on the Eurozone, which also indirectly contributed to Germany taking a hard line on austerity. The basic idea is that Germany gained a significant competitive advantage over its Eurozone neighbours, which it has since been unwilling to unwind (through above average German inflation). What this competitiveness gain did was lead to very healthy export growth and a large current account surplus, and that additional demand meant that Germany did not suffer as much as its neighbours from the second Eurozone recession that policy created. Peter Bofinger has made a similar argument.

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Response to Peter Bofinger's "Friendly Fire"

I am grateful to Professor Peter Bofinger for alleviating some of the worries I had after reading his VoxEU paper. To be clear, his comment leaves no doubt that he: 1. fully endorses the “Crisis Consensus Narrative” that large (gross) capital flows are the real cause of the intra-Eurozone imbalances and subsequent Eurozone crisis; 2. agrees with me that German wage moderation (i.e. keeping nominal wage growth below labor productivity growth) dampened domestic demand and inflation in Germany, prompting the ECB to lower the interest rate for the Eurozone as a whole; and 3. views asymmetric policies of internal deregulation and labor market reform as harmful and accepts the importance of non-price competitiveness for export performance.

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Friendly Fire

Comments on “German Wage Moderation and the Eurozone Crisis: A Critical Analysis” by Servaas Storm.

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German wage moderation: A short critical analyses on Servaas Storm´s critical analyses

Servaas Storm, a senior lecturer of economcis, has critically analysed the focus on nominal unit labour costs (ULC) taken by some economists in explaining the crisis of the European Monetary Union (EMU). “German wage moderation in this story”, writes Storm in his analysis, is according to those economists, “(mostly) to blame for the weakening of Southern Europe’s cost competitiveness as well as the large capital flow from Germany to the increasingly indebted and vulnerable Eurozone periphery.” Storm doesn´t completely deny the role of German wage moderation, but in his point of view it bears only “part of the responsibility for bringing about the Eurozone crisis”. Storm rather criticises the “single-minded emphasis on the importance of relative unit labor cost competitiveness” as “misguided”. However, what is science if not reducing complexity to one crucial factor or at least some important factors? But this is not the main point I want to raise here. The main point I want to raise is on a possible misunderstanding of wage moderation by Storm. There are definitely more interesting arguments in Storm´s analyses to question, but the question on what wage moderation or wage restraint is really seems to me the most relevant.

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German wage moderation and the eurozone crisis: A critical analysis

Progress in economics “is slow partly from mere intellectual inertia,” wrote Joan Robinson (1962, p. 79) long ago, because “[i]n a subject where there is no agreed procedure for knocking out errors, doctrines have a long life.” As a recent illustration of such inertia, it took more than five years since Eurozone crisis started full-force (in May 2010) to come to a more or less reasonable “consensus diagnosis” as proposed by a group of economists associated with CEPR (in “Rebooting the Eurozone,” published in Vox on 20 November 2015).
 

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German wage moderation and the EZ Crisis

The EZ ‘consensus narrative’ argues the Crisis should not be thought of as a government debt crisis in its origin. Instead it regards large intra-EZ capital flows that emerged in the decade before the Crisis as the real culprit. This column argues that while the narrative is correct, it is also incomplete. With its focus on the deficit countries, it neglects the role of Germany, by far the largest member state, and its contribution to the imbalances in the years preceding the Crisis. A narrative that does not account for the effects of the German wage moderation is incomplete.

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