Balanced budgets, wage restraint and more competitiveness for everybody – this is the result of the last European summit and the new definitive solution for the Eurozone crisis. Eurozone leaders (with the exception of David Cameron) have decided to follow the German way of doing business: since the euro’s introduction Germany has actually done everything it now demands from the other eurozone members. But be wary: it will mean suffering. This is why the people of the eurozone should at least know what they are getting into when they follow Germany’s lead.
Let’s begin with reviewing Germany’s economic performance since the beginning of the Eurozone. It has been dismal. With average yearly growth rates of 1.7 % between 1999 and 2008, Germany had the second lowest growth among all eurozone members, only followed by Italy with an average growth of 1.5 %. Only half of German growth was driven by domestic demand; the other half was driven by export surpluses – by definition other countries’ deficits.
Source: Eurostat, own calculations
The reason for both low internal demand and strong export surpluses was the fall of real wages: While real wages all over the eurozone have increased in the last ten years, German real wages have actually declined by 4 %. The fall in income led to low spending on consumption and imports; on the other hand, the German wage decline has massively increased German price-competitiveness vis-à-vis its eurozone trading partners and thus boosted exports.
Source: Eurostat, own calculations
Why did wages fall? First, the government at the time – a coalition of social democrats and the green party – reduced government spending exactly when the economy needed a boost, and second, it de-regulated labour markets. Especially in the first half of the 2000s, the German government wanted to be the poster child of fiscal rectitude and meet the Maastricht criteria at all cost whilst on the other hand cutting income taxes for the rich. To close the deficit government spending, especially public investment and public sector employment was cut – even though Germany already had one of the smallest public sectors in the OECD. While the rich got richer, public schools, railways and streets began to collapse, spending on education was reduced and unemployment rose.
However, unemployment was deemed ‘structural’ and not caused by low growth. So the red-green government ‘reformed’ the labour market, cutting unemployment insurance and tightening conditions for access to social welfare – while abstaining from introducing a minimum wage. Chancellor Gerhard Schroeder’s explicit goal was to create a low-pay sector in which the long-term unemployed would find jobs. The lack of minimum wages and the higher pressure on the unemployed caused a severe downward wage trend. The share of the low-pay sector (less than 9 € per hour) in overall employment strongly increased from 15 % in 1998 to 22 % in 2005 and hasn’t fallen since. It is now close to the size of the British low-pay sector but with one difference: without minimum wages, there is no bottom for German wages. Tax cuts and pressure on the poor had their natural consequence: nowhere in the OECD did inequality increase as much over the last ten years as it did in Germany.
That all those policies didn’t lead to a total economic and social collapse had only one reason: today’s crisis countries got into debt and imported German products en masse, financed by German banks. Since credit demand was flat in Germany’s stagnating economy, banks readily lent to governments, households and companies abroad. The only strong impulse for growth came exactly from those countries that German public opinion now marks as lazy spendthrifts; and from which the German chancellor Merkel now demands to do exactly what Germany did in its long period of economic stagnation.
However, there is a crucial difference between Germany’s economic environment in the last ten years and the crisis countries’ situation right now: There are no more spendthrifts out there to save the day. Whatever crisis countries now do to increase their competitiveness – and they are already drastically cutting wages and costs – there are fewer and fewer countries out there willing and able to buy those now more competitive goods and services. The new European rules – which demand everybody simultaneously to save more and improve competitiveness – will exacerbate economic and social problems in the crisis countries and drag the whole euro area into the economic abyss. Not a pretty sight. But this is what following the German model will lead to. Be prepared.