4 Lectures on the

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4 Lectures on the uropean crisis

• Lecture 2 Events

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Lecture 2 the events

• The events in Europe emphimeral peripheral
  growth and the German mercantilism

3
The origin of the crisis in capitalism

• Capitalism is based on the appropriation by the
  capitalist class of the social surplus.
• The social surplus S is what is left of the
  social product P once wages N (necessities) have
  been paid
• S P - N
• The open question is who is going to buy S, what
  Marx called the realization problem. Part of S
  is bought by the capitalist themselves as luxury
  goods and part as investment goods, but this is
  not generally enough.
• Rosa Luxemburg and Michale Kalecki argued that
  capitalism needs external markets.
• Examples of external markets are Government
  deficit spending autonomous consumption financed
  by consumption credit foreign markets (for a
  single economy, there are not foreign mkts for
  the world as a whole).

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The origin of the crisis in capitalism (cont)

• Kaleckis idea was that capitalists anticipate,
  through the financial system that can create
  liquidity, the purchasing power to the external
  markets ? banks finance consumers credit, the
  central bank finances gvt deficits, banks finance
  banks in foreign countries (chat in turn finance
  consumption or residential bubbles).
• The problem is that consumers, States, foreign
  nations become indebted with banks (or banks in
  the periphery with banks in the core), in final
  with the capitalists themselves.
• This is a lesser problem for States, as long as
  they retain their central bank (they are always
  solvent snce they can print money). Note that the
  European periphery has given up its central bank.

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The origin of the crisis in capitalism (cont)

• You may apply this model to the US crisis
  consumers credit sustained aggregate demand and
  growth in the last 25 years or so, up until the
  model did not collapse (once too marginal
  consumers were involved)
• You may apply this model to the European crisis
  where core-Europe financed consumers credit, and
  sometimes gvt deficit spending in the periphery
  up until the model did not collapse (once it was
  clear some countries were not solvent). The
  credit-debt relation within the EZ are the
  European imbalances
• Economic growth in the US drove economic growth
  in China where the US MNEs had transferred
  production to weaken the American workers
  bargaining power.
• This generated the so-called global imbalances
  (actually (CH-US).

6
Europe this time was not different

• The European crisis appears as the n-th this
  time is different episode
• financial liberalisation fixed exchange rates ?
  capital flows from the centre to the periphery ?
  housing bubble ? current account deficit and
  indebtness ? sudden stop of capital inflows ?
  default (?)
• I personally find Reinhart and Rogoff (2009) a
  non well-organised account of the history of
  defaults, but the title really conveys the sense
  of this history. Seminal explanations
  Diaz-Alejandro, C. (1985) Good-bye financial
  repression, hello financial crash (excellent
  title also) and Frenkel Rapetti CJE 2009

7
In a point FR were not prescient (this is not a
criticism!)

• this paper argues that the factors that
  trigger the booming phase preceding a financial
  crisis are different in developed and developing
  countries. The conditions that have led to
  financial crises in developing countries
  typically arose from the implementation of
  macroeconomic policies, which created incentives
  that ended up generating the boom-and-bust
  cycles. On the contrary, in developed countries
  the elements that trigger the booming phase have
  developed endogenously within the domestic
  financial systems.
• Well, the EZ case shows that similar events may
  take place also among developed countries. But,
  indeed, also in the EZ a core and a periphery are
  distinguishable.

8
De Grauwe in 1998 was impressingly prescient

• Suppose a country, which we arbitrarily call
  Spain, experiences a boom which is stronger than
  in the rest of the euro-area. As a result of the
  boom, output and prices grow faster in Spain than
  in the other euro-countries. This also leads to a
  real estate boom and a general asset inflation in
  Spain. Since the ECB looks at euro-wide data, it
  cannot do anything to restrain the booming
  conditions in Spain. In fact the existence of a
  monetary union is likely to intensify the asset
  inflation in Spain. Unhindered by exchange risk
  vast amounts of capital are attracted from the
  rest of the euro-area. Spanish banks that still
  dominate the Spanish markets, are pulled into the
  game and increase their lending. They are driven
  by the high rates of return produced by ever
  increasing Spanish asset prices, and by the fact
  that in a monetary union, they can borrow funds
  at the same interest rate as banks in Germany,
  France etc. After the boom comes the bust. Asset
  prices collapse, creating a crisis in the Spanish
  banking system. 1998!!!!!
• We are living a De Grawe moment
  http//politicaeconomiablog.blogspot.it/2012/05/de
  -grauwe-moment-impressively-prescient.html

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The failure of the neoclassical explanation of
international capital flows

• The simple patterns of events financial
  ltliberalisation fixed exchange rates ? capital
  flows from the centre to the periphery ? housing
  bubble ? current account deficit and indebtness ?
  sudden stop of capital inflows ? defaultgt
  clearly suggests that external financial inflows
  do not finance domestic investment (or not
  necessarily), but consumption, mainly housing,
  bubbles.
• This empirically disproves the neoclassical
  theory that capital flows from saving-rich/trade-s
  urplus core-countries towards saving-deprived/trad
  e-deficit peripheral-countries help the catching
  up of these countries. (Blanchard Giavazzi
  2002)
• Saving do not determine investment neither in
  closed nor in open economies (the world is, after
  all, a closed economy) ? the results of the
  capital theory controversy provide the rational
  for the empirical disproof).
• Martin Wolf points out that peripheral countries
  have little space to invest in manufacturing/expor
  t capacity given fierce competition from
  mercantilist countries so they invest in
  non-tradable sectors

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The failure of the neoclassical interpretation
and the Keynesian explanation

• Moreover, foreign saving/trade surplus in the
  core are the result of the trade-deficit in the
  periphery the story of the financial crisis
  validates the Keynesian story that financial
  credit precede (investment and) autonomous
  consumption, and that saving is an ex-post
  result.
• Reinhart and Rogoff are indeed totally
  contradictory when they share Bernankes
  saving-glut hypothesis how could China obtain a
  trade-surplus if the American household did not
  spend in the first place!
• Blanchard and Giavazzi applied the neoclassical
  causality to explain capital flows in Europe as a
  result of a catching up process of the South
  (although they note that the saving rate in the
  periphery was falling, not investment rising).
• The same argument we hear in Europe from Germany
  German savings financed the peripheral
  profligacy. In actual, these savings are the
  result of a trade-deficit in the South financed
  by capital inflow.
• Note that the situation has been made worse my
  the symmetric mercantilist policies adopted by
  Germany (on which more later on).

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To sum up the prevailing view is that the
European crisis is a balance of payment crisis. A
perfect kaleckian storm

• Championed by Martin Wolf on the FT, this view is
  becoming dominant (with the exception of the
  German politicians and economists that continue
  to argue, for political reasons or ignorance,
  that this is a fiscal crisis).
• So the model is perfectly Kaleckian-Luxemburg
  capitalists in the core-country (and satellites)
  repress domestic wages and consumption and
  finance the external markets.
• So they realize the domestic social surplus (S
  P N, where P is the social product and N the
  necessities to the workers) in the external
  markets. As known, S P N X M, profits
  are equal to net exports).
• The only problem is that the periphery
  accumulates a foreign debt! A perfect Kaleckian
  storm

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First explanation diverging REERs
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Second explanation diverging ADs
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Housing bubble
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http//www.economonitor.com/blog/2011/12/which-gra
ph-best-summarizes-the-eurozone-crisis/
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An ECB fault?

• The ECB monetary policy (one fist all, or what
  fits the core fits all) is often blamed for the
  crisis

20
An ECB fault or a European policy fault?

• Of course, I do not subscribe the Taylors Rule
  and the idea that monetary policy should have
  then been more restrictive, quite the opposite
  it is the fiscal and wage policies in the core
  that had to be much more relaxed.
• The figure above is indicative of the
  (interested) benign neglect with which the
  effects of financial liberalisation and the
  mounting European imbalances have been looked at
  up to the crisis.
• We must be clear about this had monetary policy
  been more restrictive, given the German austerity
  stance, the EZ would have avoided the foreign
  imbalances but at the price of a generalised
  stagnation.
• The results in terms of CA and net foreign
  position (or net International Investment
  Position)) unbalances we have seen above.

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The specific Italian case

• Italy is not a peripheral country and neither it
  saw massive capital inflows and an housing
  bubble.
• The Italian public debt (PD)matured as a
  consequence of the EMS from 1979 (de te fabula
  narratur) and of the divorce bewteen the
  Treasury and the Bank of Italy in 1981. The high
  interest rates combined with an enduring and
  tollerated tax evasion determined the explosion
  of the debt.
• During the EMU the lower interest rates permitted
  a reduction of the PD/GDP ratio from 120 to 105
  expecially pursued by the centre-left
  governments. These policies and the loss of
  external competitiveness, led to the stagnation
  of the GDP and of productivity growth (I think a
  full account of the events has yet to be
  written).
• In spite of the stagnation, the external account
  deteriorated.
• This was due to the German policies (see below)
  but also on the persistent inflation gap with
  Germany
• The inflation gap does not originate in the real
  wage dynamics (in fact real wages have declined
  over the last decades) but on the non-tradeble
  sector (that can fix prices). Anyway, Italy made
  an enormpus effort to reduce inflation to
  quasi-German levels, but you cannot beat Germany
  in its favourite game of having inflation always
  below competitors.

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German mercantilism

• Germany since Bretton Woods has always found
  fixed exchange rate arrangements perfectly suited
  to her mercantilist stance since the time of
  Erhard the German strategy was to maintain the
  inflation rate a little below that of competitors
  to sustain exports while enjoying a strong
  currency, what has been named Monetary
  Mercantilism (Holtfrerich)

23
Criticism to German (presumed) mercantilism is
not new . Few examples

• - The German stabilisation policies of the late
  1940s/early 1950s were criticised by the American
  economists.
• - Also in the 1950s Germany preferred to blame
  the others inflationary policies abroad led to
  the German export upsurge and obliged her to
  sterilise imported inflation by pursuing a
  fiscal surplus. The surging of the German trade
  surplus led, after the American and French
  criticism, to the DM revaluation in 1961
• - The case of the locomotive theory is
  well-known in the late 1970s chancellor Schmidt
  reluctantly accepted the idea that Germany had to
  pull the world economy along the US and Japan.
  The 2 oil shock came he swore that never again
  Germany would have played the domestic expansion
  game.

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At the origins of the German policy stance
monetary mercantilism?

• The pre-miracle German policy choices that shaped
  post-war Germany, in oarticular the centrality of
  price stability, have been denominated monetary
  mercantilism by the historian Carl-Ludwig
  Holtfrerich.
• Holtfrerich, as others (e.g. Bibow), denies that
  the obsessive objective of price stability by the
  Buba is due to the memory of the great
  hyperinflation of 1922.
• Indeed, some economists maintain that this
  memory is a well fabricated invention by the
  Buba (memories are a social construct). An
  independent central bank is not even a German
  tradition (the opposite is true), and indeed
  Adenauer opposed it (he thought that a CB should
  be accountable!)
• Why price stability then? Holtfrerich found the
  clue in the early German policy decisions.

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Monetary mercantilism (cont)

• In the early 1950s As protectionist tools could
  not be useda different way of achieving
  mercantilism, namely export surpluses, had to be
  found. The solution was to keep domestic demand
  restrained by monetary and fiscal policies, thus
  keeping imports and domestic inflation low and
  freeing production resources for more exports.
  This strategy was contingent on a system of fixed
  exchange ratesThe early Bretton Woods
  systemleft countries the opportunity to gain in
  international competitiveness by realising
  relatively more price stability than abroad.
• (The main Holtfrerichs paper is published in a
  book edited by the Buba celebrating the 50 DM
  anniversary!)
• Observe the combination of lower domestic
  inflation and fixed exchange rates! The same
  combination Germany obtained later through the
  EMS and the EMU!

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Monetary mercantilism (cont)

• Monetary mercantilism was conceived and planned
  particularly by the president of the Bank
  deutsche Lander (the Buba was created in 1957)
  Wilhelm Vocke as a long-term strategy for German
  monetary policy keeping domestic affairs
  tight in order to strengthen exports. Vocke was
  lucky
• 1) the Allies forced for an independent CB in
  1949 when a Federal gvt was not existing yet 2)
  Erhard endorsed Vockes policy 3) the Korean war
  gave a big push to German exports and the
  opportunity to keep inflation lower than the
  competitors.
• Erhard A great opportunity for the future of
  German exports has arisen out of the current
  situation. If, namely, through internal
  discipline we are able to maintain the price
  level to a greater extent than other countries,
  our exports strength will increase in the long
  run and our currency will become stronger and
  more healthy, both internally and with respect to
  the dollar

27
Monetary mercantilism and Ordoliberismus

• Price stability was also the obsessive policy
  target of Ordo-liberismus (or Freiburg school or
  social market economy), the dominant economic
  school in the reconstruction and miracle period.
  Price stability was associated by the
  ordo-liberals to the smooth functioning of the
  price mechanism. In practice, price stability is
  synonymous of wage and social discipline.
• Wage and social order imply that exports, rather
  than wage consumption, become the natural
  debouche of the surplus (in the classical-marxian
  sense). Indeed, income distribution has never
  been particularly favourable to labour in
  Germany.
• An export-oriented economy becomes in turn a
  powerful political instrument to obtain labour
  consent and discipline (reinforced by the German
  trade unions pursue of co-determination rather
  than strong wage claims? why German trade unions
  have been so docile in the post-WW period is not
  clear to me yet).

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The German model

• The success of the model in leading to improved
  standards of life (although income distribution,
  not surprisingly, has never been particularly
  fair in Germany) and the traditional paternalist
  Bismarkian welfare state did the rest.
• Erhard, declared in 1953 Foreign trade is quite
  simply the core and premise of our economic and
  social order.
• This declaration seems to allude to an export-led
  model as a way to enforce social order, and to
  social order as a way to sustain export-led
  growth
• Social order export led growth
• Price stability

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The pillars of the German model and why they do
not want to give it up

• The three institutions pillars of monetary
  mercantilism neo-corporativism, mercantilist
  micro, meso and macro institutions and policies,
  and the Bundesbank.
• The former implied a direct involvement of the
  labour movement both at the micro and the macro
  level in the maintenance of a competitive system,
  particularly in the export sector.
• At the micro-level Germany has a excellent
  training, educational and RD system at the
  meso-level the reliance on export-led growth
  creates an ideological climate that induce
  cooperation and discipline (Crouch 2008) at the
  macro level the system keep wage-growth below or
  in line with productivity growth. The government
  domestic and foreign policies have the promotion
  of German export as the priority. Paternalism is
  a traditional attitude of the German government
  the sense of the national community, traditions
  and nature (heimat) is the main component of the
  German ideology. This perfectly suit the
  mercantilist tradition (Heckscher), particularly
  in its German version (Cameralism, Historical
  School)
• This model has brought welfare and order in
  Germany would you easiliy give it up?

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Arsenic and Buba

• But, of course, as Voltaire said Incantations
  will destroy a flock of sheep if administered
  with a certain quantity of arsenic
• Just in case, the watchdog role of the model was
  assumed by the Bundesbank in a unique wage
  bargaining process directly involving the central
  bank and the leading trade union IG-metall
  (Franzese and Hall 2000 182-83).
• This role of the Bundesbank as the watchdog of
  the German mercantilist model is very important
  to understand the German opposition to the reform
  of the ECB from its present monetarist
  constitution.

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The Buba and the labour market

• A credible CB was a central element of the
  German economic policy, where by credibility is
  meant that the trade unions considered the German
  CB commitment to fight inflation at any cost as
  convincing.
• According to Franzese and Hall the centralised
  wage bargaining in Germany, led by the IG-Metall,
  made a peculiar interaction between the German CB
  and the trade unions possible The highly public
  pas de deux between the Bundesbank and the
  principal wage bargainers, which occurs at the
  time of every wage round in Germany, is a
  prominent feature of politics. The bank often
  issues pointed comments on the initial wage
  demands made by the union involved in the leading
  settlement, accompanied by detailed commentary
  about the state of the economy and warnings about
  the policy consequences of overly inflationary
  wage settlements. ... this kind of dialogue
  between wage bargainers and the central bank is
  completely absent from U.S. economic politics.
  The Federal Reserve and the Bundesbank speak
  differently because they have audiences with
  different institutional structures.

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Corporative social-democracy and mercantilism

• Interestingly, the Bundesbanks credibility was
  reinforced by the export-led model, given the
  concentration of the strongest trade union in
  the export sectors The German case also
  suggests that the effectiveness of such
  signalling mechanisms may be enhanced when the
  export sector is large and plays a pivotal role
  in wage bargaining (). The metalworking sector,
  which produces the lead bargain in most years,
  has a high export concentration. In itself, this
  induces lower settlements because wage bargainers
  in export sectors are especially concerned to
  maintain unit labor costs at internationally
  competitive levels. Actors in such sectors are
  also especially sensitive to signals from the
  central bank, however, because the restrictive
  monetary policies that the bank wields not only
  depress the level of economic activity but also
  tend to appreciate the exchange rate, thereby
  threatening export sectors especially severely by
  rendering their products more expensive in world
  markets. The direct involvement of the German CB
  in wage bargaining has been inherited by the ECB.
  Just recall again the two infamous rate increases
  in July 2008 and April 2011.
• Is it a case that most (all?) northern
  corporative social-democracies are export-led
  economies (Colin Crouch)? This might be due to
  the smallness of those countries, but this is not
  the case of Germany.

33
Corporative social-democracy and mercantilism

• Interestingly, the Bundesbanks credibility was
  reinforced by the export-led model, given the
  concentration of the strongest trade union in
  the export sectors The German case also
  suggests that the effectiveness of such
  signalling mechanisms may be enhanced when the
  export sector is large and plays a pivotal role
  in wage bargaining (). The metalworking sector,
  which produces the lead bargain in most years,
  has a high export concentration. In itself, this
  induces lower settlements because wage bargainers
  in export sectors are especially concerned to
  maintain unit labor costs at internationally
  competitive levels. Actors in such sectors are
  also especially sensitive to signals from the
  central bank, however, because the restrictive
  monetary policies that the bank wields not only
  depress the level of economic activity but also
  tend to appreciate the exchange rate, thereby
  threatening export sectors especially severely by
  rendering their products more expensive in world
  markets. The direct involvement of the German CB
  in wage bargaining has been inherited by the ECB.
  Just recall again the two infamous rate increases
  in July 2008 and April 2011.
• Is it a case that most (all?) northern
  corporative social-democracies are export-led
  economies (Colin Crouch)? This might be due to
  the smallness of those countries, but this is not
  the case of Germany.

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Social-democratic mercantilism

• As seen, export led-growth is also functional to
  secure labour acquiescence and discipline,
  solving therefore the second Kaleckian concern
  about the inconsistency of full employment and
  capitalism.
• Germany appears as a high-productivity/low wage
  economy. This is a classic definition of a
  mercantile country.
• The model, in the German case, is self sustained
  in the sense that it brings about social and
  distribution discipline (associated to decent
  standards of living), that in turn supports the
  model.
• The question is the international sustainability
  of the model, but perhaps Germans see themselves
  as a small player at the global level so that
  they expect the world to tolerate this policy.
  But they have to solve the European situation
  first.
• There is no reason why Germans (of any social
  class) would like to abandon the model, so be
  politically realist and do not talk of European
  solidarity.
• See my The European crisis political and
  institutional failures or method in the madness?
  In www.networkideas.org, re-published by
  www.irishleftreview.org

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References

• Cesaratto S. (2013). Controversial and Novel
  features of the Eurozone Crisis as a Balance of
  Payment Crisis, in Febrero E. et al., editors,
  Post Keynesian Views of the Economic Crisis and
  its Remedies, Routledge, 2013. Working paper
  http//www.econ-pol.unisi.it/dipartimento/it/node/
  1649.
• Cesaratto S., Stirati A. (2011) Germany in the
  European and Global Crises, International Journal
  of Political Economy, vol. 39, no. 4, Winter
  201011, pp.5687 working paper version
  http//www.econ-pol.unisi.it/dipartimento/it/node/
  1267
• Cesaratto S. (2011), Europe, German Mercantilism
  and the Current Crisis, Quaderni del dipartimento
  di economia politica, in Brancaccio E., Fontana
  G. (a cura di), The Global Economic Crisis. New
  Perspectives on the Critique of Economic Theory
  and Policy, Routledge, London. Working paper
  version Quaderni del Dipartimento di Economia
  politica,, n. 595 (www.econ-pol.unisi.it/dipartime
  nto/it/quaderni)