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View from Europe #2 

European Integration and the German Model: Nothing for the Left to Admire

Paul Steinhardt

11 October 2019

The German economic model is often praised. In truth, it is built on the suppression of workers’ living standards and unsustainable export growth, and breeds division, not peace, in Europe.

Germany – the European Poster Child

 

Germany, which was still considered the sick man of Europe in the 1990s, has apparently proven that, with the right economic model, the four fundamental freedoms of goods, services, capital and labour, created by the Treaty of Lisbon, can be used to one’s advantage. According to Dennis Snower, former president of the Institute for the World Economy in Kiel, the German economic “miracle” is based on “the fact that Germans have quickly realised that in the new globalised world it is all about competing successfully”.[1]

 

The story usually told is this. In 1999 a coalition of Social Democrats and the Green Party took power. They recognised the signs of the times. With radical tax cuts for companies and high-earners, money was released for investment. This enabled Germany, with the help of its ingenious engineers, to develop great products that are virtually unrivalled on the world market. The Red-Green government also had the courage to reform the outdated German welfare state and labour market, despite widespread social opposition.

 

The content of these so-called “Hartz” reforms, named for the head of the committee that recommended them, is still very poorly understood in Britain where Germany is still discussed as if it were a social-democratic success story. But Germany is nothing of the sort. The Hartz reforms replaced the Bismarckian model of unemployment insurance, which allowed laid-off workers to maintain a substantial portion of their prior incomes, with a basic insurance model, meaning unemployment now entailed penury. Labour market reforms also enabled so-called “mini-jobs” and unlimited precarious contracts, while regional collective bargaining was undermined by extending possibilities for enterprise-level agreements. Non-wage labour costs were further reduced by, among other things, partially replacing the pay-as you go pension system with tax incentivised private insurance funds.

 

There is certainly no doubt that these reforms enabled Germany to outperform many other EU member-states, particularly those that did not follow the prescribed path, like the EU’s number one problem child: Italy. The following graphs speak for themselves.

Don’t these figures show clearly that, instead of challenging the EU with the right-wing extremist Lega of Salvini, it is much more promising for the Italians to embark on the German path of virtue?

German Workers Pay the Price

On the contrary. This “success” was ultimately based on the suppression of German workers’ living standards.

 

As the next chart shows, German workers’ wages rose by a mere 12 percent in real terms from 2000 to 2017, even though their output per hour grew by 20 percent over the same period. Furthermore, any modest gains have been very unequally distributed, with the poorest in society actually seeing their incomes fall, as shown in the following chart.

Why have Germany workers been prepared to accept stagnating living standards for two decades? Partly, because Germany’s trade unions essentially bought into the Red-Green government’s agenda, agreeing to wage restraint as part of a grand bargain that would supposedly ensure long-term prosperity. However, the labour market reforms also massively strengthened the hand of employers in negotiations with workers, making it far easier to hire and fire. Moreover, since the EU’s eastward expansion, many workers from Eastern Europe – fleeting neoliberal shock therapy in their own countries – have moved to Germany to seek higher wages. Although empirical studies normally deny any negative impact on wages, there hardly can be any doubt, that the influx of foreign workers reduced the bargaining power of wage-workers and therefore suppressed wage increases. It is for this reason that big businesses are among the strongest supporters of the free movement of workers, as seen in the Network of Global Agenda Councils’ Business Case for Migration report, launched under the auspices of the World Economic Forum.[2]

 

Even if German workers continue to accept this state of affairs, the German model is unsustainable for two further reasons: first, because it relies on vulnerable markets; and, secondly, because it has created massive imbalances within the EU itself, which are slowly tearing the Union apart.

 

Exports: Can Germany’s Golden Goose Really Keep on Laying?

Germany’s economic growth depends predominantly on export surpluses. Indeed, Germany has the highest export ratio by far among the world’s five largest economies.

However, this fact, which is often presented as an unalloyed success, makes Germany vulnerable to developments abroad that are beyond its control. In particular, any slowdown in demand for German exports risks the German economy itself.

 

This risk becomes more specific when we consider Germany’s most important export markets.

Both the USA and Italy have “populist” governments who do not buy the idea that the rising tide of free trade lifts all boats. Some therefore threaten higher tariffs; others put the Euro up for discussion. Brexit could also have a negative impact on German exports to the UK. No wonder, then, that Social Democrat finance minister Olaf Scholz states flatly that “the golden years are over”. And these years were hardly “golden” for German workers anyway, as we have seen.

 

Yet, rather than changing the German model, policymakers are doubling down on neoliberalism. While insisting on the virtues of a balanced national budget, the government has suggested further tax cuts to companies and high earners, while proposing “tightening the belt” on government spending.

 

The SDP-CDU coalition agreement already commits the government to capping social security contributions as a proportion of wages at 40 percent, and Peter Altmaier, Federal Minister for Economic Affairs and Energy, now proposes to enshrine this “magic mark” into Germany’s Basic Law, our national constitution. Once again, German elites are trying to build export-led growth off the backs of German workers.

 

Sadly, German trade unions remain in lockstep with this regime. They, too, advocate a strengthening of “industrial added value both in Germany and in Europe”, echoing Altmaier’s vague calls for a “national and European industrial strategy” that “strengthens industrial value creation”.

 

It is certainly true that, as the following chart shows, industry’s share of value added in Germany is remarkably large compared with other rich countries. The government is now targeting 25 percent of GDP.

However, sustaining such a large industrial sector in a relatively small domestic market is only possible through exporting a large share of manufactured goods. Yet, as we have seen, key export markets are precarious. Moreover, less developed countries are gradually expanding their industrial capacities, while large industrialised economies will not voluntarily reduce their production capacities. This entails vicious competition for declining export markets and, unless government policy changes, a race-to-the-bottom for Germany’s workers.

 

The German Robber 2.0

The second reason to doubt the sustainability of the German model is that it is breeding divisions within the Eurozone that are gradually tearing the EU apart.

 

In his wonderful 1950 children’s anthem, set to music by Hanns Eisler, Berthold Brecht expressed his hope that Germany would behave in such a way that “people do not blanch, as before a robber” but “hold out their hand in friendship, as they do to other folk.” Unfortunately, his hope has not been fulfilled. The prosperity that he sought as a basis for peace has increasingly come to set “other folk” against Germany.

 

At the heart of this paradox are the development of relative unit labour costs. As shown below, the deliberate suppression of wages in Germany has led to wide divergences in unit labour costs and therefore inflation rates across the Eurozone. By design, such an undervaluation regime gives Germany a significant price advantage in export markets.

Accordingly, particularly since the introduction of the Euro, German companies have become massively more price-competitive vis-à-vis France and Italy, for example. This is reflected in the development of real effective exchange rates, a widely recognised measure of international competitiveness.

Germany’s relative price advantage is also reflected in its superior performance in terms of its share of global exports. Although its share has decreased, reflecting the rise of emerging export powerhouses like China, it has done so far less than that of Italy or France.

The situation is even more dramatic when looking at bilateral trade balances. Thanks to Germany’s superior price competitiveness, Italy and France both run enormous trade deficits with Germany, importing far more than they export.

Indeed, Germany is now criticised worldwide for its exorbitant trade surpluses. For example, the chief economist of the IMF, Maurice Obstfeld, recently described these surpluses as a “threat to global financial stability”.[3] But he forgets to point out the current real economic problems of the deficit countries. If profit-oriented companies permanently lose market share, they will also reduce their productive capacities. This is exactly what has happened in France and Italy, as the following chart shows.

Clearly, free trade between countries sharing a common currency entrenches a permanent competitive disadvantage to those with higher inflation rates, inflicting lasting damage on its economy.

 

The heartless response to this structural imbalance is that other countries should simply follow Germany’s lead and become “more competitive”. We saw this in the blistering austerity imposed on southern Europe following the Eurozone crisis. However, this only intensifies the frictions between Eurozone members, as we saw when Greek protestors compare Angela Merkel and Germans more generally to Adolf Hitler and the Nazis. For their part, German workers were also incapable of solidarity with their European brethren. Since they had already endured many years of wage restraint and welfare cuts, they were easily persuaded by neoliberal politicians who argued that Germany should not be expected to “bail out” economies where “lazy” workers enjoyed “excessively generous” welfare regimes.

 

It also goes without saying that pursuing “competitiveness” is not a solution to the imbalances between Germany and the other Eurozone countries. It not only implies that workers must suffer to attain economic growth. It is also a logical impossibility. Competitiveness is relative: not everyone can be competitive; one economy is always more competitive than another. If all countries try to become more price competitive, then a race-to-the-bottom ensues, and everyone will lose.

 

The only way to avoid this challenge is either wage coordination or some other kind of mechanism to compensate for inflationary differences across the Eurozone. However, these interventions have never occurred and there is not the slightest indication that they will do so in future.  

 

A state outside of a monetary union could boost its competitiveness by devaluing its currency, which makes its exports cheaper to foreign buyers – but this is impossible within the Euro. The inescapable conclusion is that there is hardly any alternative to exiting the Eurozone if one wants to avoid German predation and promote the economic development of one’s own country.

Back to the national shell?

 

For the political left, therefore, the German economic model can hardly be recommended for imitation. “Remain and German” is certainly not a strategy that can be expected to solve the many economic and social problems in France or Italy. Exiting the Eurozone, if not the EU itself, is clearly essential.

 

For German Social Democrats, who have dissolved themselves into Germany’s neoliberal policy regime, this idea is unthinkable. They denounce it as a “retreat into the national snail shell” which “disregarding the need for cross-border regulation in an interdependent world, is doomed to failure”, as public intellectual Björn Hacker puts it in a recent book.[4] They cling to what former Federal Constitutional Court judge Gertrude Lübbe-Wolff calls the “post-national narrative”.[5] According to this narrative, the EU stands for “governing beyond the nation state”, as Jürgen Habermas famously put it, in keeping with the age of globalisation.[6].

 

This argument might have some merit if the national state really had become dysfunctional, and these problems really had been overcome by the EU, which really was a well-functioning form of political organisation. But, as we have seen, nothing could be further from the truth.

 

Debating which competences should remain at the national level, or which of the competences transferred to the supranational level should be reclaimed, has nothing to do with a “flight into the past”. As Lübbe-Wolff correctly argues, it is a matter of soberly weighing up the costs and benefits of an experiment in regional governance. As she insists, “The idea that what transcends the (previous) nation-state is eo ipso better is no less silly kitsch than the idea that what is best is an ethnically homogeneous nation-state that keeps the world off its back.”[7]

 

No less “silly kitsch” is what Lübbe-Wolff calls the claim of “protective-power-amid-globalization narrative”,[8] which Hacker invokes when warning “left-wing Eurofighters” that “the home fire of good, non-nationalist patriotism can only warm for a short time” before being “blown out by the cold wind of globalisation”. In reality, the EU is nothing more than the institutionalisation of globalisation: more a wind tunnel than a shelter. As Wolfgang Streeck notes, the EU’s governing ideas could have been taken straight from Friedrich von Hayek, godfather of neoliberalism, whose 1939 article on economic federation reads “like a blueprint for today’s European Union”.[9].

 

As Hayek explained, he was attracted to the idea of a supranational economic union because it would vastly limit the “room for manoeuvre of the economic policy of the individual states”. Individual states’ attempts to intervene in industry would be doomed because they would be out-competed by “similar industries in other parts of the Union.” Furthermore, “With a common monetary unit, the latitude given to the national central banks will be restricted at least as much as it was under a rigid gold standard—and possibly rather more”. Better yet, “greater mobility between the states [would] make it necessary to avoid all sorts of taxation which would drive capital or labour elsewhere.” Moreover, the political power of domestic associations would be eradicated:

 

Once frontiers cease to be closed and free movement is secured, all these national organisations, whether trade-unions, cartels, or professional associations, will lose their monopolistic position and thus, qua national organizations, their power to control the supply of their services or products.

 

To finish the job, Hayek saw the need for supranational institutions with “the negative power of preventing individual states from interfering with economic activity” – a neat description of the European Court of Justice.

 

It is ludicrous to suggest that a system built along Hayek’s lines – which the EU clearly is – could support the “containment of market forces”, as Hacker suggests. It is explicitly designed to entrench market forces and make their containment politically impossible.

 

Could the EU be reformed along these lines? Institutionally, it has been designed to withstand such reform (see Analysis #23 – The Folly of “Remain and Reform”). But the problem runs even deeper than this. As Hayek argued, an economic federation would have “to take over the functions which the states can no longer perform”, including “all the planning and regulating which the states cannot do”. However, he maintained, “Planning, or central direction of economic activity, presupposes the existence of common ideals and common values”. Given the limited consensus existing across entire continents, “common sense” dictated that “the central government in a federation composed of many different people will have to be restricted in scope”. This, for him, was one of the attractions.

 

The truth of Hayek’s words is clearly borne out in the absence of any significant “planning” institutions at European level. Even in the wake of the Eurozone crisis, the EU has failed to develop any measures to harmonise wages or otherwise prevent destructive intra-EU competition, let alone create the fiscal transfers required to offset the enormous imbalances inherent to common currency areas.

 

The idea that “planning” – that is, democratic management of the economy, including public ownership and the welfare state – requires “common ideals and common values” is hardly unique to Hayek. Hermann Heller, the great Weimar constitutional law expert, also argued that a state’s ability to guarantee a fair balance of interests between its citizens depends on a certain degree of material, social and cultural homogeneity among its citizenry. Many researchers have also long detected a correlation between shared culture and trust and the sustainability of welfare states.[10] This is debated, and it may not be impossible to develop a deeper sense of Europeanness over time. But the processes required to build national “imagined communities” took centuries, and current levels of mutual identification and solidarity across Europe are exceedingly thin, as the Eurozone crisis exposed. As such, the idea of building a welfare state at the EU level – even one as emaciated as those existing today – appears fantastical, in the short to medium term at least.

 

A return to the national “shell” therefore seems the only way to re-establish true shelter from destructive market competition. Far from threatening a return to nationalism and division, as EU enthusiasts so often maintain, this can be done in a way that is progressive and internationalist. In any case, as the German experience shows, European integration is no way to avoid interstate tensions; on the contrary, the one clearly provokes the other.

About the author

Dr Paul Steinhardt worked as an international banker for more than two decades. Together with Heiner Flassbeck he is editor of MAKROSKOP, a German economic policy magazine.  

References

[1] In an interview on the ZDF documentary Neues Wirtschaftwunder, 1 August 2017.

[2] The Network of Global Agenda Councils, The Business Case for Migration, World Economic Forum, 30 September 2013.

[3] “Eine Bedrohung der globalen Finanzstabilität”, Die Welt, 6 August 2018.

[4] Björn Hacker, Weniger Markt, Mehr Politik: Europa Rehabilitieren (Bonn: Dietz, 2018).

[5] Gertrude Lübbe-Wolff, “Ein Narrativ für die Europäische Union? Gegen den verbreiteten politischen Kitsch im Verhältnis zu Europa”, Frankfurter Allgemeine Zeitung, 6 January 2018, p. 9.

[6] Jürgen Habermas,“Der europäische Nationalstaat unter dem Druck der Globalisierung”, Blätter für deutsche und international Politik 44(4) (1999): 425-436.

[7] Lübbe-Wolff, “Ein Narrativ”.

[8] Ibid.

[9] Wolfgang Streeck, Buying Time: The Delayed Crisis of Democratic Politics, 2nd edition (London: Verso, 2017), ch.3, referring to Friedrich A. Hayek, “The Economic Conditions of Interstate Federalism”, New Commonwealth Quarterly 5(2) (1939): 131–49.

[10] E.g. T. H. Marshall, Citizenship and Social Class and Other Essays (Cambridge: Cambridge University Press, 1950); cf. Wim van Oorschot, “Solidarity Towards Immigrants in European Welfare States”, International Journal of Social Welfare 17(1) (2008): 3-14; Will Kymlicka, “The Multicultural Welfare State?” in Peter A. Hall and Michèle Lamont (eds.) Successful Societies: How Institutions and Culture Affect Health (Cambridge: Cambridge University Press, 2009), pp. 226-253.

 

This work represents the views of the author only. It is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.