Thursday, 24 July 2014

Europe's missing demand model

I. Keynes - the very quick version

Keynes had lots of important insights, but I think the most crucial one is underplayed in my field of comparative political economy. The crucial insight is this: in a capitalist economy, workers can't afford to buy everything they make. Since to be profitable, the price of a good must equal its cost plus a mark-up, and wages are costs, aggregate wages must be less than the aggregate price of goods offered for sale. Thus, the only way for everything to be bought would be if the people drawing profits spent all of them (in addition to wage-earners spending all their wages). But they don't. Let's call this the "underconsumption problem."

The rest of his theory can be viewed as an answer to the question of how, then, can everything be bought? How can the underconsumption problem be solved? Keynes emphasised (a quick version of his key points is here) above all that some people draw wages for investment projects that do not lead to immediate sales, which they can then use to purchase consumer goods (or services). Thus, how easy it is to keep people employed to make stuff for immediate sale depends on how much investment is going on.

Investment depends on the mood of investors, which, Keynes convincingly argued, can vary wildly for no particularly good reason. If investment is too low to keep people employed, we should do something about it. Central banks, for instance, can lower interest rates, making borrowing cheaper and hopefully prompting more investment. However, interest rates are subject to the "zero lower bound"--central banks can't pay people to borrow money. When even interest-free lending doesn't prompt enough investment to keep people employed, monetary policy is "pushing on a string."

If investment isn't doing the job, then to buy up all the consumer goods on offer and keep people employed there needs to be some other source of spending, or demand, in particular spending in excess of income (spending just your income means you buy only as much as you sell, and thus you can't help make up for the fact that people in general don't want to buy everything they sell). This is why Keynesians advocate government "deficit spending" as a form of "demand stimulus." But consumers, not just government, can spend in excess of income via borrowing. Colin Crouch made a seminal contribution by coining the term "privatized Keynesianism" to refer to a systematic effort to get consumers to play this role.

For the individual country, another option is (net) exports. However, it's not possible for every country to export more than it imports.

II. Does the Eurozone have a demand model?

Different nation-states have found very different solutions to the underconsumption problem, or what you might call different demand models. Demand models seem to be quite enduring (see Monica Prasad's recent book and this article from Fred Block; also Peter Hall and David Soskice who have supplemented their initially exclusively supply-side Varieties of Capitalism approach with more attention to demand-side factors.)

However, Germany is promoting its famously (or notoriously) export-focused demand model for the Eurozone as a whole. I've made the following excellent chart to help us consider how that's working out.  (Data from here; I'm using the term investment slightly imprecisely to refer to gross capital formation.) Below the line we can see elements of the GDP--which are just the Keynesian sources of demand described above.

Some conclusions:

  • Five years from the onset of the crisis, the Eurozone has recovered only a bit more than half its lost GDP.
  • This is despite a staggering tripling in the trade surplus.
  • Export growth slowed dramatically in 2013.
  • There is no sign that export growth is feeding through to investment or household consumption.

So the answer is no--Europe does not have a sustainable demand model. All the sources of demand other than exports are stagnant or falling, and exports cannot be relied upon to replace them.

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