Sigmar Gabriel and the German model fallacy

(Background: Germany's government is a coalition between the conservative Christian Democrats (CDU/CSU), led by Angela Merkel, and the moderately left-wing Social Democratic Party of Germany (SPD), led by Sigmar Gabriel. The CDU/CSU is very much the senior partner, and was almost able to form a government by itself.)

On Monday, while Angela Merkel was enjoying the perks of being Prime Minister, her Economics Minister Sigmar Gabriel said something in France that has made some noise: namely, that in exchange for implementing structural reforms, countries ought to get more time to reduce their budget deficits, for instance by not having the costs of reforms count against treaty budget limits.  Thus, he appeared to be backing Italy's Renzi and France's Hollande.

The resulting hubbub in Germany shows just how mistaken it would be to take this as a harbinger of a German paradigm shift on austerity.  Merkel and CDU Finance Minister Schäuble denied that there was any split in the government and insisted that all were agreed that no changes in Europe's fiscal compact regulating budget deficits were needed. Schäuble took the occasion to stress the need to learn the lessons of the successful experience of the countries who reformed under supervision of the EU-ECB-IMF "Troika." (Really, I kid you not.  He said: "Wir hatten ja die Erfolge in den Ländern, die unter Programm waren, weil sie die Strukturreformen auch durch die Vereinbarung im Zusammenhang mit Hilfsprogrammen und durch eine Überwachung durch die Troika durchgesetzt haben, deswegen haben sie die Erfolge. Die Lehren müssen alle ziehen in Europa...")   The man has an interesting definition of success.

But Schäuble is a hopeless austerity fanatic. What's really depressing is the other side of the political spectrum: Gabriel of the SPD. In defending his suggestion to allow slower budget consolidation in exchange for structural reforms, he repeated a one-sided account of the origins of Germany’s euro-era economic success.

Germany, he said, did exactly the same thing in 2003. "Agenda 2010 [structural reforms] plus more time for deficit reduction." Germans should honestly admit this and aggressively [offensiv] offer this as the German model.

The problems with making the German experience a model for the Eurozone as a whole are well understood. Look at the chart below, which graphs unit labour costs (labour costs for unit of output) for Germany and other Eurozone countries. As is evident, one of these things is not like the others. Up to the crisis, Germany held the share of wages and other labour costs in output very stable, while they were rising elsewhere in Europe.

German costs stayed low for two reasons. Most commonly cited are the Agenda 2010 reforms mentioned by Gabriel, pushed through by the SPD, which made it easier to create low-wage jobs. However, wage restraint in higher-paid jobs, the result of the weakening of unions and collective bargaining and the threats of employers to relocate abroad, was also very important. 

The problem with squeezing wages as a growth strategy is that workers are not just producers, they’re also consumers. The lower wages are as a share of output—the lower unit labour costs are--the less of output workers can afford, implying that some combination of investment, government spending, and exports must make up the difference

Luckily for Germany, until 2008 shortfalls in domestic demand were compensated for by the boom elsewhere in the currency block. Divergence in unit labour costs led to a surge of exports from Germany to the rest of the Eurozone—workers there had more to spend, and domestically produced goods were losing competitiveness.

For Gabriel (and the entire German political mainstream, so far as I can tell), the lesson of all this is that Germany prospered because it undertook the tough reforms needed to ensure competitiveness.  And other Eurozone countries should do likewise.  But this is a remarkably short-sighted position:

• A strategy of squeezing wages is a strategy of relying on external demand. Europe is already running record trade surpluses, but its growth is very weak. The idea that exports could be the main engine of growth for the Eurozone as a whole is not credible, leaving aside the probable reaction of the rest of the world. 
• Competitiveness is a relative concept!  Germany’s wage squeezing worked precisely because other Eurozone countries did not undertake “tough reforms” at the same time. (This is an example of the sort of “fallacy of composition” that Blyth discusses so effectively.) This is not the situation that European peripheral countries now face. 

It's clear that for Gabriel, relaxing austerity (he offered no prospect of reversing it) is simply a means to promote what is, in fact, a disastrous and unrealistic policy of extending the German model to the rest of Europe.  Alas, nothing to get excited about.