Germany’s Chance to Be a Good European

(Originally published here.)

Bloomberg News reports that Germany’s Social Democrats are in the midst of negotiating with Angela Merkel’s conservative bloc to split the finance ministry in two. One would focus on domestic policy and the other on pan-European issues. On the surface, this won’t help the rest of the euro area very much — the mainstream parties are all opposed to a banking union and eurobonds, and many Germans resist loosening the terms of the existing bailout programs. But the SPD could help the euro area’s economy by cutting consumption taxes and spending more on infrastructure. This not only would raise German living standards, it would also make it easier for troubled countries to export their way to recovery.

The consensus among German policy makers is that Spain, Portugal and Greece are suffering because their economies aren’t competitive. If only they deregulated and cut wages, the indebted southern European countries could enjoy the success that Germany has had in boosting its economy with exports. Wolfgang Schauble, Germany’s current finance minister, recently articulated this view in a column for the Financial Times.

As Martin Wolf explained in his rejoinder, this strategy was always going to be hard to pull off within the context of slow inflation and fixed exchange rates. It could have had a chance of success if Germany, the Netherlands and other euro-area countries with large current-account surpluses had been willing to run trade deficits with the rest of the currency union. In practice, this would have required government policies that put more money in people’s pockets, such as spending increases and tax cuts.

Unfortunately, governments in the euro area’s core exacerbated the problem through tax increases and spending cuts. A new paper published by the European Commission argues that this gratuitous fiscal tightening squeezed purchasing power and made the crisis far worse than it needed to be. The group also a missed an opportunity to invest in needed infrastructure when real interest rates were negative.

The bright side is that there is still time for Germany and the rest of the northern bloc to reverse course. According to the paper, an increase in infrastructure spending of 1 percent of gross domestic product in each of the core countries would reduce their excessive current account surpluses by about 0.3 to 0.4 percentage point of GDP while also boosting GDP in the troubled countries by about 0.2 to 0.3 point. This public investment spending would also permanently boost core economies by as much as they spent because productive investments financed at zero real interest rates ought to have no long-term costs.

In other words, a paper published by the European Commission — the champions of conventional wisdom throughout the crisis — is saying that everyone in the euro area would benefit if the SPD had more influence on German fiscal policy. Countries such as Germany, with a current account surplus equal to more than 7 percent of GDP, and the Netherlands, with a surplus equal to 10 percent, could therefore afford not only huge infrastructure programs but also generous consumption tax cuts for people who haven’t seen increases in their real earnings in years.

These efforts wouldn’t be enough, by themselves, to restore prosperity to the struggling economies of Greece, Ireland, Portugal, Spain and Italy — but they would be helpful. German politicians should embrace this chance to be “Good Europeans” while acting principally in the interests of their own citizens.

(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)


About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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