From the US subprime mortgage crisis to European sovereign debt 1

The role of Germany in the financial crisis 2

© 2016 George K. Zestos  After the end of World War II, Germany adopted the Social Market Economy model, which relied on: ◦ Free markets; ◦ Strong cooperation of employers and employees; ◦ An important role for the government in the economic system. 3

© 2016 George K. Zestos  The Social Market Economy model was successful as it boosted economic growth in Germany for many years.  Figure 6.1 shows the annual economic growth rate of Germany for the period , divided into six decades, and one smaller sub-period. 4

© 2016 George K. Zestos 5

 During the decade of , Germany attained an exceptionally high average annual rate of growth of 8.3%.  Economists named this the Miracle Growth Period. ◦ Known as Wirtschaftswunder in German. 6

© 2016 George K. Zestos  After the Miracle Growth Period, the German economy performed well until the late 1990s.  The decade was a period of slow economic growth.  During the decade, the European sovereign debt crisis occurred. ◦ However, Germany was able to weather out the crisis better than most of the other EU member countries. 7

© 2016 George K. Zestos  Figure 6.2 shows the German trade balance (X-M) for the period ◦ X =Value of exports M = Value of imports.  According to Figure 6.2, Germany experienced a phenomenal growth rate in its trade balance.  Germany is considered to be an export-led growth country. ◦ This is supported by the fact that since 1952, Germany has not generated a trade deficit for a single year. 8

© 2016 George K. Zestos 9

 The role of trade in the growth of the German economy is clearly portrayed in Figure 6.3, where both the real GDP and the trade balance are presented as indices for the period  Both the trade balance and GDP trends were similar until  After 2000, the German trade balance increased at a much higher rate of growth in comparison to GDP. 10

© 2016 George K. Zestos 11

© 2016 George K. Zestos  According to some analysts, excessive German trade surpluses became an issue of concern as they began destabilizing the EU economy.  German trade imbalances were also suspected of having played a role in prolonging the European sovereign debt crisis. 12

© 2016 George K. Zestos  Figure 6.4 portrays the unemployment rate of Germany for the period  During the subperiod, the German unemployment rate drastically declined by approximately 10% down to 1%, and remained low until the early 1970s. 13

© 2016 George K. Zestos 14

© 2016 George K. Zestos  Since the early 1970s, the German unemployment rate increased until its peak of approximately 13% in  During the 1990s, Germany experienced stagnation.  This was the time during which the social market economy model no longer worked for Germany. 15

© 2016 George K. Zestos  During the 1970s, Western European economies also experienced stagnation.  The two oil crises, aging populations, overregulation, and rigid labor markets all contributed to the EU decline in international competitiveness in relation to the US and Japan. 16

© 2016 George K. Zestos  To cope with the failing European economy, EU country leaders at the March summit of 2000 decided to launch a major program aiming to transform the EU into the most competitive economy in the world.  The new program was called the Lisbon Agenda, named after the capital of Portugal, where the March 2000 summit was held. 17

© 2016 George K. Zestos  EU governments agreed to launch several programs to promote fiscal stability and improve business innovation and international competitiveness.  Such objectives were going to be achieved mainly through labor market reforms. 18

© 2016 George K. Zestos  The Lisbon Agenda required: ◦ Reductions in pensions and wages; ◦ Reductions in worker benefits; ◦ More flexibility and freedom for businesses. 19

© 2016 George K. Zestos  For many years the social market economy was a successful economic model, thus Germany attained high economic growth and high standards of living.  In the early 1990s, however, the German economy revealed weaknesses. High labor costs and other market rigidities transformed Germany into an unattractive place for investors. ◦ As a result German companies began investing abroad. 20

© 2016 George K. Zestos  The reunification of East and West Germany posed new challenges for the country.  Although East Germany, the new Länder, was the most industrialized of the Eastern European countries, East Germany was lagging far behind in economic development and technology compared to West Germany. 21

© 2016 George K. Zestos  The reunification resulted in a stagnation of East Germany’s economy, as German exporting firms that were “destroying jobs in foreign countries” (Schmidt, 2009) now turned against East Germany. 22

© 2016 George K. Zestos  Political commitment was a driving force of Chancellor Helmut Kohl’s government in its decision to reunify East and West Germany. ◦ This decision also had the full support of Germany’s allies.  Nonetheless, major mistakes were made in the integration process of East and West Germany, therefore reunification became difficult. 23

© 2016 George K. Zestos  Two adopted reunification policies were detrimental to the East German economy: 1.The decision of Chancellor Kohl’s government to impose a one-to-one parity between the two countries’ currencies. 2.The decision of the German labor unions to quickly equalize wages within the two countries despite substantial differences in labor productivity. 24

© 2016 George K. Zestos  Both policies rendered East Germany internationally uncompetitive.  To close the gap in the level of economic development and standard of living, Chancellor Kohl’s government decided to assist East Germany with massive aid amounting to $100 billion per year.  Such massive fiscal transfers were not effective at quickly closing the gap in the levels of economic development of East and West Germany. 25

© 2016 George K. Zestos  The massive fiscal transfers created two major problems for the reunified country: 1. It became difficult for Germany to meet the Maastricht fiscal criteria for membership of the EMU. 2. Germany also struggled to comply with the Stability and Growth Pact (SGP) that required fiscal discipline after the launching of the EMU. 26

© 2016 George K. Zestos  As a result, Germany was one of three large countries that violated the SGP.  Furthermore, the continuous flow of fiscal transfers from West to East Germany altered the perception of East Germans in the eyes of their compatriots in the West. 27

© 2016 George K. Zestos  According to most West Germans, East Germans were no longer the “innocent victims” of Soviet totalitarianism, but rather “the lazy recipients of their taxes.”  In some ways the perception that northern EA people had of the southern EA people during the Eurocrisis were very similar to those of West German citizens regarding East Germans. 28

© 2016 George K. Zestos  To cope with high unemployment, the Social Democratic Party (SPD), which was then in coalition with the Green Party, introduced the Hartz I-IV reforms in to revamp the stagnating German economy. 29

© 2016 George K. Zestos  The Hartz reforms introduced by Chancellor Gerhard Schröder were in line with the Lisbon Agenda.  Many of the proposed Hartz reforms became laws in Germany. 30

© 2016 George K. Zestos  The Hartz reforms made it more difficult for unnemployed workers, as many of their unemployment benefits were cut or substantially reduced.  New types of employment were introduced during this time that favored businesses.  These new types of employment became known as precarious work. 31

© 2016 George K. Zestos  The following are examples of precarious work: 1.Fixed-term contracts; 2.Agency work; 3.Temporary work; 4.“Mini-jobs”; 5.“Midi-jobs.” 32

© 2016 George K. Zestos  The Hartz reforms helped Germany weather the crisis better than other EU countries.  Several analysts believe there were other factors that predated the Hartz reforms which contributed to the fast recovery and strengthening of the German economy during the Eurocrisis. 33

© 2016 George K. Zestos  Such additional factors include: 1.Decentralization of labor unions; 2.Short Work (Kurzarbeit), and Working Time Accounts; 3.Weakening of trade unions. 34

© 2016 George K. Zestos  Even prior to the launching of the Hartz reforms, labor negotiations in Germany began at the company-specific level, instead of the national or regional levels.  Such arrangements took labor productivity of the specific plant into consideration when bargaining for wages and other workers’ benefits.  These arrangements were therefore more equitable and efficient. 35

© 2016 George K. Zestos  Short Work (Kurzarbeit) is a German labor program that is employed during periods of low product demand to reduce unemployment.  A firm has the option to apply for this program through the German Employment Office. 36

© 2016 George K. Zestos  If approved, the firm can keep several part-time workers.  However, these part-time employees get paid wages equal to full-time workers, with the difference being provided by the German Employment Office. 37

© 2016 George K. Zestos  Working Time Accounts is a labor program that allows firms to employ workers during high- demand periods without having to pay them overtime wage rates or overtime hours.  Instead, companies keep a Working Time Account for such workers. During periods of low demand these workers are paid on a full-time basis although they only work part-time. 38

© 2016 George K. Zestos  Both programs reduced unemployment in Germany, especially during the Eurocrisis. 39

© 2016 George K. Zestos  The reunification of Germany had a major impact of reducing both: 1.Trade union membership; 2.Trade union participation as a percentage of the labor force; ◦ This is shown in Figure 6.5a.  Both trade union membership and trade union participation increased immediately after German reunification. ◦ However, they both dropped substantially in the following years. 40

© 2016 George K. Zestos  By 2013, trade union membership had dropped by 5.6 million workers.  Trade union participation had dropped by 17%.  Such drastic changes in the labor market weakened the position of workers in relation to businesses. 41

© 2016 George K. Zestos 42

© 2016 George K. Zestos 43

© 2016 George K. Zestos  Labor reforms were pushed harder in Germany than any neoliberal pro-business policies were pushed in other EU countries.  This gave German firms a comparative advantage but not an unfair advantage. o Other countries were free to launch such reforms, but most did not implement them to the extent that Germany did. 44

© 2016 George K. Zestos  Furthermore, international organizations such as the OECD, IMF and the World Bank, promoted neoliberal policies. ◦ These international organizations did not, however, promote Short Work (Kurzarbeit) or Working Time Accounts. 45

© 2016 George K. Zestos  The Hartz reforms helped Germany become efficient and internationally competitive. Consequently they also helped generate large positive trade balances.  After adoption of strong austerity measures for several years, periphery EA countries were also able to generate trade surpluses starting in ◦ As a result trade surpluses with the EU declined substantially after

© 2016 George K. Zestos  German trade balances with the EA members almost dissipated by  However since 2009, the year the crisis entered Europe, Germany’s trade surpluses with non-EU countries began substantially increasing (see Figure 6.6 below). 47

© 2016 George K. Zestos 48