How Do Those Germans Do It and What Does it Mean for the US?

November 4th, 2013 at 12:12 pm

Paul Krugman has a piece up today about how Germany’s large and persistent trade surpluses play an important, destructive role in the slump in the rest of the Euro area—essentially, they import much-needed labor demand from the rest of the zone.

The implication is that there’s some type of market manipulation going on behind these imbalancing acts.  The typical culprit here is currency management, where you boost your exports through favorable exchange rates which you maintain by keeping your currency low relative to that of your competitors.  But given the common currency in the Eurozone, that’s clearly not the issue here.

Instead, it’s a) “internal devaluation,” something Paul and others have often documented, and b) enforced austerity.  And note that if you’re a periphery country, “b” keeps you from offsetting the negative effects of “a.”

Under internal devaluation, since you can’t keep relative prices down through the exchange rate, you do so by jamming down relative compensation, controlling for relative productivity differences, i.e., you hold down you unit labor costs.  Here’s a figure from Antonio Fatas showing just that.


Source: Fatas, see text.

How do the Germans keep labor costs low relative to productivity?  In no small part, it is a national strategy, agreed to by labor, producers, and government.  Paul and others object to the mercantile, “beggar-thy-neighbor” outcome, especially when coupled with the arch-austerity of a Schauble (Germany’s finance minister).  I share that view, though at the same time, I think one should separate the use of strategic industrial policy from the problems caused by German trade surpluses.

Here in the US, for example, we typically eschew industrial policy, by which I mean cooperation between the groups noted above to invest in manufacturing, increase production, market share, and net exports.  The latter is particularly important in the US case, since our trade performance has been a mirror image of Germany’s.  We’ve posted persistent trade deficits that have exported large amounts of labor demand for over a decade.

And here’s the kicker: our unit labor costs in manufacturing are well below the Germans both in levels and trends.  The latter is shown below.  Our ULC’s—which should be an important determinant in trade flows—have been essentially flat for years, up 5% since 1979 while German manufacturing ULC’s are up 64% (see here for level comparisons, where US hourly manufacturing compensation is 25% below that of Germany).


Source: BLS

In other words, based on “price,” we should be much more internationally competitive.  To be very clear, I’m not saying we should generate persistent imbalances going in the other direction.  As I read Paul and others, the problem is not German industrial policy per se.  It’s such policy in the context of deep misunderstanding (or denial) of basic macro, which in this context is really a fancy word for international accounting.

I think these numbers and trends reveal the impact of the absence of coherent industrial policy here in the US and I challenge Paul and others to think and talk about this.  Why, given our internationally low manufacturing ULC’s (at least among advanced economies), are we stuck with large, persistent trade deficits that rob us of jobs in much the same way the Eurozone periphery is hurt by the German trade surpluses?

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11 comments in reply to "How Do Those Germans Do It and What Does it Mean for the US?"

  1. jonathan says:

    Much of the answer seems to lie in market orientation. Germany aims at producing high value added products; they know they can engineer well and they export the value-added. The US of course does some of that – though it seems much engineering may be done here with the manufacturing done elsewhere – but it tends to compete as though it can be a low to mid cost producer. That puts the US in competition with actual low cost producers. Germany isn’t in competition with cheap Malaysian or Indonesian or Chinese labor. We are.

  2. smith says:

    Part of it is here:
    It’s not just German engineering, though that is part of it. German companies can’t close factories easily. This forces manufacturing into creating something that’s worth the price. It forces manufacturing to work hard with labor to squeeze out efficiencies. Japan faces a similar problem, not from worker councils, but from cultural distaste of laying off workers. Closing a factory might also symbolize failure. Culturally too, Japan mostly prefers to buy Japanese made products. Both countries see exports as a way to grow their business.

    In addition, labor costs are not a huge part of manufacturing costs anymore. But U.S. companies send jobs overseas because CEOs will do anything to save pennies short term, while sowing the seeds of their company’s and the country’s own destruction.

    We don’t need an industrial policy, government picking winners and losers, we just need to restore the labor movement to what it was briefly in the 1930s, 1940s, and 1950s, the most potent force for economic and social justice the world has ever known. There was a lot of corruption and inefficiency too, new rules needed for transparency. But end intimidation and reprisals to union organizing, enforce the law, allow immigration without employer sponsorship, restore the 40 hour work week by ending exempt status, repeal Taft-Hartley.

    • smith says:

      Krugman argues for Germans to spend, he’s not against the competitiveness of German enterprise per se, that causes the trade balance surplus. He’s telling them use your good fortune to buy stuff or invest or the Euro still could break vs. just causing a lot of misery.

    • urban legend says:

      Isn’t the corruption largely a thing of the fairly distant past, but continues to form the conventional wisdom from a few anecdotes and a well-crafted movie?

      • smith says:

        Emphatically no (I think).
        That was just from a quick google.

        It’s difficult to tell the degree of the problem because so much anti union sentiment encases the true story.

        The problem with Unions:

        Work rules that stifle productivity, fairness, and innovation.
        Big unnecessary overpaid bureaucracy that effectively imposes a tax on everyone.

        On the other hand, millions stolen from union funds seem insignificant compared to tens of billions banks stole committing fraud but getting off scot free (I think that’s a slur, excuse me Adam Smith, David Hume, etc)

        Need to do more research but why would Unions be any less corrupt than banks? In the past they were definitely more so. Need to ensure they’d be clean if restored to power.

  3. Waffles says:

    First things first, since Germany is a coordinated market economy it’s going to rely a lot more on manufacturing industries because of its comparative advantages in areas like inter-firm cooperation and investments in worker skill. So while I don’t think either the US or Germany should be running a trade surplus necessarily, it’s important to note that manufacturing is far more important for the overall German economic strategy than it is for liberal market economies like the US and UK.

    As for the US, I think that it’s a tremendously effective aid to the global economy that the US runs a trade deficit overall, since it’s been a major factor in the rise of successful developmental statism in northeast Asia (e.g. Japan, Korea, Taiwan, China). The rise of these countries’ middle class will be a great long term boon to the American and global economy. I think it’s pretty important that we maintain relationships like this with the developing world, and I don’t really see a way to end long term trade deficits without majorly disrupting this relationship. I think we do utilize industrial policy in the US whether we admit it or not (e.g. Fred Block’s “hidden developmental state” in high tech), but I’m not convinced that it would be a good thing to close our trade deficit with industrial policy targeted at US manufacturing.

    So for me it comes down to how we should divide up the developed world’s share of the trade deficit, and it probably makes sense for the US to take on a bit more than Germany, but as it stands Germany is running a beggar-thy-neighbor policy that harms its neighbors and the world (especially if they pull the EU to follow their example).

    • urban legend says:

      That’s an awfully cavalier approach to massive unemployment — and yes, we do have terrible unemployment — and declining wages. You don’t even mention it. Are we supposed to let the invisible hand take care of all that?

  4. European_IW says:

    It is true that Germany is part of the Eurozone, and you have to consider that the value of the Euro reflect ALL of the members of the EZ. Buti if Germany would have its own currency its value would certainly be 30% higher than the comparable value of the Euro.
    Another element are wages : for skilled workers in the exporting industrie they are – lets say – adequate for the workers, but a huge part of low skilled or middel skilled workers are – as in the US – very low on the edge of sustenance! and that is also a shame, and that should change, they deserve higher wages which would help the other European countries (southern for the most part)

  5. Kevin Rica says:

    Germany runs a current account surplus because its private sector saves a lot more than they need for investment. (If Germany is such a wonderful economy, why don’t Germans wish to invest more there?) Those surplus savings are exported and finance Germany’s current account surplus.

    If Germans wish to export those savings, the countries that provide the alternative investment opportunities should make sure that they pay taxes for the privilege. Germans are known as irrepressible tax cheats and curiously, the German Government tolerates and even encourages it. (The largest U.S. bill is $100 in order to discourage illicit cash payments and money smuggling. But the Germans are wedded to the €500 bill. Easier to stuff into a suitcase for a trip to Switzerland.)

  6. Amit says:

    I think Dean Baker has spent a fair amount of time explaining the causes of the US trade deficits:

    – IMF policy (guided by Larry Summers) in the wake of the 1997-98 Asian crisis, causing Asian countries to hold larger foreign reserves.
    – The status of the USD as the world’s reserve currency.

    Both of these caused the dollar to appreciate against other currencies, making the US less competitive.

  7. jeff says:

    Unit labor cost is probably to blunt an instrument when comparing specialized high-end manufacturing. A nd the U.S. is nowhere close to competing when it comes to less specialized areas where even China is getting ‘too expensive’.

    Along with that, go to the MBA graduate pages of any major university. Few students are interested in manufacturing beyond offshoring it to some foreign place and letting a Li Ka-shing magnate manage it.