Source: AMECO

      In Germany, on the other hand, productivity, real compensation, and nominal unit labour costs have increased very slowly. It cannot be overstressed that gains in German competitiveness have nothing to do with investment, technology, and efficiency. The competitive advantage of German exporters has derived from the high exchange rates at which peripheral countries entered the eurozone and, more significantly, from the harsh squeeze on German workers. Hence Germany has been able to dominate trade and capital flows within the eurozone. This has contributed directly to the current crisis.

4. INTERNATIONAL TRANSACTIONS: TRADE AND CAPITAL FLOWS IN THE SHADOW OF GERMANY

Current account: Surplus for Germany, deficits for periphery

      The international transactions of eurozone countries have been shaped in large measure by the policies adopted to support the euro. The euro has been devised as a common measure of value and means of payment within the eurozone; the intention was that it should also become means of payment and reserve outside the eurozone, thus competing directly with the US dollar as a form of world money in the world market. Monetary and fiscal policies of eurozone countries have had to be consistent with this aim, thus imposing a common monetary policy and tight constraints on fiscal policy for each state. The institutional and policy framework of the eurozone have not arisen merely due to ideological dominance of neo-liberal thinking within the EU. They have also been dictated by the need to sustain the euro in its role as world money within and outside the eurozone.

      The pattern of international transactions that has emerged for eurozone countries is consistent with the putative role of the euro. In the first instance, peripheral countries were obliged to join the euro at generally high exchange rates. Core countries, above all Germany, insisted upon this policy with the ostensible purpose of ensuring low inflation. High inflation in individual countries would have undermined the ability of the euro to compete internationally against the dollar. The implication was to reduce at a stroke the competitiveness of peripheral countries in the internal market. To this poor start was added sustained loss of competitiveness, discussed in the previous section. The result, shown in figure 14, was inevitable: emergence of entrenched current account deficits for peripheral countries, matched by an equally entrenched current account surplus for Germany.

      Care is obviously necessary in interpreting this picture. Greece, Portugal and Spain have run substantial balance of trade deficits, but they have also had significant surpluses on services. Ireland has followed the opposite path, again reflecting its own mode of integration into the eurozone based on higher investment, much of it directed to housing, and intensified labour flexibility. For all, inability to restrain nominal labour unit costs at German levels and, more fundamentally, inability to set productivity growth on a strongly rising path, resulted in current account deficits mirrored by surpluses for Germany. Note that two thirds of German trade is with the eurozone. Note also that the trade of the eurozone with the rest of the world is roughly in balance.

      Fig. 14 Current account balance (percent GDP)

      Source: IMF BOP

      The euro and its attendant policy framework have become mechanisms ensuring German current account surpluses that derive mostly from the eurozone. Peripheral countries joined a monetary system that purported to create a new form of world money, thus signing away some of their competitiveness, while adopting policies that exacerbated the competitiveness gap. The beneficiary of this process has been Germany, because it has a larger economy with higher levels of productivity, and because it has been able to squeeze its own workers harder than others. Structural current account surpluses have been the only source of growth for the German economy during the last two decades. The euro is a ‘beggar-thy-neighbour’ policy for Germany, on condition that it beggars its own workers first.

      Fig. 15 Capital and financial account (Net, $ bn)

      Source: IMF BOP

Financial account: German FDI and bank lending to the periphery

      Inevitably, the picture appears in reverse on the capital and financial account (fig. 15). Germany has exported capital on a large scale, while peripheral countries have been importing capital.

      The financial account comprises fundamentally foreign direct investment (FDI), portfolio flows, and ‘other’ flows that are heavily driven by banks. The direction of aggregate flows between Germany and the periphery of the eurozone can be gauged from the composition of the German financial account (fig. 16).

      The driving forces behind sustained capital exports by Germany since the introduction of the euro have been ‘other’ and FDI flows. Portfolio flows have been weaker, even turning inward for much of the 2000s. Put summarily, Germany has been recycling its current account surpluses as FDI and bank lending abroad. Bank lending peaked in 2007–8 and, as is shown below, this has been a vital element of the current sovereign debt crisis.

      Fig. 16 Composition of German financial account (euro, bn)

      Source: Bundesbank

      The geographical direction of the recycling of surpluses is clear, once again, from the composition of German capital exports. The eurozone has been the main recipient of German FDI (fig. 17), while also competing with the non-euro part of the EU for German bank lending in the 2000s (fig. 18). Once the crisis of 2007–9 broke out, German banks restricted their lending to non-euro EU countries but continued to lend significantly to eurozone countries.

      Fig. 17 German outward FDI by region (euro, bn)

      Source: Bundesbank

      To recap, international transactions of eurozone countries have been driven by the requirements and implications of monetary union. Peripheral countries have lost competitiveness relative to Germany because of initially high exchange rates as well as because of the ability of German employers to squeeze workers harder. The result has been a structural current account surplus for Germany, mirrored by structural current account deficits for peripheral countries. Consequently, German FDI and bank lending to the eurozone have increased significantly. ‘Other’ flows to peripheral countries rose rapidly in 2007–8 as the crisis unfolded, but then declined equally rapidly. That was the time when peripheral states were forced to appear in credit markets seeking funds.

      Fig. 18 German ‘other’ outward flows by region (euro, bn)

      Source: Bundesbank

5. RISING PUBLIC SECTOR BORROWING: DEALING WITH FAILED BANKS AND WORSENING RECESSION

The straitjacket on fiscal policy

      The public sector of peripheral countries, and above all Greece, has been at the epicentre of the current turmoil. The reasons for this, however, are only partially related to the intrinsic weaknesses of the public

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