Yesterday, it has been 20 years since the fall of the Berlin wall and the eventual collapse of communist political and economic system in Central and Eastern Europe. However, there is still discussion about economic costs and benefits of German reunification (Wiedervereinigung). I've been motivated to open this debate by professor Becker's analysis (link) on the size of countries and by the recent article in Financial Times by the contributing German economist (link).
Economists in Germany and the rest of the world have long warned against the consequences of the unification of East and West Germany. After the unification, German central bank set the exchange rate at 1:1. Because East German workers' relative productivity level lagged far behind the West German level, East German workers migrated to West Germany in search of higher wages. When wage rates between West and East Germany were equalized in the absence of productivity catch-up in East Germany, the excess labor supply in the East led to high unemployment and slow changes in the economic structure. As the exchange rate was equalized and wages prevented from the natural adjustment to productivity growth, the unemployment soared as East German manufacturing sector couldn't employ labor anymore. The unemployed received massive transfer payments which, even more than a decade after the reunification, still present about 4 percent of total German income.
Today, the figures suggest that East German GDP per capita is roughly 70 percent of the Western German level and the unemployment rate exceeds 12 percent - more than twice the Western level. Low population density and high share of rural population are the main structural obstacle to higher productivity growth in the East. The majority of models in economic geography and urban economics suggests that agglomeration economies occur where population density is high. The latter yields significant advantages in terms of spillovers, search cost, factor mobility, know-how and economies of scale. Low population density is a major obstacle in attracting investment mostly because firms are not eager to locate at the periphery in the presence of high search costs and in the absence of high-skilled labor, agglomeration and linkages to economies of scale. In the U.S, for instance, Pittsburgh's industrial restructuring from resource-based steel industry into knowledge-intensive information technology, biotechnology and software development required agglomeration which combined high-skilled labor, human capital, access to regional and international markets as well as high population density.
In Germany, for example, Hamburg generated the highest GDP per capita (€51,000) among cities and Bavaria (Bayern) generated the highest GDP per capita (€36,000) among German states. Hamburg and Munich, as well as the linking cities located in their vacinity are among the most densely populated areas which enabled them to develop core industries, spillovers, know-how and dynamic knowledge externalities. There is an overwhelming evidence that differences in population density are a good source of growth difference between east and west Germany.
After the unification, German fiscal policymakers favored an expansive fiscal policy which directed federal expenditures into poorer regions of the East to boost the development of infrastructure. However, at an exchange rate 1:1, West German firms were reluctant to invest in East Germany mainly because of higher relative price of labor. As East German workers moved to the Western part of the country, west German firms hired eastern workers. As brain drain became widespread, the convergence of east German income per capita slowed.
East Germany were far better off, if the country remained independent. The reunification of Germany would yield singificant economic benefits, if the unification itself were based on close economic integration with the establishment of free trade area and free movement of capital, goods and labor. If East Germany remained independent and retained its own currency without the uncovered exchange rate realignment to to West German exchange rate parity, the relative price of East German labor wouldn't increase and thus the unemployment rate would be significantly lower than it has been ever since the reunification. Thus, West German firms would easily find attractive investments in East Germany. The process would dramatically reduce disparities in population density compared to the West. Under such scenario, East Germany's macroeconomic stabilization and institutional reforms would be a lot easier and the overall economic and political transition much less painful.
Showing posts with label Germany. Show all posts
Showing posts with label Germany. Show all posts
Wednesday, November 11, 2009
Wednesday, August 05, 2009
GERMAN ECONOMIC DISEASE
Hans Werner Sinn recently wrote a piece in WSJ discussing anemic growth prospects of the German economy (link). The German economy is expected to decline by about 6 percent annually, following a major decline in export sector. Foreign orders decreased by 43 percent in January and February. Many commentators emphasized the risk of Germany's exposure to foreign trade and its vulnerability to global economic shocks.
In spite of absorbing a rather strong shock from a decline in exports, the major backlash of the German economy is the rigid labor market and the lack of wage flexibility. In recent years, German policymakers launched the increase in minimum wages as an attempt to ward-off international low-wage competition from emerging market economies. What happened? In turn, workers in low-wage industries were protected againist labor-intensive producers from India, China and so forth.
In addition, as minimum wages grew, the labor cost of low-wage workers increased to such an extent that employers couldn't afford to hire them. Consequently, the creation of high-wage jobs was discouraged as "skills" were less abundant than low-wage jobs. High tax burden and extensive labor cost discouraged job formation and thus many young German minds voted with their feet and moved abroad to places such as neighboring Switzerland, Canada, United States and Australia.
It is simply not true that the expected output contraction will accelerate only because of the near collapse of export and manufacturing sector. Economists and policymakers often discuss the backbones to economic growth. The empirical studies showed that the rigidity of labor market comes at the cost of less job creation and productivity decline. This is exactly what happened in Germany.
When I was writing one of the forthcoming papers, I estimated the potential daily working time in OECD. While Korea hits the top with a stunning average of more than 9 hours of daily labor supply, Germany hits the bottom with no more than the average of 6 hours of daily labor supply. In microeconomics, this is a pure substitution effect - higher tax wedge discourage labor supply and induces individuals to consume more leisure. To stimulate labor supply, the policymakers should liberalize labor market and remove the disincentives to work. Second, the liberalization of the labor market goes hand in hand with the reform of the old-fashioned German welfare state. Keeping minimum wages above the wage rate in the private sector will not diminish the unemployment rate and stimulate job creation.
Also, providing the unemployed with generous entitlements and welfare benefits, will not cure the disease of low productivity. Third, in 2008, government spending reached equaled 45.7 percent of the GDP should be reduced. German economic performance lagged behind the EU. Between 1995 and 2009, the economies of EU15 grew by 27.1 percent on average. German economy expanded by 14.3 percent, only surpassing Italy, whose economy expanded by 11.9 percent during that period. A wise combination of deregulation of labor market, reform of the welfare state and reduction in government spending is the right path for German economic recovery.
In spite of absorbing a rather strong shock from a decline in exports, the major backlash of the German economy is the rigid labor market and the lack of wage flexibility. In recent years, German policymakers launched the increase in minimum wages as an attempt to ward-off international low-wage competition from emerging market economies. What happened? In turn, workers in low-wage industries were protected againist labor-intensive producers from India, China and so forth.
In addition, as minimum wages grew, the labor cost of low-wage workers increased to such an extent that employers couldn't afford to hire them. Consequently, the creation of high-wage jobs was discouraged as "skills" were less abundant than low-wage jobs. High tax burden and extensive labor cost discouraged job formation and thus many young German minds voted with their feet and moved abroad to places such as neighboring Switzerland, Canada, United States and Australia.
It is simply not true that the expected output contraction will accelerate only because of the near collapse of export and manufacturing sector. Economists and policymakers often discuss the backbones to economic growth. The empirical studies showed that the rigidity of labor market comes at the cost of less job creation and productivity decline. This is exactly what happened in Germany.
When I was writing one of the forthcoming papers, I estimated the potential daily working time in OECD. While Korea hits the top with a stunning average of more than 9 hours of daily labor supply, Germany hits the bottom with no more than the average of 6 hours of daily labor supply. In microeconomics, this is a pure substitution effect - higher tax wedge discourage labor supply and induces individuals to consume more leisure. To stimulate labor supply, the policymakers should liberalize labor market and remove the disincentives to work. Second, the liberalization of the labor market goes hand in hand with the reform of the old-fashioned German welfare state. Keeping minimum wages above the wage rate in the private sector will not diminish the unemployment rate and stimulate job creation.
Also, providing the unemployed with generous entitlements and welfare benefits, will not cure the disease of low productivity. Third, in 2008, government spending reached equaled 45.7 percent of the GDP should be reduced. German economic performance lagged behind the EU. Between 1995 and 2009, the economies of EU15 grew by 27.1 percent on average. German economy expanded by 14.3 percent, only surpassing Italy, whose economy expanded by 11.9 percent during that period. A wise combination of deregulation of labor market, reform of the welfare state and reduction in government spending is the right path for German economic recovery.
Tuesday, August 04, 2009
THE IMPACT OF RECESSION: GERMANY vs. AMERICA
Douglas J. Elliott of the Brookings Institution compares the impact of this year's recession in the U.S and Germany (link):
"Equally importantly, Germany is justifiably proud of its prowess in exports, particularly industrial machinery and automobiles. Somewhere between 40% and 50% of Germany’s GDP comes from exports, depending on when and how you measure it. This is more than three times that of the U.S., although it is important to note that Germany is a considerably smaller country and is closely integrated with its European neighbors, who are the largest importers of German products. (If the U.S. counted sales from the Northeast to California as exports, our figure would be sharply higher than it is.) Germans view their trade surplus as a sign of virtue and the source of overseas investments that will carry the country through a future in which their aging population cuts back on output and necessarily lives more on the fruits of past labor."
"Equally importantly, Germany is justifiably proud of its prowess in exports, particularly industrial machinery and automobiles. Somewhere between 40% and 50% of Germany’s GDP comes from exports, depending on when and how you measure it. This is more than three times that of the U.S., although it is important to note that Germany is a considerably smaller country and is closely integrated with its European neighbors, who are the largest importers of German products. (If the U.S. counted sales from the Northeast to California as exports, our figure would be sharply higher than it is.) Germans view their trade surplus as a sign of virtue and the source of overseas investments that will carry the country through a future in which their aging population cuts back on output and necessarily lives more on the fruits of past labor."
Saturday, December 22, 2007
WILL THE LARGEST EUROPEAN ECONOMY RECOVER FROM A NON-REFORM DISEASE?
The Economist has recently published an article about the current state of Germany's economy. At this time, Germany faces persistent structural problems affect the dynamics of economic performance. The sub-prime mortgage mess has not been stretched to German market as less than 10 percent of German exports go to the United States and thus, German exposure to U.S slowdown is not huge. Germany's economic growth is estimated to fall from 2,6 percent in 2007 to 2 percent or less in 2008. What is actually behind a lingering growth performance? The growth of export performance is likely to decline, facing a drop from 8 percent in 2007 to 4,8 percent in 2009.
Among the economic issues, there was a significant surge of inflation which hit 3,1 percent annually in 2007 mostly due to higher food and energy prices. A detailed analysis of the demand conditions may reveal that the coefficients of price and income elasticity of demand have been quite inelastic, moving somewhere in the interval between 0 and 1. The suppliers know very well, that if demand is quite inelastic and consumer behavior quite monotonic, price increases could prop up their income. Germany's inflation rate may be transiotry as there are strongly supported expectations about the normalization of energy and food prices in the period to come.
Although consumer sentiments remained well-positioned, consumption-inflated spending may not boost the potentials of German economy on the way to recovery from low overall growth.
Germany's future and prosperity will crucially depend on the pace of economic reforms. The policy outcome of current government coalition is mixed. Labor-market reforms contributed one fifth to overall growth but there is a number of issues hampering the ability of German economy to operacompete successfully in a global environment. Bundesbank, German central bank, has shown that the contribution of labor to economic growth is likely a result of drawing unskilled workers into labor supply. Also, German government cut public spending and put limits on the growth of overall spending. Quite logically, the investment picked up an incentive and grew at a higher rate.
An impeding obstacle to Germany's prosperity is the attitude oriented against the economic reforms. The preference of economic justice over the need for tomorrow's change is a road to self-destruction. The consequence of such a misty combination of political and voting behavior is the lack of willingness and political courage to implement much-needed reforms. Steming away and streaming for status quo is what causes riots, dissatisfaction and an endless cycle of statist propaganda inflated by politicians, interest groups and the media.
Unemployment benefits, raising the minimum wage in public sector and similar policy implementation strongly discourage the economic performance from going to growth to searching for privileges from the state through various mechanism such as tax system, collective bargaining and public sector. In Germany's case, the raise of minimum wages in a state-controlled postal company, is nevertheless a sign of rent-seeking. If such collective demands are granted, the steps in the wrong direction will multiply. There is hardly any argument for the minimum wage. On demand side, minimum wage is a form of taxation that raises the overall cost of labor and increases the probability of being fired or unemploymed in the future. On supply side, the minimum wage reduces the productivity potentials and does not stimulate labor supply to spend more hours in the market.
Regulating job market will not boost job creation subject to external pressure on the allocation of labor resources and productivity of the labor supply. The pursuit of various form of unemployment insurance, which has flipped Germany into a mirage of structural unemployment, discourages laborers from seeking a job. It rather encourages seeking priviliges from the state and the lack of incentives to search job due to unfavorable working environment and the influence of trade unions on job growth and labor market.
The question is whether Germany will move out of the cage of low growth and discouraging structural picture. The answer is mix of particular sets of policy conditions and macroeconomic estimates. On macroeconomic level, inflation expectations remain favorable and consumer price index is expected to normalize subject to transitory shock on particular prices. On fiscal level, estimates suggest that more should be done to decrease public spending, cut taxes on productive behavior and reduce government size and consumption. Many futures answers to thequestion of where Germany will stand in the future, will depend on whether the polocymakers will give up the political payoffs emerged from rent-seeking and special interest groups.
Going in the reverse way, where political decision-making neglects economic costs, further makes it quite difficult for policymakers to implement long-range reforms regarding health-care, welfare state and labor market. In those areas, the presence of pressures from interest groups and trade unions will radically oppose the economic reforms to protect the benefits handed to special groups and priviliged from the state. There is no need to endure old-styled western European type of corporatist society where the interests of stakeholders are protected at first hand.
There is always a need for change in economic and structural terms, just as deregulation and openness created German economic miracle after the World War 2. Change is the engine of tomorrow's freedom and progress and an opportunity is rare, while a clever man will never let it go.
Rok SPRUK is an economist.
Copyright 2007 by Rok SPRUK
Among the economic issues, there was a significant surge of inflation which hit 3,1 percent annually in 2007 mostly due to higher food and energy prices. A detailed analysis of the demand conditions may reveal that the coefficients of price and income elasticity of demand have been quite inelastic, moving somewhere in the interval between 0 and 1. The suppliers know very well, that if demand is quite inelastic and consumer behavior quite monotonic, price increases could prop up their income. Germany's inflation rate may be transiotry as there are strongly supported expectations about the normalization of energy and food prices in the period to come.
Although consumer sentiments remained well-positioned, consumption-inflated spending may not boost the potentials of German economy on the way to recovery from low overall growth.
Germany's future and prosperity will crucially depend on the pace of economic reforms. The policy outcome of current government coalition is mixed. Labor-market reforms contributed one fifth to overall growth but there is a number of issues hampering the ability of German economy to operacompete successfully in a global environment. Bundesbank, German central bank, has shown that the contribution of labor to economic growth is likely a result of drawing unskilled workers into labor supply. Also, German government cut public spending and put limits on the growth of overall spending. Quite logically, the investment picked up an incentive and grew at a higher rate.
An impeding obstacle to Germany's prosperity is the attitude oriented against the economic reforms. The preference of economic justice over the need for tomorrow's change is a road to self-destruction. The consequence of such a misty combination of political and voting behavior is the lack of willingness and political courage to implement much-needed reforms. Steming away and streaming for status quo is what causes riots, dissatisfaction and an endless cycle of statist propaganda inflated by politicians, interest groups and the media.
Unemployment benefits, raising the minimum wage in public sector and similar policy implementation strongly discourage the economic performance from going to growth to searching for privileges from the state through various mechanism such as tax system, collective bargaining and public sector. In Germany's case, the raise of minimum wages in a state-controlled postal company, is nevertheless a sign of rent-seeking. If such collective demands are granted, the steps in the wrong direction will multiply. There is hardly any argument for the minimum wage. On demand side, minimum wage is a form of taxation that raises the overall cost of labor and increases the probability of being fired or unemploymed in the future. On supply side, the minimum wage reduces the productivity potentials and does not stimulate labor supply to spend more hours in the market.
Regulating job market will not boost job creation subject to external pressure on the allocation of labor resources and productivity of the labor supply. The pursuit of various form of unemployment insurance, which has flipped Germany into a mirage of structural unemployment, discourages laborers from seeking a job. It rather encourages seeking priviliges from the state and the lack of incentives to search job due to unfavorable working environment and the influence of trade unions on job growth and labor market.
The question is whether Germany will move out of the cage of low growth and discouraging structural picture. The answer is mix of particular sets of policy conditions and macroeconomic estimates. On macroeconomic level, inflation expectations remain favorable and consumer price index is expected to normalize subject to transitory shock on particular prices. On fiscal level, estimates suggest that more should be done to decrease public spending, cut taxes on productive behavior and reduce government size and consumption. Many futures answers to thequestion of where Germany will stand in the future, will depend on whether the polocymakers will give up the political payoffs emerged from rent-seeking and special interest groups.
Going in the reverse way, where political decision-making neglects economic costs, further makes it quite difficult for policymakers to implement long-range reforms regarding health-care, welfare state and labor market. In those areas, the presence of pressures from interest groups and trade unions will radically oppose the economic reforms to protect the benefits handed to special groups and priviliged from the state. There is no need to endure old-styled western European type of corporatist society where the interests of stakeholders are protected at first hand.
There is always a need for change in economic and structural terms, just as deregulation and openness created German economic miracle after the World War 2. Change is the engine of tomorrow's freedom and progress and an opportunity is rare, while a clever man will never let it go.
Rok SPRUK is an economist.
Copyright 2007 by Rok SPRUK
Subscribe to:
Posts (Atom)