From: Rakesh Bhandari (rakeshb@STANFORD.EDU)
Date: Fri Feb 20 2004 - 21:06:21 EST

Le Monde diplomatique


February 2004

Germany: capital flees
Germany's generous social welfare provisions and once powerful unions
didn't cause its economy to stagnate. The real problem has been money
leaving the country in search of easy profits.

GERMANY has been the sick man of Europe for some time, with high
unemployment and a stagnating economy. The diagnosis of German
economists is unanimous: the labour market is unable to balance
supply and demand because of high social welfare benefits and
excessive trade union power. The Nobel economics laureate Robert
Solow called this diagnosis "a naive belief that unemployment must be
a defect of the labour market, as if the hole in a flat tyre must
always be on the bottom, because that is where the tyre is flat".

Experts in other disciplines would have slunk away with their tails
between their legs after that criticism. Not our economists. They
continue to insist that the cause of Germany's economic troubles is
the labour market. The Deutsche Bank's economic staff point to a
series of problems: the difference between gross and net wages due to
high taxes and social security contributions; high real wages due to
an excessively distribution- oriented wage policy; insufficient wage
differentiation, between sectors and regions and between skill
levels; strong legal labour protection against dismissals; strong
barriers against increased labour time flexibility; incentives to
work blunted by high wage replacement rates of unemployment and by
welfare benefits. All of these are said to have the same root cause:
an overdeveloped welfare system.

In this view, the German economy is suffering not from unemployment
but from a cost-induced drop in labour output caused by over-generous
welfare benefits. This diagnosis culminates in the breathtaking claim
that the suppliers of labour as a factor of production have been the
big winners in recent decades. Considering how the economy and wages
have actually evolved since Germany's reunification, the "winners"
are not the only people surprised by this diagnosis.

The nine new eastern Länder make up 30% of German territory and have
20% of the population. In 1992 they contributed less than 8% to
Germany's total economic output. Economic activity in the East fell
dramatically after reunification and the number of people in
employment dropped rapidly from almost 10 million to around 6
million. Yet despite de-industrialisation, the growth rates of the
early 1990s were fairly impressive. They were sustained above all by
the expansion of the building sector, which was fuelled by subsidies,
tax incentives and public investment in infrastructure.

Since 1997 the gap has widened again. Unemployment is twice as high
in the East, and productivity is much lower than expected, even in
ultra-modern factories. Reunification not only failed to produce an
economic take-off in the East; it hampered growth in the West. The
main burden fell on West Germany's social welfare programme, whose
benefits were extended to the East. Social welfare accounts for over
50% of gross public transfers to the nine new Länder. Net transfers
for the whole of the 1990s amounted to 4.5% of the West German gross
domestic product. Overall social welfare expenditure rose from 22.2%
of GDP in 1990 to 32.2% in 1995 and has remained at that level.

Astonishingly the huge increase in social welfare expenditure was not
financed by additional general taxation, but by higher social
insurance contributions and a rapid rise in state indebtedness. As
long as East German economic distress was seen as a temporary
phenomenon, the Bundesbank tolerated the growing public debt -
especially as there was a major influx of investment to the new
Länder. But with the recession in 1993 investment dropped throughout
Germany and failed to return to its previous level. All hopes that
high transfers of charges to the East would soon be unnecessary had
to be abandoned. Between 1991-2001 the growth rate for the German
economy as a whole was 1.5%, lower than all the rich OECD countries
except Switzerland and Japan. Since growth was insufficient to create
more jobs, unemployment continued to weigh heavily on the social
welfare budget, rising from 7.7% in 1993 to 9.7% in 1997. By 2000
unemployment had gradually fallen to 7.8% but is now rising again.

Unemployment depresses wages, as the textbooks tell us. But only if
real net wages are considered. Between 1991-2002 average real net
annual wages fell by 2.6%, while real GDP grew by 15% and labour
productivity by almost 21%. Over the same period income tax and
social security contributions rose by 56.4%, constantly widening the
gap between gross and net earnings.

The stagnation in real earnings was compensated to some extent by an
increase in free time. The average number of hours worked per year
fell by 6.3% between 1991-2002. Since net real earnings fell by a
smaller percentage, the average wage earner can be said to have
benefited from economic growth and higher productivity in the form of
a little more free time.

Nevertheless, in a situation of weak economic growth and high
unemployment, wage earners were scarcely able to defend their real
net earnings. By shifting the burden of reunification on to wages,
the state created a widening gap that made labour more expensive,
despite the stagnation of real wages. The much-maligned trade unions
have at most succeeded in maintaining the level of real net wages
over a long period of significant, though weak, economic growth. The
standard claim that high wages are responsible for unemployment may
be true of the East, where wages are too high in relation to
productivity, but it is certainly not true of Germany as a whole.

When it comes to international competitiveness, relative unit labour
costs are the decisive factor. The cost of labour depends both on
exchange rates and on productivity. Comparative studies show that
unit labour costs, calculated in DM, have weighed more heavily on
German industry than on its main competitors, but have clearly lagged
behind when calculated in dollars. From a starting value of 100 in
1992, they had fallen by 2001 to 94.1 in the United States, 89.3 in
Japan, 62.6 in France, 78.7 in Germany and 95.3 in the United
Kingdom. Clearly, the German economy is suffering far less from a
labour cost problem than from an exchange rate problem.

The claim that Germany's economic woes are caused by high wages is
contradicted by the fact that the main burden of low growth has been
borne by wage earners, either in the form of unemployment or in
higher contributions. The standard diagnosis that unemployment is
caused by high wages, which are themselves the result of an
inflexible labour market - the welfare state and the unions - is
based not on empirical analysis but on the dogma of vested interests.

So if Solow is right, and the hole in the tyre is not at the bottom,
where is it? Unemployment can have other causes than inflation and a
rigid, socially and legally structured, labour market. It can result
from under-investment. If capital reserves do not grow sufficiently
while production is being rationalised, the demand for labour falls.
And in Germany investment has been falling since the late 1970s. The
share of net investment - capital investment minus depreciation - in
national income has dropped from over 22% to a recent and
catastrophic 3.5%. It is always possible to argue that when rising
wages depress profits, investment falls. But, if so, the reverse
should be true: a wage freeze should produce greater profits and
higher investment. In Germany, however, the opposite has happened:
profits have grown and investment fallen.

In the great wave of speculation of the late 1990s the volume of
German direct foreign investment rose from ?302bn at the end of 1998
to ?628bn by the end of 2001, compared with a total of ?372bn for
total net domestic investment over the same period. At the same time
German speculation in foreign shares increased rapidly up to the 2001
crash. Clearly, much of the profits that German companies and
affluent individuals had made in Germany were invested abroad.

Here, too, there is a standard explanation. The Deutsche Bank staff
have argued that "when the return on the factor capital diminishes,
not so much additional capital will tend to be provided. If, at the
same time, opportunities for investment are more attractive abroad,
capital will be employed there instead."

So there was no shortage of investment capital. The decision not to
invest in Germany was simply the result of more attractive investment
opportunities offered abroad. German capital was sucked into a
maelstrom of high US profits, speculation and greed; the salaries of
top managers shot through the roof. Daimler's merger with Chrysler
resulted in a 466% pay increase for Daimler board members. Who could
resist such temptation?

The flow of capital to the US came to an end when the bubble burst in
2001. But domestic investment did not pick up again, in fact the
opposite happened. So the question is: has German capital abandoned
German capitalism? The flight of capital ought in fact to lead to
profitable domestic investment opportunities, since it puts both wage
earners and politicians under pressure.

In a context of high unemployment, someone whose job is at risk will
be inclined to put up with the restructuring of his working
conditions and the redistribution of wealth in the direction of
greater profit. Politicians will tend to accommodate to neo-liberal
policies. Agenda 2010 is a case in point, with Chancellor Schröder
taking major steps to increase profits by lowering taxation,
increasing deregulation and depressing labour costs.

Do dominant German business circles really believe they will be able
to maintain the benefits of Germany's coordinated market economy
while rampaging after profits on the US model? If the complementary
institutions of Rhine capitalism are destroyed by withholding
investment and taxes, German entrepreneurs may wake up in a world in
which they have the worst, not the best, of the two variants of
capitalism: they will have a shrunken public sector providing poor
services and a deregulated economy with little competition, a badly
educated and badly trained workforce and employees who grudgingly let
themselves be bullied by greedy authoritarian managers.

The continuity of financial policy from the former finance minister,
Theo Waigel, to the present incumbent, Hans Eichel, offers little
hope of a change of direction. Germany is once again the world's
champion exporter, but its economic success abroad is having little
impact on the domestic market and foreign investment is highly
unlikely to fill the breach.

Either private investment must be attracted back to Germany by a
series of concessions, or a social democratic variant on Scandinavian
lines, based on a demand policy driven by greater public investment
and more jobs in the public sector, will have to be tried. But in the
present political climate the idea seems utopian.

* Heiner Ganssmann is professor of sociology at the Free University of Berlin

Translated by Barry Smerin

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