Ending the creditor's paradise': A German social democrat's duty

As I sat in my office at Brown University in December 2014, an email popped into my inbox with the title 'Herzlichen Gl? 1/4 ckwunsch – Sie sind der 1. Preistr??ger des Hans-Matth??fer-Preises f? 1/4 r wirtschaftspublizistik.' This was the award given by the Friedrich Ebert Stiftung (FES), the research foundation closest to the German Social Democratic party (SPD), and the Hans-Matth??fer Stiftung for the best economics publication in German in 2014. I was – to say the least – surprised.

My 2013 book, Austerity: The History of a Dangerous Idea (Oxford University Press), had recently been translated into German by the publishing arm of the FES. Indeed, I had been there a month earlier, in Berlin, to do a book launch, which was very well attended. Since then the book has been reviewed, positively, in the German press, with Suddeutsche Zeitung giving it a rather glowing review. Something odd was going on.

Clearly, despite the impression we get in the US, there was movement in Berlin away from the 'austerity is the only way' approach to thinking about the eurozone crisis, at least among the social democrats – but how much movement? Consider that during the negotiations to form the current coalition with German chancellor Angela Merkel's Christian Democratic Union, the SPD could have made an issue out of how the policies designed to heal Europe were causing great harm, a fact acknowledged even by the IMF by 2012. But they chose not to do so.

True, as German (and French) politicians know only too well, there are no votes in talking about Europe, only costs, so not speaking up is locally rational. But not speaking up when such inappropriate policies are being applied to Germany's European partners is collectively disastrous. Indeed, what is so tragic in this crisis is how the centre-left throughout Europe have not just accepted but in many cases actively supported policies that have done nothing but hurt their supposed core constituencies.

So I was awarded the prize at a ceremony in Berlin for 'thinking differently' about economics. Martin Schultz, the head of the European Parliament, gave the introduction. Peter Bofinger, the voice of macroeconomic reason on the German equivalent to the US Council of Economic Advisors, gave a speech praising the book. I had 10 minutes to say something useful at the end of the event. But what should I say that would be of use to the 600 social democrats gathered in the room?

I had just been there a month before, giving the message of the book, and I didn't want to do that again. I wanted to be useful, and supportive of this shift in thinking. But I also wanted to remind the SPD of who they are supposed to be and whom they are supposed to defend. I hope this was how the following was received.

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It is both an honour and an irony to stand here today and receive the 2014 Hans-Matth??fer-Preis f? 1/4 r Wirtschaftspublizistik. The honour is to be recognised at all, given the competition. To name but a few of my fellow contenders, Thomas Piketty may be my favourite economist, and Wolfgang Munchau may be my favourite journalist – so to be recognised amongst them is an honour.

But it is also somewhat ironic to be so recognised in the one country that seems, at least at the elite level, to be utterly impervious to the message of the book that you are recognising this evening. Perhaps at least in this room, and among social democrats, that message is gaining strength.

Austerity as economic policy simply doesn't work. In the cases where it looked like it worked, something else was really doing the work, usually the devaluation of a sovereign currency at the same time as the expansion of a much larger trading partner gave exports a short-term boost. Budgets were cut as exports expanded, but it wasn't the cuts that mattered, it was the expansion.

But I have stood here before and spoken about Austerity, so let's take the few minutes we have here today to look forwards rather than backwards.

All eyes are on Greece and the possibility of default or 'Grexit'. Indeed, it's an impossible position for all sides. The Greeks cannot pay back what they owe, given that the policies enacted to help them grow have resulted in the collapse of nearly a third of their economy. The young and the talented have left, leaving pensioners and the public sector behind.

But to recognise that fact and accommodate policy opens up issues in debtor countries, such as Ireland and Portugal and Spain, that creditor countries such as Germany do not want to deal with.

So how do we move forward, and what is the role of a social-democratic party in shaping this path? Two issues stand out for me. The first is what I refer to in Austerity as 'the false promise of structural reform'. There can be no doubt that the debtor countries of Europe need major reforms in taxation systems, labour markets, business regulation and a host of other areas.

But"

1. When we say 'structural reform' we really have no idea what those words actually mean, and we often fall back on them as a back-handed acknowledgment that austerity has failed; or
2. We misunderstand what we did when we refer to previous episodes of structural reform, and thereby miss that it is impossible for anyone else to do what we once did.

Let me explain. 'Structural reform' used to be called 'structural adjustment'. And European lefties like us used to condemn it as absurd, ridiculous, 'neoliberalism gone mad' – and yet we seem quite happy to unleash these policies, despite the damage that they have done in the developing world, upon our European partners.

When you ask for the content of what structural reform means, it seems to be a checklist of lower taxes, deregulate everything in sight, privatise anything not nailed down, and hope for the best. But are these policies not disturbingly American, if not Thatcherite? Indeed, isn't this everything that the SPD is supposed to be against, and much of which the German public would never put up with?

European reforms take the more subtle cover of simply asking everyone to become 'more competitive' – and who could be against that? Until one remembers that being competitive against each other's main trading partners in the same currency union generates a 'moving average' problem of continental proportions.

It is statistically absurd to all become more competitive. It's like everyone trying to be above average. It sounds like a good idea until we think about the intelligence of the children in a classroom. By definition, someone has to be the 'not bright' one, even in a class of geniuses.

But something has to be done, and we are often told that Germany was the 'sick man' of Europe, that the country took the 'bitter medicine' of the Hartz reforms and became more competitive. Because of this, when the crisis hit, Germany survived and came back stronger. The conclusion quickly follows that the rest of Europe needs to embrace 'structural reform' too.

This is a popular story, but it's quite wrong, and its application to other countries rests upon a rather obvious misreading of recent German history. Christian Dustmann and his colleagues have examined this question in depth and concluded that what really made the German economy more competitive were three interrelated phenomena that happened a decade before Hartz.

First – and I know all about this being married into a family of East Germans – was reunification. Having 10 million extra workers suddenly enter the labour market puts massive downward pressure on wages, which begins to show up around 1994.

Second, moving parts suppliers for the German auto complex out to the former eastern bloc countries makes the inputs for German exports even more competitive. This starts around the same time.

Third, German unions, at the same time, realise that globalisation starts east of the Elbe and simply stop asking for wage increases. The combined result is a squeeze on wages that lasts for nearly 20 years, and which is masked by the transfers of the welfare system. This is where your competitiveness comes from.

What Hartz does, a decade later, is to remove young single people from the welfare rolls and places them in so-called mini-jobs. The result of this is an expansion of the sheltered service sector, and of chronic low pay, that has to be addressed years later by the introduction of a minimum wage. Indeed, almost all the jobs created by Hartz are low-productivity, sheltered service-sector jobs.

The export sector – the 'competitive' part of the economy – depends upon demand generated elsewhere in the world, and it continues to shed rather than add jobs, as capital substitutes for labour in high-skilled production.

If Dustmann et al are correct, and I think that they are, then the ability to transfer these lessons to other countries is zero. No one else has an East Germany waiting around the corner to push down labour costs. And even if everyone did, all that would do is reduce consumption in the aggregate, thereby impoverishing everyone.

The take-home lesson is perhaps then that Germany is only Germany because everyone else is 'not Germany'. To try and make everyone a bit more like Germany can only mean the expansion of a poorly paid service sector and the introduction of a minimum wage to compensate. I do not think that's what structural reform advocates recommend, but it's where we may end up.

My second point returns us to the notion that we have grown quite comfortable talking about 'creditor nations' and 'debtor nations' rather than 'European nations', as if being a debtor or a creditor is a national characteristic. Indeed, one of the most poisonous aspects of this period and policy of austerity is the discourse it produces that reduces complex formations of class and institutions to essentials of race and identity.

But look beyond this, and there is a bigger issue for left parties to deal with, one that they unfortunately helped to create. Back in the 1970s, a period that now seems quite benign, corporate profits were very low, labour's share of income was very high, and inflation was rising. We were told that this was unsustainable, and new institutions and policies were constructed to make sure that this particular mix of outcomes would never happen again.

In this regard we were singularly successful. Today, corporate profits have never been higher, labour's share of national income has almost never been lower, and inflation has given way to deflation. So are we happier for this change?

What we have done over the past 30 years is to build a creditor's paradise of positive real interest rates, low inflation, open markets, beaten-down unions and a retreating state – all policed by unelected economic officials in central banks and other unelected institutions that have only one target: to keep such a creditor's paradise going.

In such a world, why would you, the average worker, ever get a pay rise? Indeed, is it any wonder that inequality is everywhere an issue? In Europe this plays out at the national level, and at the international level of creditor countries (good) and debtor countries (bad), where the rights of the creditors must be protected and the mantra that 'you must pay your debts' must be respected.

Yet even in terms of simple welfare economics, this is nonsense. If the cost of squeezing the debtor is to keep her in debt servitude, or if the losses to the creditors are less than the costs of servicing the debt in perpetuity, then default is efficient, if not moral.

Today it is a profound irony that European social democrats worry deeply, as they should, about the investor protection clauses embedded in the proposed transatlantic investment treaty with the US, and yet they demand enforcement of exactly the same creditor protections on their fellow Europeans without pausing for breath for the money they 'lent' to them to bail out their own banking systems' errant lending decisions.

Something has gone badly wrong when social democracy thinks this is OK. It is not. Because it begs the fundamental question, 'what are you for – if you are for this?' The German social democrats – for we are all the heirs of Rosa Luxemburg – today stand as the joint enforcers of a creditor's paradise. Is that who you really want to be? Modern European history has turned many times on the choices of the SPD. This is one of those moments.

It's great that my book has helped to remind you of the poverty of these ideas. But the point is to recover your voice, not just your historical memory. Your vote-share isn't going down because you are not shadowing the CDU enough. It's going down because, if that is all you do, why should anyone vote for you at all?

I hope that reading my book reminds the SPD of one thing: that the reason they exist is to do more than simply to enforce a creditor's paradise in Europe.

I thank you for this award, and I hope that this book encourages us all to think again about the economy we want to build for ourselves, our children, and our fellow Europeans.

Mark Blyth is Eastman professor of political economy at Brown University and author of Austerity: The History of a Dangerous Idea.

This article is published with the author's permission. It was previously published in the US by the Jacobin.