Cross-posted from Brussels Morning (https://brusselsmorning.com)
What is called economics in Germany has become unchallenged ideological preaching. It is not about understanding economic interrelations, but a theology of conviction that is not grounded on facts and theory.
It is hard to believe that the “crème de la crème” of German economists fail time and again to soberly assess unfolding events. Two former chairmen of the Council of Economic Experts (Lars P. Feld and Christoph M. Schmidt), two incumbent members (Monika Grimm and Volker Wieland) and the presidents of the economic research institutes in Kiel and Munich (Gabriel Felbermayr and Clemens Fuest) have recently submitted a joint letter published by Frankfurter Allgemeine Zeitung (FAZ) calling for a “return to a market economy.” Their article focuses on the level of European debt:
“Due to the common monetary policy, in a crisis, no state can rely on national monetary policy, unlike the U.S. or Japan, for example. Looking ahead to the post-Corona period, the sustainability of public finances in all EU member states is therefore of great importance. Each member state should be held responsible {for its level of debt}. But it would be difficult for Germany to make the case for budget discipline if the country continues to rely on government spending and higher deficits.”
Almost everything about this assessment is wrong and misleading. This kind of economic discourse can have terrible consequences for Europe and the European Monetary Union (EMU) because German politicians tend to endorse it without a challenge.
What is economics?
I will try to explain this harsh standpoint by breaking down the argument put forward, sentence by sentence, because there is an imminent need for a broad discussion in Europe about university education in economics. It cannot be that someone who fails to meet scientific benchmarks of evidence-based policy analysis can offer public advice on the basis of primitive prejudice. It is precisely these biased views that are taken up by laymen in economics at the political top and sold as the last word in wisdom. The result is political misjudgement that is devastating to Europe as a whole.
Focus for a moment on the succinct point made that in the EMU no state can “rely on national monetary policy” because there is a common monetary policy. This assertion is correct but at the same time trivial and misleading. Of course, national monetary policy cannot be relied upon in a monetary union because it no longer exists. The relevant question is whether in any crisis, member states can rely on European monetary policy.
The factual answer to this question must reference the actual monetary union created by the Maastricht Treaty rather than an ideal monetary union that does not exist. And the factual answer is that EMU member states have been able to rely on European monetary policy during the COVID-19 crisis. From the outset, the European Central Bank (ECB) made it clear that it was ready to do whatever it takes to prevent a divergence of monetary conditions in the Union, despite an early blunder by President Christine Lagarde. That means nothing less than an ECB readiness for capital market intervention for each state, comparable to those in Japan and the U.S. In effect, that means guaranteed access to very low long-term interest rates despite the massive increase in government debt. In that respect, the statement of the economists’ group is either irrelevant or deliberately misleading, depending on how one likes to interpret it.
The next sentence of their analysis builds on the same mistake. The sustainability of government finances after the Corona pandemic is not a relevant question. There is no sign that the ECB will abandon its policy of influencing long-term interest rates and interest rate differentials among member states after the Corona crisis has subsided.
Whether EMU member states should rely on this ECB policy in any kind of crisis is quite another question. During the Greek and Cypriot crises, the ECB did not provide similar support, suggesting they were undergoing national crises. Subsequently, the measures taken by the ECB were accompanied by political conditionality in a manner that was quite beyond the bank’s mandate. While there are indications that the ECB would not choose to repeat the same kind of intervention today, the question remains open as to whether one can rely on the ECB to react tomorrow as it does today.
German Idealist Economics
The fact that this question remains open is due to design flaws in EMU, which are largely attributable to German influence in the drafting of the Treaty of Maastricht. Influential political circles in Germany wanted a monetary union in which the nation states would not rely on the support of the ECB either in national or in European crises situations. In short, German wisdom mandates that EMU member states should rely solely on the wisdom of capital markets to finance their public debt. That is what elite German economists believe is the valid approach.
Thus, one pretends that a certain political position, fed by certain economic prejudices, corresponds to reality. This is a clearly unscientific approach: one does not describe and explain reality by reference to an ideal and largely illusory version of the world that corresponds to their biases but not to reality.
Anyone taking a position on such an issue would have the theoretical and empirical burden of proof, allowing them to make the case that a monetary union can function without a lender of last resort for all its member states. The standard internationally is that central banks are lenders of last resort. And in making that case, they would also have to argue that capital markets do not actually require central bank intervention because they function perfectly at all times and under all circumstances. That is an absurd argument that one does not need to dwell upon.
Politically speaking, if accepting the notion of monetary union without a Central Bank was an explicit precondition to joining the EMU, the union would never materialise. If Germany had explicitly made the political case that the no-bail-out clause prohibiting solidarity between member states and the perverse “independence” of the central bank – preventing from acting as lender of last resort – is central to the project of monetary integration, that integration would never happen.
EMU member states are not the architect of their own fortunes
The fourth sentence of the elite economists’ group referencing the “national responsibility” of each EMU member state with regard to the sustainability of public finances is nonsensical. This argument is founded on the factually incorrect and unscientific assertion that a monetary union can operate without a lender of last resort. In fact, each member state of the EMU can be held to account only if there are no external factors affecting the economic process. Whether the volatility with which member states are faced is domestic or international in nature is a question of fact and it can be assessed unambiguously.
Immediately after the start of monetary union, Germany, the largest member country, pursued a policy that can only be described as a massive external disruption for all other countries. With the help of political pressure to subdue wages, Germany aimed for a lower than agreed inflation rate and thus a real devaluation. By improving its international competitiveness, Germany sought to reduce its unemployment (at the expense of others).
This was a clear violation of the spirit and the unwritten rules of a monetary union, although at the time the structural significance of the German current account surplus and its consequences for other member states was not clear for all to see. Acting on a proposal from the Commission, the European Council did subsequently introduce regulation sanctioning countries that run persistently high current account surpluses, which clearly shows that the serious imbalance of Germany’s current account cannot simply be ignored when evaluating the national leeway for EMU member states fiscal policy.
However, anyone writing about the public finances of an EMU member country with academic pretensions generally cannot avoid writing about Germany’s current account surpluses and their effect on the other countries. The reason is that that any economy’s public finances can only be assessed in conjunction with financial balances (expenditure-revenue) of private households, companies and international trade.
Clearly, it is impossible for an economy that is linked to a monetary union to generate current account surpluses when the biggest member of the EMU undermines their competitiveness. A perpetual decline in national wages in absolute terms has negative consequences for the economy as a whole, including the ability to generate growth. If we add to this picture extremely low interest rates and the fact that, despite the zero interest rates, the company sector is a net saver in most countries, it is obvious that there cannot be a solution without additional deficit spending by the governments. There is no way to fight a recession or high unemployment that are triggered by an external factor, such as the COVID-19 pandemic, without resorting to the state’s ability to borrow.
That is why the last sentence of the economists’ group can only be called cynical. It would be an “easy to convey” blessing for every other member of the eurozone if Germany now pursued a deficit-driven economic policy aiming at high growth with lower current account surpluses. Without such relief for the eurozone, it is impossible to demand “budgetary discipline,” because the best will in the world would stumble against objective circumstances.
Disregarding logic and empirical evidence
The critique of this position article raises the fundamental question of what gives government-appointed scientists the right to disregard unambiguous empirical evidence, such as the relationship between unit labour costs and inflation or entrepreneurial savings. How is it that reputable economists with a public governance mandate can defy logical relationships like the fact that the fiscal balance of an economy must add up to zero. How can they responsibly prescribe public policy as scientists, meeting no scientific standards?
Although there are critical student associations at some faculties, such as the “Plural Economics” or the “Critical Economists,” the one-sided neo-classical substance of German status quo economics appears mainstream and unchallenged. That is dangerous, as such microeconomic approaches to public policy have dominated public entrepreneurial and media discourse. Obviously, this systemic thinking is incapable of being self-reflective and self-critical. Professors who decide on new professorships always select candidates who guarantee the continuation of mainstream thinking. Who would risk being criticised by one of his own colleagues? In so-called scientific journals, especially those that are cited, one can only publish if they echo the neoclassical mainstream.
As long as there are no political personalities who can reference their own expertise to question this serious deplorable state of affairs, the call for scientific guidance and data driven policy is toxic. And the debate about the relation between economy and society – one of the most important and complex issues of our time – does not take place. The question is when political and social stakeholders will realise the significance of a substantive economic debate.