Why the Neoclassical Story About German Wage “Moderation” Causing the Eurozone Crisis is Wrong

Yves here. A row has broken out among European economists as a result of Servass Storm’s publication of a paper that challenges orthodox thinking about what caused the Eurozone crisis. The conventional story has it that the proximate cause was German wage “moderation” as in wage restrictions, which allegedly made German goods more competitive. The right has used this interpretation to cudgel Greece and other periphery countries into making labor market “reforms”; the left has not disputed the idea that labor policies led to German trade surpluses, but instead takes the tack that Germany is engaged in unsustainable “beggar thy neighbor” policies. The Storm analysis shreds this picture by focusing on why and how Germany’s export sector has been successful and incorporating the role of banking and the ECB, critical elements utterly absent from the conventional account.

This post is well written and forcefully argued, so I hope you’ll read it in full.

By Servaas Storm, Senior Lecturer in Economics, Delft University of Technology and co-author, with C.W. M. Naastepad, of Macroeconomics Beyond the NAIRU (Cambridge, MA: Harvard University Press), which won the Myrdal Prize of the European Association for Evolutionary Political Economy. Originally published at the Institute for New Economic Thinking website

In response to my critical analysis of German wage moderation and the Eurozone crisis, Heiner Flassbeck and Costas Lapavitsas spell out their version of what is roughly the neoclassical textbook model of a currency union. Their main point is that there would not have been large unsustainable current account imbalances within the Eurozone, and consequently no sovereign debt crisis in the deficit countries, if all member states had kept their nominal wage growth equal to labor productivity growth plus 2% (the inflation target). Professor Wren-Lewis (2016) has been making the same point.

In this account, this delicate equilibrium has been deliberately upset by nominal wage moderation in mercantilist Germany, with a growing German trade surplus just being the flipside of the growing trade deficit in Southern Europe. It is rather ironic, in my opinion, that a similar logic is used by mainstream observers such as Sinn (2014) or even Mr. Schäuble himself, with this difference: Sinn and Schäuble argue that the current account imbalances were caused by a failure of the crisis countries to follow Germany’s successful example in cutting down their unit labor costs. Let me be clear: the issue for me is not which side to this debate—those who accuse Germany of beggaring-its neighbors by undercutting wages or those who praise Germany for being super cost-competitive—is right. Both sides are mistaken in thinking that the simple textbook model can be credibly used to argue that Eurozone imbalances were driven by (exogenous) losses or gains in unit labor cost competitiveness. It is a myth—or, as Marx would perhaps have it, a fetish: a reified totem which stands in the way of understanding what is really happening. It is high time to ditch this myth for at least the following five reasons.

Where Are the Big Banks?

Firstly, the model presented by Flassbeck and Lapavitsas has a distinctly pre-Hilferding (1910) flavor to it, as in their take, Eurozone capitalism still has to enter the stage of “monopoly finance.” What role do big banks, gross cross-country financial flows, and the ECB play in Flassbeck and Lapavitsas’ analysis? The answer is none. Their exclusive focus is on exports and imports of goods and services, and their silence on banks, financial flows and interest rates reflects a view that the “financial sector” of the Eurozone is just passively adjusting to whatever happens in the real economy. Their view comes out clearest when they compare the Eurozone countries (each one lacking an own national currency) to a country having its own currency, so as to argue that in the latter case, trade surpluses (or deficits) can only be temporary, because after a while an automatic appreciation (depreciation) of the “equilibrium” exchange rate would bring down the surplus (deficit).

In the real post-Hilferding world, however, there is no such textbook automatism, because the impact of trade flows on the exchange rate is—generally—overwhelmed by the impact of cross-border gross financial flows, which (importantly) are mostly unrelated to trade (Akyüz 2014; Bortz 2016). This holds true for the Eurozone as well: billions of euro lent by German banks to (financial) firms in Ireland and Spain, and by French banks to (financial) enterprises in Greece, Ireland, Portugal and Spain were unrelated to the financing of trade (see O’Connell 2015). It is exactly these gross financial flows from the Eurozone core to the periphery, mostly coming from powerful too-big-to-fail banks (O’Connell 2015), which played the central role in bringing about the imbalances and destabilizing the zone, a role recognized by Professor Bofinger (2016) and by the so-called Consensus Narrative (2015)—but left unmentioned and un-analyzed by Flassbeck and Lapavitsas whose “diagnosis” of the Eurozone crisis thus resembles Hamlet without the Prince of Denmark.

What About Oligopolistic Competition?

Secondly, Flassbeck and Lapavitsas entertain a rather tenuous notion of competition between firms, which, they argue, is centered around reducing unit labor costs by means of productivity gains. They write that “supply side conditions are pretty much given for all [enterprises] since market forces tend to
equalize the prices of intermediate goods and the cost of capital” [italics added] and hence more innovative firms (those which manage to cut unit labor costs) tend to be more profitable and grow, while less innovative ones lose market share and ultimately perish.

This is remarkable. To make their argument work, they presume that (global) competition ensures factor price equalization across countries—which is something most neoclassical trade economists would doubt on empirical grounds—and which theoretically requires one to assume perfectly competitive markets. It must be noted that Wren-Lewis (2016) falls back on exactly the same assumption. This implies that according to Flassbeck, Lapavitsas and Wren-Lewis, firms don’t have price-setting power, share the same production technologies, and produce more or less similar (homogenous) goods. All this is unrealistic: in the real world, price-setting oligopolistic firms operating massive global production chains engage in product differentiation, branding, etc. and produce goods that are very different in terms of their complexity, quality and embodied technology (see Felipe and Kumar 2011; Janger et al. 2011).

What Flassbeck and Lapavitsas fail to see is the Eurozone’s material conditions : German firms, producing high-tech, high value-added, high-priced and mostly very complex manufacturing goods, do not directly compete with Spanish, Portuguese, Greek or even most Italian firms, which are specializing in lower-tech, lower value-added, low-price and less complex goods (Simonazzi
et al. 2013). German firms are price-setters and dominate their niche markets, while Greek and Portuguese firms instead compete with low-cost Asian producers—on costs (but not just labor costs)—and get pushed out from their markets by their Chinese competitors (Straca 2013). The upshot is that real-life competition in oligopolistic markets cannot be reduced to just unit-labor-cost competition—whatever the textbooks want us to believe. And if one insists on focusing on unit labor costs, then there is no reason why one should not also look at unit capital costs (or profit margins), as is argued by Felipe and Kumar (2011); oligopolistic firms might as well compete on profit margins.

Empirical Evidence

Thirdly, Flassbeck and Lapavitsas offer no empirical evidence in support of their claims. Let me highlight four empirical “facts” which run counter to their main claim. Firstly, relative unit labor cost elasticities of export/imports tend to be much smaller (in absolute size) than the corresponding
price elasticities, due to the fact that (a) wage costs constitute just about 22% of total production costs; and (b) price-setting firms do pass on only about half of higher wage costs onto higher prices (Storm and Naastepad 2015). This means that a high export price elasticity of −1.2 corresponds to a much smaller unit-labor-cost elasticity of export demand of (roughly) —0.13. Hence, to push up (real) exports by a meagre 2% nominal wages would have to decline by as much as 15% (assuming unchanged productivity). This looks much like the tail is wagging the dog.

Secondly, there is clear evidence to show that in countries like Spain the trade deficit increased because of faster import growth, while export growth stayed constant. If this is so, the question is why (higher) relative unit labor cost would one-sidedly impact imports and not exports?

Thirdly, if one wants to identify the impact of relative unit labor costs on trade, one should filter out other influences on trade and most prominently the impact of income and demand growth. But doing so will show that world income growth already completely explains export growth and domestic income growth fully explains import growth for most economies concerned (Bussière et al. 2011). Put differently, the income effect is mostly found to overwhelm any cost-competitiveness impact, especially in the longer run (see Schröder 2015 for elaboration).

Finally, following good writing practice, I have kept the most important finding until the end: unit labor costs in the crisis countries started to increase only following a preceding deterioration in their trade accounts (Diaz Sanchez and Varoudakis 2013; Gabrisch and Staehr 2014). This indicates that rising unit labor costs were the consequence, rather than the cause, of the growing imbalances. It is difficult to see it otherwise. The empirical evidence speaks volumes—against the unit-labor cost myth (for concurrent arguments, see also: Felipe and Kumar 2011; Wyplosz 2013; Diaz Sanchez &Varoudakis 2013; Gabrisch & Staehr 2014; Janssen 2015; Schröder 2015).

What About Incomes and Aggregate Demand?

Fourthly, what is salient about the analysis of the Eurozone imbalances by Flassbeck and Lapavitsas is that it includes no role for (or reference to) “aggregate demand” or “income.” Theirs is an example of unwarranted reductionism in which the exports of, say, Germany (which constitute the imports of, say, Spain) depend solely on the relative unit labor costs of Germany vis-à-vis Spain.

This cannot be true. Clearly, Germany’s exports to Spain will also depend upon Spanish aggregate demand, if only because a considerable part of Spanish imports consists of capital goods (machines and equipment) and intermediates (high-tech materials and components) and therefore is complementary in nature (Bussière et al. 2011). Let us assume that a country’s exports E depend on world income W and its relative unit labor costs c, while its imports M depend on domestic income Y and relative unit labor costs c. We can then write the following general expression (in logarithms) for that country’s trade balance (see Fagerberg 1988):


where the world-income elasticity of exports by country
i; the income elasticity of imports by country i; the relative-unit-labor-cost elasticity of exports by country i; and the relative-unit-labor-cost elasticity of exports by country i.

Using this equation it is straightforward to see that Flassbeck and Lapavitsas, but also Wren-Lewis, who all focus on relative unit labor costs, are missing an important part (if not all) of the action. Their claim is that if relative unit labor costs in the Eurozone are constant (
c = 1 and ln c = 0), the trade balance will not change. It follows from equation (1) however that this only occurs under very special conditions, namely when the export growth of a country induced by world income growth is equal to the import growth of that country induced by domestic income growth. There is absolutely no reason why these special circumstances would generally apply and hence, under normal and realistic conditions, one must expect trade balances to either improve or to deteriorate—depending on whether the export growth induced by world income growth exceeds the import growth induced by domestic demand growth or not.

Let me now become more specific and consider Spain which specializes in mid- to low-tech exports goods, the world demand for which is not very income-elastic (is rather low); at the same time, Spain’s imports high-tech capital goods and sophisticated intermediates (from Germany) for which the income elasticity () is rather large. As a result, for Spain >. This implies that even when Spain grows at the same pace as the world (or Eurozone) economy, its trade balance must deteriorate, because its import growth exceeds export growth.

Exactly the reverse holds true for Germany which caters high-tech capital and consumer goods to the fastest growing destinations (e.g., China and, until recently, Russia). Hence, the export demand for Germany’s high-tech manufactures has a high world-income elasticity, while most of Germany’s imports are complementary (and increase in line with domestic production and demand) (Bussière et al. 2011). Accordingly, for Germany < and hence its trade surplus tends to grow—even when Germany is growing at the same pace as the world (or the Eurozone). These asymmetric growth patterns are the direct consequence of structural differences in productive specialization (Simonazzi
et al. 2013). They go unacknowledged in the account of Flassbeck and Lapavitsas and of Wren-Lewis.

Higher Wages and Higher Inflation in Germany Will Not Help.

Finally, Flassbeck and Lapavitsas argue in favor of higher German wages (and higher German inflation), just like Wren-Lewis (2016), in the mistaken belief that this will lower Germany’s cost competitiveness, reduce its trade surplus, and thereby rebalance the Eurozone as a whole. German exports and imports, as I argued above, are not very sensitive to changes in relative unit labor costs, however, and hence there will be only a limited amount of expenditure switching (away from German products and toward foreign goods), as has also been convincingly shown by Schröder (2015). Let me repeat for clarity’s sake that I am strongly in favor of higher nominal wage growth (in excess of labor productivity growth plus 2%) in Germany. It will definitely help Germany. But it will not help the crisis-countries of the Eurozone.

Higher German wage growth and higher German demand simply do not constitute a recovery strategy for the Eurozone, as is shown by the (direct and indirect) value-added spillover effects of German growth on value added in other European countries, which occur through direct and indirect backward production linkages operating in global production chains. Specifically, if German growth results in higher production and value-added generation in the U.S., and if U.S. firms source intermediates and components from South Korea, and if in turn South Korean firms use inputs produced in Italy or Spain, this circuitous indirect impact of German growth on value added in Italy or Spain is included in the total value-added spillover effects reported in Table 1. The estimated value-added spillovers of German growth are, in other words, very comprehensive estimations. The value-added spillovers have been calculated using the full world input-output data matrix for 2011 from the World Input-Output Database (WIOD), which includes 35 sectors (including 14 manufacturing industries) in 40 countries (including all 27 members of the European Union as of 1 January 2007). The estimates provide a sobering “reality check” on what German growth can do for the economic recovery of the Eurozone.

The assumption is that German GDP increases by € 100 billion (which means German GDP is growing at 3.7%). Through global production chains, German growth creates € 29.5 billion of income in the rest of the world and about € 7 billion in the selected European countries listed in Table 1. This already shows that a focus on just the Eurozone is a narrow one, because most of the trade and value added spillovers of German growth happen outside the zone. Of the value-added created by German growth within Europe, almost 57% (€ 3.99 billion) is extra income in Austria, Belgium, France and the Netherlands, another 20% (€ 1.4 billion) in Poland, the Czech Republic, Slovakia, and Slovenia, and the remainder (€ 1.66 billion) in Southern Europe. To make my main point: the combined value-added spillover of German growth in the Czech Republic, Slovakia, and Slovenia (with a combined population of 17.9 persons) is larger in absolute terms than the corresponding combined value-added spillover in Greece, Portugal and Spain (with a combined population of 68.4 million people). German growth significantly raises GDP growth in the Netherlands, Belgium, Austria, as well as in Poland, the Czech Republic, Slovakia and Slovenia—but there is hardly any noticeable growth spillover in Greece, Italy, Portugal and Spain (Table 1). Reflating Germany by raising German wages, demand and growth would be nowhere near enough to bring about a turn-around in Southern Europe. It is wishful thinking, and it ignores fundamental asymmetries in production, technology and specialization which together constitute the material conditions of the Eurozone system.

Table 1
Value Added Spillovers

Caused by a €100 billion Increase in German GDP (2011)

Value added spillovers (billions of €)

GDP 2011 (billions of €)

% change in GDP












The Netherlands















Western Europe

























Southern Europe










Czech Republic





Slovak Republic










Eastern Europe





Rest of the world


Total foreign value-added spillover


The Real Issues (Again)

All this talk about labor-cost competitiveness diverts attention away from the real problem of the Eurozone: the common currency and monetary unification have led to a centrifugal process of structural divergence in terms of structures of production, employment and trade (as explained in my earlier notes). This centrifugal process has been fueled and strengthened not just by the surge in cross-border capital flows following the introduction of the euro, but also by the common currency itself as well as by the centralized and uniform interest rate policy of the ECB which up to 2008 was perhaps appropriate for stagnant and low-inflation Germany, but was undeniably out-of-sync with inflation levels in Southern Europe (see Lee and Crowley 2009; Nechio 2011; O’Connell 2015; Storm and Naastepad 2015). Cheap credit in the South created unsustainable asset bubbles and facilitated untenable debt accumulation which fed into higher growth, lower unemployment and higher wages—but (totally in line with market rates of return) all concentrated in the non-dynamic and often non-tradable sectors of their economies. German wage moderation mattered a lot, not through its supposed impact on cost competitiveness, but via its negative impacts on (wage-led) German growth and inflation, which in turn prompted the ECB to lower the interest rate in the first place.

The consequent crisis of the Eurozone is a deep crisis of inadequate aggregate demand in the short run and unmanageable structural divergence between major member states in the long run. Hence, the real questions are: how to bring about structural convergence between member countries of a common currency area (so far lacking any meaningful supranational fiscal policy mechanisms) in terms of productive structures, productivity levels, and ultimately incomes and long-term living conditions? What is the appropriate interest rate for the structurally divergent “core” and “periphery” if it has to be one-size-fits-all? And how can banks, the financial sector, and capital flows be made to contribute to a process of convergence (rather than divergence)? There are no simple answers and it is easy to yield to sheer “pessimism of the intellect.” But unless progressive economists source the “optimism of the will” and start seriously addressing the real issues, rather than rehashing myths about unit-labor cost competitiveness, the future of the Eurozone looks very bleak indeed.

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  1. diptherio

    It’s a tangential point to this article, but I think it’s worth repeating that it is not mathematically possible for all countries to become net-exporters (until we start shipping goods to Zeta Reticuli). Any economist, therefore, whose major advice to countries is to increase their exports, is not being entirely serious…or they have yet to grok the fallacy of composition.

    1. James Levy

      It’s the same with aggregate demand–like markets for exports, it is just supposed to happen, to come into existence ex nihilo and unbidden.

      It has to be in the graduate schools that anyone who thinks (as opposed to drawing within the lines) is forced out or flunked out. That’s the only explanation I can have for how the most obvious facts get discounted, dismissed, or ignored in Economics.

      1. Skip Intro

        While it is tempting to consider academic economists as largely fulfilling the role of a medieval priesthood that produced ideological justifications for economic violence that salve the consciences of the predators and quell the frustration of the prey, new research by an actual scientist has revealed a systemic philosophical error:


        In the wake of the financial crisis, many started questioning different aspects of the economic formalism.
        This included Ole Peters, a Fellow at the London Mathematical Laboratory in the U.K., as well as an external professor at the Santa Fe Institute in New Mexico, and Murray Gell-Mann, a physicist who was awarded the 1969 Nobel Prize in physics for his contributions to the theory of elementary particles by introducing quarks, and is now a Distinguished Fellow at the Santa Fe Institute. They found it particularly curious that a field so central to how we live together as a society seems so unsure about so many of its key questions.
        So they asked: Might there be a foundational difficulty underlying our current economic theory? Is there some hidden assumption, possibly hundreds of years old, behind not one but many of the current scientific problems in economic theory? Such a foundational problem could have far-reaching practical consequences because economic theory informs economic policy.
        As they report in the journal Chaos, from AIP Publishing, the story that emerged is a fascinating example of scientific history, of how human understanding evolves, gets stuck, gets unstuck, branches, and so on.

        Read more at: http://phys.org/news/2016-02-exploring-gambles-reveals-foundational-difficulty.html#jCp

        Bottom line: economists assume that an average over an ensemble is the same as an average over time, which seems to work for thermodynamics and particle physics, but apparently does not apply to human beings, risk estimates and thus economics.

    2. craazyboy

      The missing link again is tariffs. I’m pretty sure you could have a common currency, and cure trade imbalances with tariffs. With separate currencies, you get currency wars, and financial flows can have more to do with currency values than trade flows. Plus instability. Then the real losers in currency wars are the working class, not the elites, so income inequality gets worse.

      A major part of the Euro club was to eliminate tariffs, not just have a common currency. But economists have their tariff gene removed at the same time they get their PhD, so that explains the blind spot in all the “analysis”.

  2. Left in Wisconsin

    Very interesting post.

    This is a side point, but could you imagine the reaction if nominal wage growth in Germany was 6 or 8% a year for several years? Hard to imagine that this would not be seen explosively both by German employers and other wage earners around Europe.

  3. GlobalMisanthrope

    This is great.

    Interestingly, Yanis Varoufakis has deputized this argument, in more skeletal form, in his post-ministerial public appearances. He even uses the same term, centrifugal forces, to describe the phenomenon.

    I wonder if Storm is a DiEM 25 supporter.

    1. chris

      this would be strange as Varoufakis considers Flassbecks analysis on the Euro Crisis as “one of the most poignant”

      by the way, i am a regular follower of Flassbecks blog and i do not think that he in any way underestimates the impact of financialization on the european economy, but he links them to the competitiveness (as function of productiveness and wages!) and inflation imbalances in the eurozone, and several countries, but especially Germany, missing the eurozones inflation target. I would consider him one of the sharpest critics of neoclassical theory, especially in the german speaking world.

      he also always backs his views with a lot of empirical evidence! You should, for the sake of dialog, give him a chance to make a statement on this site!

      1. Yves Smith Post author

        He and Lapavitas made them on INET, which has far more reach with the relevant audience (elite economists). And the Storm paper also links to their rebuttal, and those links are preserved in our cross post, so I don’t see what you are complaining about. Trust me, Flassbeck is not concerned with what NC readers think. And we don’t hew to the MSM “we have to let each side have their say” convention. If we did, we’d be running pro Donald Trump posts too, as well as “Lehman was fine, subprime is contained” posts in the runup to the crisis and “Elizabeth Warren is being mean to banks” posts. Our point is that we provide analysis and we tell readers pretty explicitly when we think one side of a finance or economics argument has the better grasp of what is going on.

        And Storm recounts exactly what you say about Flassbeck’s position on wages and “competitiveness” leading to inflation imbalances. He recites that in some detail and then rebuts that, so I don’t see what your beef is about.

  4. Jim Haygood

    ‘Cheap credit in the South created unsustainable asset bubbles and facilitated untenable debt accumulation.’

    A huge trade in the Nineties, which made many hedge funds rich, was betting on the convergence of euro zone sovereign spreads as the euro was phased in between 1999 and 2002.

    Euro zone sovereign spreads stayed converged until 2010, when they blew up again and went all “early Nineties” on us. This graph portrays the whole sad, futile round trip:


    By the way, where can I buy one of them “reified totems” that Storm speaks of?

  5. Tom

    Welcome in the real world! Excellent post. Schäuble is a fool and Flassbeck no less. I see no solution. It takes decades if not centuries to develop a high tech manufacturing center like Germany´s. On top there are intangible cultural factors involved. To my mind Germany should just pay to keep the South afloat. But fool Schäuble doesn´t understand. Not the least because fools like Flassbeck and his nauseous counterpart Sinn rule economics. It is really economy for dummies. If you have ever worked in an export oriented German engineering company you know that the above is a no brainer. Of course the powers that be don´t shout it out over the rooftops that wages are only a small part of production cost. But at least economists should know better instead of engaging in moralistic posturing. The left blames the whole mess on German wage “suppression” the right on Southeners living above their means. Economy is a dismal science indeed. Before Storm and Nastepaad though I bow my head

    1. Left in Wisconsin

      It takes decades if not centuries to develop a high tech manufacturing center like Germany´s.

      But it only took us about two decades (1980-2000) to completely destroy ours!

      1. Tom

        This is capitalism after all. If you can print your “gold” i.e. the worldwide reserve currency Dollar all kinds of distortions happen. If Wisonsin had been a country of its own the powers that be that is the bankers would have been running scared and the government would have shit its pants to lose an asset like the midwest engineering companies. But no such luck if you can print your Dollars and then with these printed Dollars fund private equity and then go about stripping whole industries. I have seen it happen. In the Eighties there was a mighty machine tool industry in the US then company after company stopped investing. Great boom for a few years and then the inevitable decline. But who cares if you can build a gold plated useless fighter like the F35? Much easier and much better business.

      2. tiebie66

        The same two decades it took China to develop a high tech manufacturing center like Germany´s. If Greece puts its mind to it, it can be done. But they’d rather whine.

        Ergo nonsense: It takes decades if not centuries to develop a high tech manufacturing center like Germany´s.

        1. Tom

          Sorry, but you are misinformed. Whatever the Chinese produce is produced on either Japanese, German or North Italian tool machines. The only US manufacturer of note is Chartered. Bet you never heard of it. The greatest value is in the production facilities. That is economic reality.Maybe the Chinese will break through in the future. For now they mostly still assemble. It is true that the Iphone is assembled in China. But look up the suppliers. Really, just look it up.

  6. susan the other

    Trade surpluses are just temporary for Germany. When China develops a machine tool industry Germany will join the ranks of the periphery. Because trade is a moveable feast. No country should base its economic health on strong exports. For lots of reasons. And being realistic about this sad truth would curb everyone’s enthusiasm for both austerity in some crazy race to the bottom and financial stimulus to create jobs and demand. Both solutions end up in the same place. What the world needs is economic stability. One good move would be to promote more diversity and national autarky/self sufficiency. No credit bubbles necessary and no austerity vacuums either. And trade practices could revert to national advantages but on a modest scale.

    1. Left in Wisconsin

      Germany does have a couple things in its favor that will slow the destruction of its machine tool and other high tech mfg firms:

      1. German preference for German products. Incredibly long lasting. I haven’t been to Germany in awhile. It would be interesting to know if Japanese or Korean cars have made any headway in Germany yet despite the fact it is hard to argue they are less advanced than German cars. And, for reasons that escape me, German cars still have cachet all over the world.

      2. German “social pacts” still require German employers to pay hefty severance for eliminating German jobs. And mfg wages are never going to be a huge part of product costs, so the incentive to outsource from Germany is low.

    2. cnchal

      The German machine tool industry has been bought by the Japanese machine tool industry.

      Circa 2009, Japan’s Mori Seiki entered into a strategic partnership with Germany’s Deckel-Maho-Gildemeister (DMG) of Gildemeister AG, yielding the current two DMG Mori Seiki organizations. In 2015 it was reported that the company will carry out a takeover bid to acquire its German partner.

      DMG MORI SEIKI CO., LTD. is a manufacturer of machine tools, peripherals and systems, with more than 160,000 installations around the world. Mori Seiki is directed by President Masahiko Mori (森 雅彦 Mori Masahiko?), Dr. Eng., and employs over 4,000 individuals worldwide.

      How’s that for productivity?

      For self sufficiency we have gone from Mao’s iron smelter in the backyard to Made in China mini CNC machine tools for the cost of an expensive fridge.

      1. Tom

        That is just one company of thousands. Anyhow Gildemeister and Mori Seiki got together out of common interest. One has certain strength where the other is weak and vice versa. You are seriously deluded if you think that you can extrapolate from one company to an entire industry.

        1. cnchal

          . . . Anyhow Gildemeister and Mori Seiki got together out of common interest.

          Deckel and Maho were two competing German companies that specialized in milling machines that merged with Gildemeister, which specialized in lathes. This concentration at the top of the German machine tool sector is being taken over by Mori Seiki, the big whale of the Japanese machine tool industry.

          DMG used to compete with the remaining Japanese companies like Mori Seiki and the now dead Hitachi Seiki. With the takeover by Mori, that is no longer the case.

          Their common interest is in reducing competition. Mori Seiki already made lathes and mills, the same things that DMG did.

          I am not sure where you get “That is just one company of thousands” unless you include the thousands of Chinese backyard machinery makers.

          The machine tool industry is being consolidated and concentrated into a few large organizations, eliminating the “competition” in their business.

          In automotive industry terms, it’s as if Honda or Toyota were to buy or take over the merged entities of Volkswagen, BMW and Mercedes Benz.

  7. hemeantwell

    What Flassbeck and Lapavitsas fail to see is the Eurozone’s material conditions : German firms, producing high-tech, high value-added, high-priced and mostly very complex manufacturing goods, do not directly compete with Spanish, Portuguese, Greek or even most Italian firms, which are specializing in lower-tech, lower value-added, low-price and less complex goods (Simonazzi
    et al. 2013).

    From my reading of F & L this was not the core issue for them. They seemed to accept the differences in manufacturing tech, and instead emphasized the lowering of German demand for periphery goods due to the Grand Bargain between German capital and labor. Also, I believe that, contrary to the opener of the article, F & L do take into account financial flows out of Germany; at least in part they represented the investment of of higher profits obtained via wage suppression. Crudely, instead of wages and profits in Greek industry, Greeks got loans from German banks and we know that story. The author’s point as to whether increased demand for periphery production by German workers would have made that much difference seems more on target.

    1. Yves Smith Post author

      Financial flows in a world with few/no capital controls. have almost nothing to do with trade. International financial flows are over 60x trade flows (see Borio and Disyatat 2010, a seminal BIS paper). Moreover, had they had anything to do with trade flows, you’d 1. expect the destination country to primarily the ones with which it was running trade deficits, and 2. countries to suffer financial crises to be only ones running trade deficits (again not the case. witness the US Great Depression and Japan).

      1. afreeman

        Settle down, take some time off, hunt up The Great Rebalancing, Michael Pettis, 2011 and read or re-read his first chapter—the first 13 pages alone explain the great befuddling in terms anyone with a reasonable grasp of arithmetic and double-entry book-keeping can understand. Bernie is right: no president can do much about the great befuddling without a Revolution, which Pettis or Hudson could start were they to join forces and focus on the plainest of English in 15 pages or less that the rest of us could spread like wildfire. Message to Pettis: his latest blog post on what China can and may or may not do is fine writing, but FAR FAR too long!

        Sneak preview here: https://www.goodreads.com/book/show/17061941-the-great-rebalancing

  8. nostromo

    Yes, I also saw a bit of a straw-man at the beginning of the article.

    Re: your ending point, the solution is obvious: transfer from non-productive and finance feeding 1% to 99%, i.e. raise wages AND taxes, progressively, and transfer a fraction of the money collected via public investment and subsidies to the depressed areas. It is what states have always done, until neoliberalism destroyed them. And if Europe would implement both things together, say 5% linear wage increase and 2% progressive Eurotax increase, it would not be unpopular, specially as unemployment and precariety started dwindling… But this would also probably require some careful management of immigration flow, as a better governed Europe would attract even more people.

    1. Yves Smith Post author

      The onus is on you to prove the straw man, not assert it. I read the pieces that Storm addresses and I see his characterization of them as accurate.

      1. nostromo

        I agree with what the previous comenter said. This amounts to saying that a substantial part of Mr Storm’s paper is “attacks an argument different from (and weaker than) the opposition’s best argument,” which is the definition of straw-man.

        I also agree with him that

        The author’s point as to whether increased demand for periphery production by German workers would have made that much difference seems more on target.

        But even there I missed that he takes into account increase of transfer from the central economies to the peripheral ones via agricultural imports or tourism (important source of incomes for Spain, Greece and Portugal).

        1. Yves Smith Post author

          No, your definition of straw man is inaccurate. A straw man is rebutting a MISREPRESENTATION of someone’s argument. You are claiming that Storm did not rebut Flassbeck’s and Lapavitas’s “best” argument. That’s not a straw man.

          Further I disagree with your assertion that he failed to do that. Did you actually read the Flassbeck/Lapavitas paper? It appears not. It is close to a textbook recitation of theory (as Storm correctly states), fails to provide empirical data (as Storm correctly states), fails to deal with the role of banks (as Storm correctly states), fails to deal with data that is inconsistent with theory (as Storm correctly states and describes that data in specific detail), fails to address the idea that treating “counties” as competitors is a poor and misleading analytical frame, fails to acknowledge that labor is a small percentage of the cost of goods, and incorrectly treats cost as the only basis for competition!

          Tell me what “best argument” Storm missed? All I see from the critics is handwaving and dishonest argumentation in lieu of a real response.

  9. Ignacio

    I concur with many commenters: this is an excellent piece of analysis. It still leaves open the question on how to deal with the centrifugal forces unleashed in the eurozone, basically the single currency as it has been designed plus the integration of the financial system.

    Given that yet many economists, Varoufakis is a good example, consider that an euro exit or euro breakup is not an option that would degenerate in negative spirals due to bad debt structures (Michael Pettis argues), and given that the political and social environment in the Eurozone is (very) far from the optimistic will that Mr. Storm invokes as needed to address the issue, it seems that we are condemned to suffer the centrifugal forces until a disorderly euro breakup occurs.

    I see only two alternative ways to get away from this pessimistic view:

    1) Rational euro-exits allowed: it is assumed that euro-exits are unmanageable because any country leaving the euro would have a lot of euro-denominated debt and this would result on negative currency depreciation spirals. This is based on the principle that debt has to be denominated in the original currency in which it was issued. If we shift to a different principle, namely that debt that was issued by an euro member and denominated in euros has to be re-denominated in the very same currency that the sovereign country issues after the exit, it would not be so difficult to grant an orderly and rational euro exit.

    2) Spontaneous convergent structural economic changes occur: Germany shifts part of its production to low or mid tech products while Spain shifts on the contrary. Banks voluntarily and possitively get involved in this process.

    1. GlobalMisanthrope


      You say “we” so I’m assuming you’re in Europe. What are your thoughts on the potential of DiEM 25 to put in place a democratic structure for addressing these problems?

      1. Ignacio

        Yes, I live in Spain. I think the potential is very low. Conservatives focus on labor costs and progressives seem unable to focus on anything. New parties, at least in Spain, but almost certainly in other countries, seem to be clueless on these problems. They focus on corruption but they don’t see the role of capital flows within the eurozone and the role of the single currency in the centrifugal evolution of the EU.

        1. GlobalMisanthrope

          Yes, but Yanis Varoufakis is launching DiEM 25 specifically to address the structural problems that make the Euro unsustainable. He argues that a Europe-wide crisis requires a Europe-wide solution and that breaking up the Euro Zone will only exacerbate the centrifugal forces and ultimately hand victories to the right throughout Europe.

          He seeks to build a democratization movement that will function as a tool for organizing across national borders to return control of Europe to the people. Do you see any potential for it to galvanize the left across Europe? Couldn’t it be an effective educational tool, as well, to bring the real issues before the general public?

  10. Rodger Malcolm Mitchell

    Still the same old economics. Complex, RubeGoldbergian solutions for a simple problem. The euro nations surrendered the single, most valuable asset any nation can have: Monetary Sovereignty. They gave up control over their own money.

    Back in 2005, I predicted the eurozone crises in a speech, when I said, “Because of the Euro, no euro nation can control its own money supply. The Euro is the worst economic idea since the recession-era, Smoot-Hawley Tariff. The economies of European nations are doomed by the euro.”

    It was obvious then and it is obvious now.

    If only the U.S. understood its own Monetary Sovereignty, we wouldn’t cut deficits and have recessions every five years on average.

  11. salvo

    well, interesting text. Since I’m a regular reader of Flassbeck’s blog, I sent him a mail with the link to Storm’s text. Though I noticed today that he has already answered to that critic. Unfortunately I missed that text.
    Flassbeck’s text is only in German, and since I haven’t the time to translate all of it, here is the essential part, as I see it.

    Storm has totally misunderstood what a currency union is, how it works and what it means for its members. Essentially a currency union means an agreement to maintain a specific inflation target und to transfer his own monetary policy to a common institution. If all members maintain that inflation target there won’t be any real appreciation and depreciation, so no competitive differences and the ensuing problems.
    It’s wrong to explain competitive differences with differences in productivity. Competitive differences result from different unit labor costs developments, that is to say wages in relation to productivity.
    Storm doesn’t deny a german ‘undervaluation’, as he also states that, calculated on the basis of the unit labor costs, the real exchange rate has fallen (devaluated). This is clearly the result of a wage moderation in relation to german productivity. To say german wages have increased relatively little but german productivity relatively strong (even if this were true, what in relation to France is not the case at all), says nothing else than that german wages have increased too little.


    1. ScottB

      I don’t think this responds to Storm’s main point that deficits are much more about the types of products traded and their income elasticities, and not so much about relative wages.

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