How Germany Gamed the Euro and Worsened the Crisis

The country's policies, intended to boost exports, have hurt the eurozone as a whole. Fortunately, there may be a solution.

German Chancellor Angela Merkel speaks at party convention in Leipzig / Reuters

BERLIN -- On a recent trip to Greece, I visited my aunt in her Athens apartment. I'd arrived from Berlin, and she, like many Greeks these days, wanted to talk about Germany in not the nicest terms.

"The Germans are so strict!" she said, feeling, as do most of her compatriots, under the thumb of German-backed austerity measures. After all, she added, Greeks had for long been such loyal buyers of German products.

In order to illustrate this point, she pinched the collar on her button-up blouse. The shirt, she said, was made in Germany. She then pointed to the pot in which she was warming up the lunch she had prepared for us. It was also made in Germany. So was the oven, for that matter, and the refrigerator too. And as she pointed out later, even the porcelain cup with which she was drinking her coffee. "But what," my aunt asked, "do the Greeks sell back?"

She was alluding to a very important and often overlooked point. Since the advent of the euro currency, Germany has maintained a trade surplus, with about 40 percent of its exports going to other eurozone nations. But German policies meant to bolster these exports are now increasingly coming under the scrutiny of some economists, who blame German practices for some of the structural problems at the core of the eurozone's problems.

The issue is not so much that Germany sells a lot of stuff to other nations in the euro zone, as much as it doesn't buy back as much as it should.

"The problem is not Germany's high exports, it's the export surplus," says Till van Treeck, an economist with the Germany-based Macroeconomic Policy Institute. "Imports have been particularly low because domestic demand has been so weak." In real terms, he points out, private consumption in Germany over the past decade has barely increased.

Germany's aversion to debt and overspending has, of course, spared the nation from the sovereign debt rating reductions and credit bubbles that have troubled its neighbors. In addition, the German tendency to save for a rainy day -- a consequence, it's often thought, of  collective angst and the ingrained trauma of repeated war and economic collapse -- also helps keep consumption proportionately lower than in other nations. These traits are, of course, nothing to criticize.

But add stagnating wages  as part of Germany's export-oriented growth policy to the equation, and you get  an economy increasingly dependent on selling goods abroad, rather than consuming at home. Since Germany is the largest economy in Europe, accounting for a quarter of the GDP of the entire eurozone, this has a huge impact on its struggling neighbors, who'd like to sell more of their wares in Germany.

If you compare wage growth across the different eurozone nations, the result is startling. From 2000 until 2010, Germany's average annual growth rate of hourly private sector labor costs was 1.7 percent, the lowest in all of Europe and nearly half the European Union average.This represents, according to a recent Macroeconomic Policy Institute report, a "blatant downward deviation" from the eurozone average.

This phenomenon is largely the result of German government deregulation of its labor market shortly after the euro was introduced, making it possible, for instance, for German companies to hire temporary workers and pay them less than their full-time colleagues.

Germany's lower labor costs are meant to lower unemployment and add fuel to the nation's growth engine: manufacturing and exports. If the cost of producing goods is cheaper, they can be sold abroad cheaper as well, undercutting competitor's prices.

Germany, with its design and manufacturing prowess, has long been a proud exporter of automobiles and machinery. But this didn't always necessarily come at the expense of its neighbors. The introduction of the euro complicated matters. Beforehand, due to flexible exchange rates, a comparatively lower German wage growth, says Sabine Stephan, an economist at the Macroeconomic Policy Institute, would have led to a higher medium-run Deutsch Mark valuation, naturally offsetting any price-competitive export advantage. Meanwhile, less competitive nations with weaker currencies, like Greece, would still have been able to sell their goods on the German market relatively cheaply.

The euro changed all that. I can see signs of this when I go food shopping in Berlin. As my aunt asked, what do Greeks sell back? Perhaps feta cheese? But even when I've seen Greek feta for sale in a German supermarket, it's virtually always next to a German-made competitor that is nearly half the price. The Greek version might taste better, but because Germans have less expendable income, not all that many are likely to buy it. Even some headache-inducing, poor-quality Greek wines are much more expensive in Germany than better domestic wines.

Now, to get the cost of such items down, Greece's only real option is to try to depress costs and wages at home. German-backed austerity measures, in fact, are meant to make Greece do so, in essence, making the nation more like Germany.

As the Greek government wrestles with the deeply unpopular austerity measures mandated by its European creditors and the International Monetary Fund, one of the thorniest issues, appropriately enough, is proposed private sector wage reductions. Greek political parties on both left and right are reluctant to bow to pressure to slash the minimum wage, arguing the move would sink the ailing Greek economy even further into recession.

While labor costs in Greece, Italy, Portugal, and Spain were higher than the eurozone average before the debt crisis, those costs have since come down significantly, says the Macroeconomic Policy Institute report.  Current proposals to further bring down labor costs are meant to increase price competitiveness in order to boost exports. But whereas the improvement in export performance for a nation like Greece would be marginal, if any, says Stephan, the drop in domestic demand has a far greater recessionary effect. Also, as the economist van Treeck argues, "It's logically impossible for them to have the same growth model as Germany," since "not everyone can have a surplus."

So what's the solution? Stephan argues that its far more important for Germany to push its labor costs up than it is for crisis-laden nations to adjust them further downwards. In this event, nations like Greece would not need to suppress wages as much to become price competitive, while Germans would be able to buy not only more of their own products, but more of their neighbors' as well. Raising German wages, she said, "is the only sustainable path" towards remedying some of the structural problems at the root of the debt crisis. Otherwise, she added, "the situation is hopeless."

Ironically, Germany's competitive wage and export practices may not only be harmful to its neighbors, but ultimately to itself.

"The German conversation is obsessed with export and national competitiveness," says van Treeck. German media, he adds, speak of the importance of Germany as an "export world champion." Yet, he says, higher domestic consumption would better contribute to German GDP growth, which idled near the bottom of eurozone nations through 2007, despite the country's rising trade surpluses.

It might seem counterintuitive to question the benefit of German wage policies, at least for Germany, at a time when national unemployment is at a record low of 5.5 percent (especially as it hits 23 percent in Spain and near  19 percent Greece). But the matter of low-wage jobs and rising income inequality stirs passions in Germany. A recent Süddeutsche Zeitung headline about German employment numbers, "Miracle with a Shady Side," captured how many Germans feel about their country's successes. From 2005 to 2010, the article explains, the number of low wage earners (less than 9.76 euros per hour in the West,  and 7.03 euros in the East) grew 13.5 percent. In addition, it says, almost half of all new full-time jobs are low-wage.

Some economists argue that Germany's lower wage growth  might have had only a marginal boost for its exports, especially since wage stagnation in Germany has disproportionately affected services jobs, and to a lesser extent manufacturing (though the two are intertwined). And many German exports are luxury or high-quality items, which are in demand regardless of marginal differences in the price.

A recent report from the International Labour Organization, a United Nations specialized agency, also singles out German wage policies. "As German unit labor costs were falling relative to those of competitors over the past decade, growth came under pressure in these economies, with adverse consequences for the sustainability of public finances," it says. But the report also questions how much benefit those German policies had on the nation's exports. "As a matter of fact," it says, "recent export successes owe little to these wage policies and more to the geographical orientation of German exporters to dynamic emerging economies."

Putting German wage growth more in line with the European average, then, would arguably be good for everyone. It would allow, as the Macroeconomic Policy Institute report puts it, German workers to receive "a fair share of the economic gains of the past decade." It would also give the weaker eurozone nations a chance to catch up and sell more   to Germany's enormous consumer market.

To blame the European debt crisis solely on Germany's competitive export policies would be absurd. Clearly, nations like Greece and Spain require broad and overdue reforms, which is part of why they  are hard hit . Yet, if growth in wages and consumption in the eurozone's largest market continue to languish far behind the rest, the great advance toward European integration that German leaders have heralded for decades may quite simply collapse before any sensible reforms are given a chance to work.