This is a remarkable exchange of articles:
- Peter Bofinger in VoxEu on “German wage moderation and the EZ Crisis“, 2015-11-30
- Servaas Storm (TU Delft, economics of productivity) with a critical review of this, 2016-01-08
- Bofinger’s response – “Friendly Fire“, 2016-01-20
- Servaas Storm’s reponse again, 2016-01-20
- Heiner Flassbeck and Costas Lapavitsas who take issue with Storm too, 2016-01-28
- Storm who replies again, 2016-01-28
Storm’s criticism shows some kind of trauma at TU Delft. Like Germany has the trauma of hyperinflation, TU Delft has the trauma of wage moderation. The Dutch government has an entrenched policy of wage moderation, and the research group at Delft TU has been arguing against this for so long, that when they hear the term “wage moderation” then they automatically argue against this. The research group and everyone else better be warned that this hangup better be resolved. Economists in the world are being disinformed.
Readers would be advised to first read the two articles by Bofinger (VoxEU and “Friendly Fire”), then below discussion, and then Storm’s articles to verify that there must be something like this trauma at TU Delft indeed.
Supportive material would be Storm on how Brexit challenges economic thinking, 2016-06-26. Storm indicates that he still is looking for the proper analysis, so that we can infer that his position on wage moderation forms only part of a puzzle.
“We desperately need a new paradigm to reform the system and make it work for the majority (…) Unless there is serious new economic thinking beyond austerity, deregulated finance, and a corporate dominated politics and state, social and political tensions will continue to build up within the E.U.”
Bofinger’s “Friendly fire” response contains a graph that shows the close connection of German productivity per person and per hour. Presuming that this also holds for other countries then this distinction need not confuse the argument.
Storm’s earlier key statement
In July 2015, Storm & Naastepad of TU Delft already presented this key statement:
“Myths, Mix-ups and Mishandlings: What Caused the Eurozone Crisis?
The Eurozone crisis has been wrongly interpreted as either a crisis of fiscal profligacy or of deteriorating unit-labour cost competitiveness (caused by rigid labour markets), or a combination of both.
Based on these diagnoses, crisis-countries have been treated with the bitter medicines of fiscal austerity, drastic wage reductions, and far-reaching labour market deregulation—all in the expectation that these would restore cost competitiveness and revive growth (through exports), while at the same time allowing for fiscal consolidation and private-sector debt deleveraging. The medicines did not work and almost killed the patients. The problem lies with the diagnoses: the real cause of the Eurozone crisis resides in unsustainable private sector debt leverage, which was aided and abetted by the liberalization of (integrating) European financial markets and a “global banking glut”.”
Thus, curiously, the TU Delft researchers of productivity repeat the finding by our colleagues who look for restructuring debt and financial markets. In itself I support the diagnosis that 1981-2007 are Keynesian years. I also support notions of restructuring of money and finance, see my paper Money as gold versus money as water. Yet,my point for this current weblog entry is that the TU Delft has a hangup on wage moderation, and that this causes disinformation and needless discussion, in a similar fashion as the German hangup on hyperinflation. Economic advisors might be in need of psychiatrists who help them deal with their anxieties.
Supplementary, there is my own text on the myth on German wage bargaining.
German readers might benefit from this text by Kleinknecht & Kleinknecht (2015) (in German), “The Erosion of “Made in Germany”: What Germans Should (Not) Learn From the Dutch“, ZBW – Leibniz-Informationszentrum Wirtschaft.
Alfred Kleinknecht and his focus on wage moderation
The TU Delft research group had been started by Alfred Kleinknecht (1951), now emeritus.
Kleinknecht had started originally at VU Amsterdam. His institute got financial support from the Dutch Ministry of Economic Affairs. The Ministry was clearly interested in economic analysis of technological development.
At that time, Dutch economic analysis was dominated by the VINTAF model at the Central Planning Bureau (CPB). This combined a “keynesian” demand side with a capital vintage supply function. There was no direct substitution between capital and labour, but a Leontief technology per vintage that increased the vintage effect. A high wage would cause the elimination of older technologies, and a subsequent reduction of the wage would not be able to restore what had been eliminated.
Kleinknecht has been arguing much of the same during his career: Higher wages will increase productivity, partly by eliminating older techniques and partly by spurring innovation. Kleinknecht’s argument is not always based upon the assumption of vintages, and rather upon Schumpeter’s “creative destruction” and more often upon empirical research that is neutral on assumptions on particular technologies. His recent estimate on 19 OECD countries for 1960-2004 is that 1% wage increase might cause 0.4% increase in productivity (“Erosion”, p 409), for me with some doubt of the causal order. It would be important that other researchers replicate that finding.
One might assume that the Dutch Ministry of Economic Affairs would embrace Kleinknecht. The opposite happened. They withdrew all subsidies, and Kleinknecht had to look for another place to work.
- From the VINTAF discussion, Dutch policy makers including the labour unions concluded to a policy of wage moderation. Maintaining employment was more important than increase in productivity.
- Kleinknecht published articles that criticised this policy of wage moderation, for causing lower welfare in the long run. Apparently, the Ministry did not enjoy this criticism.
Eventually, Kleinknecht was able to restart at TU Delft to proceed with his analysis. He also kept singing the same song, and was often ridiculed by other economists for not supporting the conventional wisdom of wage moderation. Yet his work was published in major journals, and we can observe that he has a major track record.
There are people who are critical about the EU austerity after the 2007+ financial and euro crises. Such arguments are often less developed with vague references to say Keynes and demand management. The criticism by Kleinknecht et al. is much more specific, with also strong arguments. For example, the EU encourages labour market flexibility and the abolition of various arrangements, but Kleinknecht points to the importance of stability on the labour market. Companies must make risky investments in new technology, and they require workers who commit themselves. Bomhoff, referred above, argues that new companies entering the market should be able to pay lower wages, but this is an argument rather on wage structure and not on flexibility.
PM. Another positive point about Kleinknecht is that he warned in 2007 about the risk of an “earthquake on financial markets” (see here). There is Dutch Dirk Bezemer (also at INET) who wrote about such warnings by economists, but Bezemer doesn’t mention Kleinknecht, just like Bezemer doesn’t mention my work.
How a focus causes a blind spot
As I already explained in 1996 (Dutch article) Kleinknecht wasn’t aware back then of my alternative analysis and criticism of the policy of wage moderation. Given my analysis, Kleinknecht’s analysis on technology is supportive but not crucial.
Apparently, Kleinknecht has never wanted to study my analysis. Part of his reluctance can be understood, since my analysis has also been hit by censorship so that there are key parts that are not available yet. Part may be that Kleinknecht didn’t want to have another clash with the establishment. He already had his own struggle and didn’t need another one for someone else. Yet the censorship by the directorate of CPB exists since 1990 and Kleinknecht had his inaugural lecture at VU only in 1994.
I can only speculate what his motivation might be, since he hasn’t been willing to discuss this with me, and there is no need for speculation. It suffices to observe, and check above ZBW 2015:
- Kleinknecht has his focus on technology and wage moderation
- he doesn’t refer to my work on the Great Stagflation in the OECD, including the Dutch policy of wage moderation
- and he doesn’t inform other scientists about the censorship of science since 1990 by the directorate of the Dutch CPB.
The TU Delft research group
In the past I sent an occasional update email to Kleinknecht, since he was the director of the TU Delft research group. I did not communicate with his co-authors. It is unclear to me to what extent Kleinknecht has communicated to others about my work. Thus, now that he has retired, and when I see that Servaas Storm repeats some of the arguments, I wonder whether this might mean that there is scope for a fresh restart, or that the hangup on wage moderation has become part of the TU Delft paradigm.
A note on VINTAF
For the record: The VINTAF model died a soft death at CPB and was replaced by models without vintages. The major industrial effect in the Dutch economy was the demise of the industry of clothing and textiles. Once this had happened, there wasn’t cause to presume a major vintage effect. In my own analysis, the demise of the clothing and textile industry can also be explained by a wrong management of the wage structure. My criticism on VINTAF is also my criticism on Kleinknecht et al. They neglect the impact of taxation and social premiums on the wage structure. Low tax exemption causes high minimum wages, while this industry might have adapted better with lower wage costs and thus high tax exemption. Holland would be served by differential management of wages and taxes. The domestic market requires lower taxes and thus lower wage costs (for barbers and gardeners) and the export market can allow for higher taxes and higher wages (for high tech industry and agriculture). This can be regulated by high exemption for taxes and premiums, and a VAT at 1%. This alternative analysis started at CPB itself by Marein van Schaaijk and Anton Bakhoven. I supplemented this with the analysis of the tax void, dynamic marginal tax rate, shift of the Phillipscurve, and the need for an Economic Supreme Court, see DRGTPE.
Return to the beginning
The reader may now return to the beginning of this weblog entry. One may check what the exchange is all about.
My take on this
Let me also give you my take on this. In my perception, Storm is fighting Kleinknecht’s Dutch ghosts from the past.
Storm 2016-01-08 states:
“The sad truth, however, is that Bofinger and Wren-Lewis are right for the wrong reason—hence their interventions are less than helpful, because rather than knocking out the remaining errors in the “consensus diagnosis”, they help perpetuate a mistaken doctrine: that relative unit-labor-costs matter [?] are the prime determinant of a country’s international competitiveness, current account balance, and foreign indebtedness. “
This confuses description and cause. Statistics show such differences. If Southern Europe doesn’t invest in technology as Germany does, then we can observe such relative unit labour costs (ULC). The cause would be investments.
“Rising relative unit labor costs supposedly killed Southern Europe’s export growth, raised current account deficits, created unsustainable external debts and reduced fiscal policy space, and hence, when the crisis broke, these countries lacked the resilience to absorb the shock. It follows in this story that the only escape from recession is for the Southern European countries rebuild their cost competitiveness—cutting wage costs (because Eurozone members cannot devalue their currency) by as much as 30% (as proposed by Sinn 2014), which requires in turn that their labor markets be thoroughly deregulated.”
This looks like a chicken-egg problem. Who would invest in Southern Europe if wage costs are so high ? If there is wage restraint, then investments would not be so large to generate sufficiently low unit labour costs.
“Secondly, of course it is true that Germany and German wage moderation bear part of the responsibility for bringing about the Eurozone crisis. Bofinger and Wren-Lewis have the best intentions while making this point (alas, the road to hell is paved with good intentions ….), but their single-minded emphasis on the importance of relative unit labor cost competitiveness is misguided for at least the following three reasons.”
When Bofinger and Wren-Lewis point to a particular factor, one cannot call this “single-mindedness”. The model is obviously larger than a single variable. First Storm grants part of their argument and then denies all of it.
(1) “Unit labor costs make up less than 25% of the gross output price, while a second reason is that firms in general do not pass on all (but mostly only half of) unit labor cost increases onto market prices. (…) Germany excels in non-price (technology-based) competitiveness and does not engage (much) in price competition.” It may be doubted that Germany could simply raise the prices of its quality export products without a dent in their exports. Thus the prices and labour costs matter.
(2) “It was German engineering ingenuity, not nominal wage restraint or the Hartz “reforms”, which reduced its unit labor costs. Any talk of Germany deliberately undercutting its Eurozone neighbors is therefore beside the point. ” The point was that wage moderation had an important contribution, and this is not negated by pointing to something else.
(3) “The only rational explanation for the observed time-sequence is that Southern Europe first experienced a debt-led growth boom, which then led to higher imports and higher capital inflows leading only after a lag of many quarters to lower unemployment and higher wage growth in excess of labor productivity growth (see Storm and Naastepad 2015c).” He might have mentioned that low domestic demand in Germany also reduced the scope for exports by Southern Europe to Germany (like holidays). The German balance of payment surplus had to be invested abroad, simply because of accounting rules. Thus if Germany had targeted for a external balance, Southern Europe would have faced a different situation.
According to Storm German wage moderation would be a factor but not the key one:
“In a nutshell, since the mid-1990s, Germany has become stronger and more productive in high-value-added, higher-tech manufacturing (in conjunction with outsourcing to Eastern European countries), while Southern European countries became more strongly locked into lower-tech, lower value-added and, often, non-tradable activities (Storm and Naastepad 2015c).”
“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 all concentrated in the non-dynamic and often non-tradable sectors of their economies.”
This repeats point (3) above, and is the common critique about irresponsible banks, who did not take proper account of the creditworthiness of their customers (or the system of central banks, that did not take account of these systemic effects).
Storm is a student of the economics of technology, but arrives at issues of finance:
“What is the appropriate interest rate for the structurally divergent “core” and “periphery” in a one-size-fits-all monetary union? And how can banks, the financial sector and capital flows be made to contribute to a process of convergence (rather than divergence)”
“(…) ditch the dangerous myth that unit labor cost competitiveness is the prime problem”
- Nobody put the notion of “primacy” on the table. The model has more variables. Storm seems to fear such primacy because of the TU Delft research group hangup on wage moderation.
- He overlooks the observation by Keynes, and repeated by Bofinger, that surplus countries have a responsibility too. Bofinger explicitly argues for a rise of wages in Germany while those in Southern Europe are restrained. Bofinger’s analysis is targeted at explaining that German wages should rise, and the argument is sound.
- Does Storm really imagine a banking system that facilitates investments in Southern Europe even when unit labour costs guarantee a capital loss ? (Though levels are important rather than changes. E.g. compare hourly wage costs in Germany about 34 and Spain about 22 EUR per hour, which then must be met with productivity.)
Dutch Wikipedia reports that Kleinknecht in 2007-2008 was member of a committee that advised the GreenLeft political party about its programme principles. Potentially one might understand Kleinknecht’s hesitance as a scientist to study my analysis and join the protest against the censorship of science since 1990 by the directorate of the CPB, yet such hesitation also affects such advise in such political environments. The first is worse, since the second is politics only, and the GreenLeft might be deluded anyway, yet it overall makes one wary about the anatomy of Holland and the spillover effects on Europe and the world.
On Flassbeck and Lapavitsas later on.