Disclaimer- This is essentially a case study and can be quoted as example in Mains answers/interview if remedial measured are asked of you in any of the platform.
Let’s hope US policymakers have woken up to the fact that the country is in a period of sclerosis, where its economic institutions seem to be inefficient along a variety of fronts. When things aren’t working, one good idea is to look around and see which countries are doing better.
Right now, Japan is one such country. But in many ways, Germany looks like the most successful economy in the developed world.
This wasn’t always the case. It was a German economist who coined the term “Eurosclerosis” to describe the slow growth that plagued the country from the 1980s through the 1990s. In the late 2000s, even as the US economy boomed, Germany’s unemployment rate exceeded 10%.
But almost a decade after the global financial crisis, the country has found its legs. Unemployment is down. Labour force participation has risen steadily. Wages have gone up as well, outpacing the US since the 1990s and looking healthy in recent years.
This stellar performance comes even as Germany faces many of the same challenges as other rich countries.
Its fertility rate is low—just 1.38 children per woman, even lower than Japan. And its population is slowly shrinking. That means that a smaller and smaller base of German workers has to support a growing number of retirees.
Germany also hasn’t escaped the global productivity slowdown. Like other rich countries, it’s struggling to produce more from the same amount of resources.
And Germany has also been dealing with the challenge of automation, possibly even more than the US. Only Japan has substantially more industrial robots than Germany.
If, as some now claim, robots are a big threat to jobs and wages, German workers should be suffering; instead, their wages have been growing at a steady clip, even as employment has risen.
What is Germany doing right?
The country has a very large state sector, generous welfare spending and a trade unionization rate almost twice that of the US. Though the country did undertake a few free-market reforms in the early 2000s, there has been no major wave of deregulatory mania.
Nor did Germany escape the 2008 financial crisis or the Great Recession, both of which hit it hard. In fact, political and financial instability in the European Union probably was a drag on the country.
A new article by economists Christian Dustmann, Bernd Fitzenberger, Uta Schönberg and Alexandra Spitz-Oener proposes a theory for the German revival. Essentially, they say, it’s all about exports and unions.
The authors note that Germany’s exports have increased steadily. Though the country accounts for less than 5% of global output, it has about 9% of world exports. Sales to other countries account for about half of Germany’s gross domestic product—more than twice as much as for China.
Why is Germany such an export powerhouse?
Dustmann, et al. attribute it to the country’s wage competitiveness. In Germany, wages are set by collective bargaining at the industry and regional level, rather than at the company level as in the US.
According to the authors, German unions’ willingness to hold down wages led to lower production costs in Germany, allowing the country to export more.
And although it may seem counter-intuitive at first glance, limiting wage gains eventually led to faster wage growth.
Think about it. Companies deciding where to produce things have to base their decisions not just on today’s wage level, but on their expectations of future wage changes.
German unions’ willingness to contain or forgo raises in bad times could act as an insurance policy for companies in good times, making them feel safer about building expensive factories and making risky long-term investments in the country.
But there are also other, more troubling explanations for Germany’s performance.
The country’s exports have not been matched by imports—Germany runs a very large trade surplus.
Under normal conditions, economists believe that if a country runs a trade surplus, its exchange rate should rise to cancel out some of the imbalance.
But Germany is part of the euro- zone, most of which is in an economic slump. That slump holds down the euro’s exchange rate against that of many other countries, making German exports cheap.
Also, the unified currency doesn’t allow the exchange rates of slower-growing countries such as Greece or Spain to fall against Germany, meaning that Germany gets a boost to exports within Europe.
Some of Germany’s export competitiveness, then, might be coming at the expense of other countries. And some might depend on other European nations being in a slump. Those advantages would be either unhealthy or temporary.
But if Germany’s success really is due to its unique method of collective bargaining, other countries—especially those with large persistent manufacturing trade deficits, such as the US and India—should think about ways to emulate the German system’s advantages.
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Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.