The Political Economy of Persistent Current Account Imbalances

Mercantilism in a Liberal World Order:
The Political Economy of Persistent Current
Account Imbalances
Mark Manger
University of Toronto
Thomas Sattler
Université de Genève
[email protected]
[email protected]
October 27, 2015
Papier presented in th IC3JM’s Permanent Seminar series
Universidad Carlos III, Madrid (Getafe)
Abstract
Why do some countries run persistent current account surpluses? Why
do others run deficits, often over decades, leading to enduring global financial imbalances? Countries that continuously export more than they
import and save more than they spend (surplus countries) accumulate capital that needs to be reinvested abroad. Countries that import more than
they export and consume more than they save (deficit countries) borrow
from surplus countries. Such persistent imbalances are the root cause of
most financial crises and contributed to the ongoing Eurozone crisis. We
propose that differences in wage bargaining institutions explain a large
share of imbalances via their effect on the change in real exchange rates
and the trade balance. We estimate both short- and long-run dynamics and
find ample support for our hypothesis: In surplus countries, wage growth
can be restrained in line with productivity gains. We interpret this as a
political equilibrium predicated on a relatively closed and uncompetitive
service sector.
Word count: 10946
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1
1
Introduction
Why do some countries run persistent current account surpluses? Why do others run deficits, often over decades, leading to enduring global financial imbalances? A current account deficit means that a country spends more on imports
and interest payments than it earns from exports and investments abroad, so it
accumulates international liabilities. A surplus means that a country earns more
from exports and investments than it spends on imports and interest payments,
and therefore accumulates claims on deficit countries. The strains of recycling
capital between surplus and deficit countries are at the heart of most financial
crises. Persistent imbalances created political friction between the US and Japan
in the past and the US and China today. Imbalances in the Eurozone contributed
to the as-yet unresolved crisis. Moreover, if developing economies are running
current account surpluses and important developed economies deficits, then capital is inefficiently allocated on a global scale. Unsurprisingly, commentators
across the political spectrum, from liberals like Paul Krugman (2009) to conservatives like Martin Feldstein (2011), agree that global imbalances are among
the most pressing economic policy issues of our time.
Although in the aftermath of the Global Financial Crisis some external deficits
have shrunk, most of this has been due to the reduction of demand: The IMF’s
2014 World Economic Outlook underlines that “external imbalances in 2013,
although declining, remained almost twice as large as would be consistent with
fundamental and desirable policies” (IMF, 2014, 12). Chinn, Eichengreen and
Ito (2014, 489) note that “(. . . ) unless a number of countries jointly implement substantial policy changes, global imbalances are unlikely to disappear.”
In short, global financial imbalances remain problematic and may again cause
financial crises in the future.
And yet, our limited understanding of the causes of persistent imbalances
stands in stark contrast to their political and economic importance. While the
literature in economics has identified what needs to be done—surplus countries need to spend more and save less, deficit countries need to deleverage,
export more and import less—it is much less clear why countries seem to avoid
macroeconomic adjustment even at great political and economic cost. This lack
of understanding distorts the public debate and hobbles effective policy choice.
In this paper, we shed light on the domestic origins persistent surpluses and
deficits. We offer an institutional explanation for why some countries maintain
trade surpluses while others run deficits, and why the same countries manage
to restore export competitiveness more quickly through a domestic adjustment
process after external adverse shocks. More technically speaking, we explain
why some countries experience a systematically slower appreciation of their
real exchange rate1 and why they manage to return their real exchange rate to a
1 For
greater clarity, following everyday use, we refer to an “appreciation” when prices rise,
even though such a change is defined with a negative sign in economics.
2
long-term equilibrium after exogenous shocks. We also provide the outlines of
a model to explain why these institutional features are a political equilibrium.
Our study makes several theoretical contributions and has important policyrelevant implications. First, we build on concepts from the Varieties-of-Capitalism (VoC) literature (Hall and Soskice, 2001; Hancké, 2009; Iversen and Soskice, 2006; Iversen, Pontusson and Soskice, 2000) to explain international outcomes that present a challenge for standard macroeconomic theory. Second,
we provide an alternative explanation to the one offered by Iversen and Soskice
(2010) that accounts for not only different levels of prices across countries, but
also relative differences in average real exchange rates over time as well as the
speed of adjustment to exogenous shocks. Finally, we clarify that an automatic
resolution of global imbalances is unlikely as long as these institutional differences persist in surplus and deficit countries, so solutions need to be cognizant
of their importance and persistent hectoring against alleged government policy
(e.g. Wolf, 2008, 2014) misses the mark.
2
Patterns of Current Account Imbalances
Even though the Balance of Payments (BoP) is one of the most central concepts
in international economics, current accounts exhibit long-term empirical patterns that are difficult to reconcile with existing theories. Some countries have
been almost permanently in deficit throughout the post-war period, while others
have been quite consistently in surplus. Australia and Japan in figure 1 illustrate
this pattern well: Australia has for practical purposes never achieved a current
account surplus except in 1974 and 1975, when resource prices surged unexpectedly due to the first Oil Shock. Meanwhile, Japan has been consistently in
surplus from 1981 on, with a brief interruption after the shut-down of its nuclear
plants in 2011 that caused a surge of fossil fuel imports.
Such extreme values are not peculiar to these two economies, but rather a
characteristic of many industrialized countries, as figure 2 shows. Portugal, New
Zealand, Greece, Canada and the U.S. are other examples of long-term deficit
economies. Germany, the Netherlands and Switzerland are long-term surplus
countries. Finally, some show regular ups and downs, e.g. Italy, France and
South Korea, while the Scandinavian countries switched from long-term deficit
to long-term surplus after the 1980s.
While the existence of imbalances per se is not surprising, it is puzzling
why some major economies have a “built-in" tendency to run either a deficit
or a surplus throughout almost the whole post-World War II era. Whatever the
reasons, imbalances should eventually adjust via the exchange rate or relative
prices. This puzzle has inspired a burgeoning literature on the causes and consequences of long-standing imbalances. These studies generally emphasize that
in order to run a surplus, a country needs to save more than it consumes and
3
Figure 1: The Australian and Japanese Current Accounts
Australia
Japan
4
Current Account (% GDP)
Current Account (% GDP)
0
−2
−4
2
0
−2
−6
1960
1970
1980
1990
2000
2010
1960
1970
1980
year
1990
2000
2010
year
Figure 2: Average Current Account Balances of OECD countries
# years
in deficit
31 / 36
38 / 39
34 / 34
49 / 51
43 / 56
31 / 36
47 / 61
33 / 41
30 / 41
26 / 37
26 / 41
28 / 44
19 / 36
19 / 41
16 / 35
18 / 36
16 / 36
16 / 61
14 / 61
2 / 44
2 / 23
Portugal
N. Zealand
Greece
Australia
Israel
Spain
Canada
USA
UK
Ireland
Italy
Austria
France
Sweden
Korea
Finland
Denmark
Germany
Japan
Netherlands
Switzerland
-10
-5
0
5
10
Current account balance, % of GDP
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invests. Simple consideration of macroeconomic identities show this.
In a closed economy, private investment is defined as I = GDP − C − G,
where I is investment, C private consumption and G public consumption. Any
output not sold to willing buyers in the marketplace becomes inventory investment. Furthermore, savings must equal investment (S = I). In an open economy,
GNP is GDP plus net investment income (NINV ), since some domestic GDP is
produced by foreign capital, so that GNP = GDP + NINV . Savings is defined
as S = GNP − C − G. Hence we can express the current (CA) alternatively as
CA = S − I or as CA = X − M + NINV + NUT , where X is exports and M is
imports and NUT are net unilateral transfers (aid payments, remittances and
such). Most of the literature starts with the former definition and hones in on
the intertemporal choice between consumption today and saving and earning a
return in the future.
2.1
Current Knowledge
We can identify four relevant strands of literature: The twin deficits argument,
the savings glut as a consequence of reserve hoarding by emerging markets,
the financial deepening hypothesis, and the rigorous (but rarely empirically explored) intertemporal approach.
Twin deficits. The “twin deficits” hypothesis originated in the Reagan era,
when a defence build-up coincided with tax cuts, causing large public deficits
and ballooning current account deficits to coincide (Volcker, 1987). Research
has found some empirical validation of this view for the 1980s and 2001-2004
(Chinn, 2005). Casual observation of e.g. the considerable government deficit
in the late 1980s and early 1990s in Canada combined with a sizeable current
account deficit suggests that similar forces were at work, in particular since
the rapid consolidation of Canadian public finances in the second half of the
1990s briefly created a current account surplus. Nonetheless, such shocks can by
definition not explain persistent imbalances, since some countries with current
account surpluses have nonetheless run sizeable government deficits over many
years, as the case of Japan shows.
A global savings glut. Since the late 1990s, many developing countries
have accumulated large holdings of foreign reserves. This has raised the question whether the policies driving this outcome are primarily export-promotion
through undervaluation–with reserves as a byproduct–or if reserves themselves
are the objective. The former view sees the current account surpluses of East
Asian countries as a tacit bargain whereby these countries finance the current account deficits in the United States to maintain demand there (Dooley, FolkertsLandau and Garber, 2003, 2009). The latter view argues that in reaction to the
frequent current and capital account crises of the 1990s and in particular the
1998 Asian Financial Crisis, emerging markets have decisively switched from
pegs and overvalued currencies to considerable intervention in the foreign ex5
change market. Foreign reserves are therefore a policy of self-insurance (Aizenman and Lee, 2008; Gruber and Kamin, 2007; Jeanne and Rancière, 2008). Either way, the result is a glut of savings and depressed real interest rates in the
deficit countries (Bernanke, 2005).2
Insufficient financial deepening. A variation on this argument revolves around
financial market imperfections, as originally proposed by Lucas (1990). While
people in fast-growing emerging markets seek a safe store of value, investment
opportunities are either not keeping up with savings or financial market imperfections make them appear unattractive because of associated risks. In consequence, capital flows to the US and other locations that produce safe assets
(Caballero, Farhi and Gourinchas, 2008; Caballero, 2006; Caballero and Krishnamurthy, 2009). With high legal uncertainty and expropriation risk, developing
countries may therefore experience large private capital outflows and (in comparison) modest inflows of foreign direct investment (Ju and Wei, 2006). While
this partially explains the Chinese case, it sheds little light on the persistent current surpluses of developed countries with quite deep financial markets and the
persistent surpluses of others.
Asset price distortions. Several recent contributions underscore the distorting effects of low interest rates, and show how asset bubbles interact with political institutions and parties. Ansell (2014) and Ansell and Broz (2013) find that
as house prices rise, voters demand less social insurance in countries experiencing capital inflows, with the opposite effect at work in surplus countries. But
why then do households in some countries borrow systematically more against
future income than in others? Ahlquist and Ansell (2014) offer a compelling answer: In countries with majoritarian election systems that produce a right-wing
bias, politicians will respond to growing inequality by making credit accessible to lower-income groups, while in proportional representation systems with
their built-in left-wing bias, they will opt for redistributive policies instead. The
rapidly worsening inequality in the United States and the UK, for example, is
thus to blame for the increase in borrowing by private households, which should
in turn have affected the current account balance negatively.
Intertemporal trade. The most rigorous approach sees the current account as
an intertemporal allocation of consumption (Obstfeld and Rogoff, 1995). This
class of models is based on the standard assumption that individuals dislike
fluctuations in consumption and use savings (i.e. assets) to smooth consumption
over time. Insofar as countries’ economic cycles are not in sync, transitory
shocks can already cause differences in savings. Absent such differences in
cycles, countries have to have different preferences for consumption smoothing.
Some prefer consumption today, others postpone it to the future. In several
papers, Kraay and Ventura (2000; 2003) build on this model to explain how
countries react to income shocks by investing partly at home and partly abroad.
2 Despite criticism from many sides (Obstfeld, 2010) that US monetary policy was accordingly too lax, policymakers disavow any responsibility (Bernanke, 2010).
6
These models, however, are much better at explaining short-term movements
than long-term equilibria. In general, there is very little research exploring why
whole countries would have significantly different discount rates than others
over long periods of time.
Empirical studies of these arguments requires modelling the current account
as determined by savings and investment behaviour. The seminal papers have
been submitted by Chinn and collaborators (Chinn and Ito, 2007; Chinn, 2005;
Chinn and Prasad, 2003), who find that government budget balances, (among
developing countries) financial deepening and terms of trade volatility are correlated with current account surpluses. Macroeconomic uncertainty also increases
domestic saving and slightly negatively affects investment. They also control
for the net foreign asset position, making their approach compatible with an
intertemporal savings model. The papers therefore offer support for the twin
deficit view, a global savings glut based on precautionary savings and insufficient financial deepening. However these papers offer little in the way of clear
causality, underpredict the US current account deficit and Chinese surplus, and
cannot account for the large German current account deficit during the 1990s in
contrast with its sizeable surplus since 1999.
What these papers miss is that current account surpluses and deficits tend
to change very little in their relative levels over time. Some countries are predominantly deficit countries over decades, others run large surpluses. In this
study, we propose an alternative view: we start from the observation that for
most countries, the current account is largely driven by the trade balance, to
the extent that many older textbooks treat the two as equivalent in practice (see
e.g. Krugman and Obstfeld, 1997, 308). Rather than primarily focusing on
savings, we start with the trade account. We show that specific institutional features allow some countries to maintain a systematically slower increase in the
real exchange rate, and thus become relatively more export-competitive over
time. Countries without such institutional features can thus only respond by
either actively devaluing their currencies vis-à-vis the surplus countries or by
running current account deficits over long periods of time. Moreover, persistent
surplus countries also respond to exogenous negative shocks in productivity or
real exchange rates by rapidly reversing their effects through a mechanism of
wage repression in the exporting sector. However, we submit that direct wage
repression policies are unlikely to be politically sustainable in a democracy, in
particular if it is successful and the manufacturing sector grows and provides
many jobs. A necessary corollary, we argue, is a relatively closed and uncompetitive service sector, which in turn exacerbates trade imbalances since many
(though by no means all) countries running current account deficits are also relatively more competitive exporters of services.
7
3
Theory
Our theoretical argument centres on institutional differences between deficit and
surplus countries, in particular institutions that shape collective wage bargaining and the political compromise between manufacturing and services sectors.
In line with the Varieties-of-Capitalism (VoC) literature (Hancké, 2009), we argue that countries with coordinated, centralized wage bargaining institutions are
able to restrain wage growth in line with increases in total factor productivity.
At the same time, countries with such wage bargaining institutions tend to have
higher real exchange rates, meaning that prices of comparable goods are on average higher than in other countries. We submit that high real exchange rates
are the result of a protected services sector that is uncompetitive in international
comparison and thus drives up domestic prices. High real exchange rates are
therefore a consequence of a distributive mechanism that reallocates income
from workers in the tradable manufacturing sector to workers in the services
sector. We deliberately avoid the terms “tradable” and “non-tradable” sectors,
because it is really only the protectionist regulation of the services sector that
renders these services non-tradable. With very few exceptions, e.g. in professions such as hairdressers and car mechanics where long-standing relationships
and proximity requirements coincide, services become tradable through the temporary movement of workers.
3.1
Centralized Wage Bargaining and Real Exchange Rate
Appreciation
The central contribution of the VoC literature can be summarized as follows:
In a system with an independent central bank and coordinated and centralized
wage bargaining in the export sector, unions in this sector will not ask for wage
increases that outpace productivity gains, because attempts to do so would invite interest rate increases by the central bank to keep inflation in check. At the
same time, the centralized, coordinated organization of wage bargaining makes
it possible to enforce collective agreements throughout the economy. In equilibrium, unions will therefore make moderate demands and wage inflation will
be kept low without the need to raise interest rates (Calmfors and Driffill, 1988;
Soskice, 1990).
This approach has recently been applied to explain the Eurozone crisis.
Hancké (2013) argues that workers in the internationally exposed sector have
an incentive to restrain wages, while those in the non-exposed sector (i.e. in the
public and parts of the services sector) have no such incentives. With wage coordination, the restraint in the exposed sector is also applied to the non-exposed
sector; without such coordination, the non-exposed sector will bargain for wages
and hence cause ballooning current account deficits (see also Johnston, 2012;
Johnston, Hancké and Pant, 2014).
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Our argument is closer to Höpner and Lutter (2014), who criticize Hancké
and collaborators by pointing to the divergence in until nominal labour costs
(NULCs), which were lower in manufacturing than in the wider economy in
countries with coordinated wage bargaining relative to countries with uncoordinated wage bargaining. We agree with this interpretation of some of the underlying causes of Eurozone crisis, but our paper has a much broader scope. We
argue that such divergences are systematic and occur even when countries have
nominal exchange rate devaluation as a policy at their disposal. In fact, they are
a persistence feature of the international economy since at least the end of the
Bretton Woods era, and possibly much longer.
Although the emphasis on unit labour costs is gaining acceptance, it is less
appreciated countries with such coordinated wage bargaining systems (for example Denmark, Germany, the Netherlands and Sweden) also have consistently
higher real exchange rates (defined as price level of consumption divided by the
exchange rate relative to the United States), yet are also highly successful exporters. This is puzzling because high prices should be reflected in high costs,
and thus make such countries relatively less competitive. Iversen and Soskice
(2010) focus on the cross-sectional aspect of this puzzle. They present a model
in which state-subsidized skill formation is an equilibrium outcome in coordinated market economies with proportional representation (PR) systems: A constant supply of skilled workers reduces upward pressure on wages in the tradable
sector, but this is only sustainable because a PR system facilitates coalitions of
skilled and semi-skilled workers.
The strong point of the model is that it shows an institutional equilibrium that
guarantees relative competitiveness through an investment in skills. However
we note that state-subsidized vocational training is in fact uncommon in much
of Europe including the Netherlands and Belgium, both highly coordinated market economies, and completely missing in Germany, the largest economy that
runs persistent current account surpluses. What’s more, the authors dismiss the
possibility that costs are higher in some countries than others because of trade
barriers,3 and thus cast aside the voluminous literature on the political economy
of trade.
We suggest an alternative explanation. We note that the real exchange rates
of countries with centralized wage bargaining systems appreciate systematically
more slowly than those of countries with uncoordinated wage bargaining institutions. Why would centralized wage bargaining institutions have these effects?
From a traditional VoC perspective, this outcome is merely a by-product of better macroeconomic performance: lower wage inflation also implies a slower
appreciation of the real exchange rate. This cannot, however, be the full story,
as the difference in inflation performance is much smaller than the current and
3
Iversen and Soskice note that their analysis focuses on the post-Bretton Woods period
“widely regarded as the beginning of a truly globalized international economy” and therefore
do not consider trade distortions separately.
9
trade account imbalances. Neither does export-competitiveness combined with
a high real exchange rate automatically lead to trade surpluses, as it is equally
possible to be a competitive exporter and have a balanced trade account.
We submit that in countries with centralized wage bargaining (CWB) institutions, firms and unions in exporting industries will bargain to achieve outcomes
that maintain competitiveness. We assume that firms in exporting industries
have limited pricing power when they sell into foreign markets,4 and receive information about the prices of their competitors. Firms can also directly observe
their own productivity gains, so that in combination they can assess how much
wages can be increased without making their own exports uncompetitive: An
increase in wages exceeding the increase in productivity will lead to the firm
pricing itself out of the market.
In countries with CWB systems, unions are generally industry-wide confederations, as opposed to the craft- and company-specific unions in decentralized
systems. Unions therefore bargain for wage increases for a whole industry with
employer “peak” federations. As the VoC literature as shown, coordinated wage
bargaining primarily means that unions can enforce wage settlements across
the whole industry (Calmfors and Driffill, 1988), and will bargain for relatively
moderate gains because of the threat of interest rates hikes by an independent
central bank looming if they overplay their hand (Iversen, 1999). This prevents
wage inflation while keeping the non-accelerating inflation rate of unemployment (NAIRU) low. In countries that lack such centralized bargaining institutions and union confederations that can enforce industry-wide agreements, either the NAIRU or inflation have to be systematically higher, or unions have
to be weakened to keep wage demands in line. Since 1980, Southern European
countries have seen for the former, in particular higher structural unemployment,
while Anglo-Saxon countries have pursued union-weakening policies.
While wage restraint and centralization are clearly important determinants
of low inflation in Northern European countries, by itself they cannot explain
why these countries generate consistent trade and current account surpluses.
First, wage restraint on its own does not predict whether a consumption basket
consists of more or less imported goods, and is thus entirely compatible with a
balanced current account. Second, if countries with centralized bargaining institutions compress wages but have floating currencies, as is true for most of them,
then countries with decentralized institutions can simply devalue their currencies as needed vis-à-vis those of countries with centralized institutions. Obviously this is also what e.g. Italy, France, Spain and Portugal have repeatedly
pursued by devaluing against the Deutsche Mark. Such repeated devaluations
notwithstanding, CWB countries have continued to generate current account
4
If overseas demand is not infinitely elastic, then countries can improve their welfare by
raising wages and therefore improving its terms of trade (Rama, 1994) but we believe this is
only applies to a handful of global industrial sectors like e.g. aircraft manufacturing.
10
surpluses.5 This fact is not explainable with reference to internal bargaining
between employers and workers in a polity with an independent central bank.
Moreover, some models even show that with growing integration of product
markets, the Calmfors-Driffill relationship will become less relevant and economic growth should converge regardless of the wage bargaining regime (Danthine and Hunt, 1994). Nonetheless, the VoC concepts provide key theoretical
building blocs.
Consider first that for export-oriented firms in centralized bargaining settings, what matters most is to maintain cost competitiveness in international
comparison. Firms will therefore have an incentive to inform unions about productivity improvements, who will in turn moderate their wage demands. To the
extent that wage bargaining is centralized and coordinated, wages will therefore
rise only slowly relative to other countries, and employment in export-oriented
industries will either be maintained or grow. This simple mechanism has a direct consequence for the trade balance: all else equal, the prices of exports from
CWB countries will grow more slowly than those of countries with decentralized institutions. This will find expression in the real exchange rate defined
as the cost of an equal basket of consumption (i.e purchasing-power parity, or
PPP) divided by the nominal exchange rate. Since an appreciation of the real
exchange rate reduces cost competitiveness of exporters, such an appreciation
will result in a negative shift in the trade balance. Slower appreciation thus implies a tendency for a trade surplus, as expressed in hypothesis 1. By extension,
as expressed in hypothesis 2, these countries are also more likely to sustain a
current account surplus, although we expect the relationship to be less strong.
Hypothesis 1 Countries with greater wage bargaining centralization are more
likely to sustain a trade surplus in the long run.
Hypothesis 2 Countries with greater wage bargaining centralization are more
likely to sustain a current account surplus, but the relationship should be weaker
than for the trade balance.
It is important to keep in mind that these relationships hold in the long run
only: If a CWB country experiences an exogenous shock, its trade and current
account balance will return to its long-run equilibrium. But reaching this equilibrium again requires a repression of wages in the exporting sector. Since most
collective bargaining agreements are valid for at least one year, we can expect
the external balances to be in surplus again only with a lag.
Given these hypothesized relationships, what then explains why centralized
wage bargaining countries have higher real exchange rates? In other words,
5
The often-overlooked fact should give pause to those who propose a break-up of the Euro
as a means to resolve intra-European imbalances whose existence preceded the Euro by decades.
11
why are they starting from a higher level than others? To answer this question, we submit that in theory and all else equal, CWB countries should experience what we call an inverse Balassa-Samuelson effect. The original BalassaSamuelson (Balassa, 1964; Samuelson, 1964) prediction was that as developing
countries open their economies, the tradable sector will see productivity and
wage increases. Insofar as demand rises in the whole economy, wages in the
non-tradable sector will thus rise as well. An inverse Balassa-Samuelson effect
occurs if wages in the tradable sector are compressed due to an external force
(in our case, centralized wage bargaining institutions) so demand for services
and hence wages in the non-tradable sector are lowered. Moreover, in periods
when wages in the non-tradable sector exceed those in the tradable sector, we
should see labour reallocation from the latter to the former.
Empirically, however, such an inverse Balassa-Samuelson is clearly not evident, otherwise we would see a lower real exchange rate in countries with centralized wage bargaining institutions, while the opposite is true in reality. What’s
more, while such an economy would clearly be a highly competitive exporter,
we doubt that such a policy would be sustainable with guaranteed collective
bargaining rights and democratic elections: it would imply that wages are institutionally compressed in the two of three sectors of the economy (the third
being the public sector). Finally, as pointed out by Raess (2014), this creates the
puzzle why unions in less export-oriented firms should remain in centralized
wage bargaining at all since they can gain by leaving the coordinated bargaining setup. To resolve this puzzle, we point to another often overlooked factor:
Many countries with highly centralized wage bargaining institutions also have a
tightly protected services sector with barriers to entry within the country in the
form of professional licensing and other regimes.
3.2
Protectionism in the Service Sector
While the services sector has seen considerable liberalization in OECD countries since the creation of the WTO, the conclusion of the GATS negotiations
and—in particular—within the European Union because of the (gradual) completion of the Single Market, we still observe considerable variation in the degree of services liberalization across countries. Unfortunately, there is little
comparative data on services sector restrictions, and moreover none that measures the effect on domestic prices that would allow us to test this aspect empirically.
Anecdotal evidence, however, is plentiful. In Germany and Austria, nearly
all service sector professions are treated as skilled trades that require the membership in a guild or professional association, entry to which is restricted to
those who undertake a three-year apprenticeship. Starting an independent business requires a further five years of professional experience and an exam as
master craftsman. While this often-lauded "dual system" vocational training
12
provides relatively highly-skilled craftsmen and ensures high quality workmanship, it also creates a formidable barrier to entry and maintains monopoly profits
for these professions. The reach of these restrictions is hard to overstate: in Germany, even window-cleaning requires a three-year apprenticeship. While not
all countries have similarly medieval guild requirements, in most countries with
highly centralized wage bargaining institutions we also find restrictions on the
entry into services professions—this is the case for the Austria, Belgium, Germany, the Netherlands, and Finland. Notable exceptions are Denmark and Sweden, although there are various certification requirements to practice a skilled
trade that follow publicly-funded training programs. By contrast, comparable
requirements do not exist in the UK, Australia, Canada and the United States.
These restrictions have a direct effect: By reducing supply and limit competition they sustain elevated prices. This implies a redistribution of income from
the high-productivity export sector to the low-productivity non-tradable sector,
and also causes the real exchange rate to be higher than it would be given the
wage compression in the exporting sector and relative to countries where services provision is less regulated. The sustainability of CWB institutions therefore depends on a heavily protected services sector.
We suggest that there is a further, indirect effect: CWB countries with sheltered services sectors will also generally be less competitive in services, and
will therefore impose restrictions on services purchases from abroad that would
help to balance the trade and current account. In other words, the current account and trade surpluses of countries with highly centralized wage bargaining
regimes not only reflect a highly competitive and productive exporting sector—
usually in manufacturing—but also a much less competitive and less productive
closed services sector.
Given current data constraints, it is not possible for us to directly test the link
between wage bargaining centralization and protectionism and elevated wages
in the services sector. We can, however, explore the first part of our theoretical
framework and test our hypotheses on data on current account imbalances. The
following section presents such a test.
4
Analysis
We focus our analysis on the period after 1976, the year in which the Bretton Woods financial regime officially ended with the ratification of the Jamaica
Accord and floating exchange rates were permitted by the IMF, and end our
analysis in 2011. The endpoint is due to data constraints. We also examine if
the run-up to the Global Financial Crisis and its immediate aftermath represent
a structural break (Chinn, Eichengreen and Ito, 2014), but our conclusions do
not change if we exclude the period after 2007.
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4.1
Data
The analysis focuses on two versions of the dependent variable. First, we examine the trade balance, i.e. the difference between exports and imports, which
is the key component of the current account. The mechanism that we outline
above primarily affects relative competitiveness of production and therefore export and import activities of a country. Second, the analysis shows how these
mechanisms translate into the current account as a whole, which is the sum of
the trade balance and net foreign transfers. For both, we use the ratio of trade
balance (TB) and current account (CU) to GDP. All data on these variables
is from the IMF Balance-of-Payments Statistics (BOPS) and selected national
sources.
Our central explanatory variable is wage bargaining centralization. The
most frequently used measure is due to Iversen (1999), but it only covers a
small number of countries and years from 1973 to 1993. A similar approach
is taken by Kenworthy (2008). The most comprehensive data has been assembled by Visser (2013) at the Amsterdam Institute for Advanced Labour Studies
(AIAS) that provides a broad index for all OECD and EU as well as several
other industrialized countries for the years 1960-2011 in its ICTWSS dataset.
This longitudinal measures permits a panel analysis, although for most countries, wage bargaining centralization remains a slow-moving variable with the
attendant challenges for the estimation. We rely on this data as it is highly correlated with both alternative indexes for the years in which we have data, with
correlation coefficients ranging from a minimum of 0.79 between Iversen and
ICTWSS and 0.91 between the ICTWSS and the Kenworthy index.
A second key explanatory variable is the change in the real exchange rate.
To measure the real exchange rate, we use the price level of GDP in a particular
year relative to the United States in a given year. This data is from the Penn
World Table. We use the difference in the log of the real exchange rate index,
which approximates the percentage change of the real exchange rate from the
previous to the current year.
The empirical models include a variety of control variables that previous research identifies as important determinants of the current account and its components (Chinn and Prasad, 2003). This research finds that the initial stock of
net foreign assets/GDP is one of the strongest determinants of the current account. Net foreign assets are the difference between foreign assets of domestic
residents and domestic assets owned by foreigners. Foreign assets generate income from abroad, while foreign liabilities require the payment of interest to
parties abroad. Net foreign assets are equivalent to the sum of past current account balances. Similarly, the fiscal balance/GDP is an important determinant
of current account because it represents that the public half of the “twin deficits”
hypothesis. Greater fiscal deficits generally are associated with greater current
account deficits. Data on fiscal balances comes from the OECD and national
14
accounts.
To capture differences in demographic structures, we use two variables. Dependency ratio (young) is the share of people under 15 compared to those between 15 and 65. Dependency ratio (old) is the share of people over 65 compared to those between 15 and 65. The idea is that high dependency rates
should lower the savings rate and hence the current account balance, since
old and young individuals are more likely to spend more than save (Ando and
Modigliani, 1963). Because the working age population has peaked in most
industrialized countries during the past 40 years, there may be a general downward pressure on current accounts. As measures of financial deepening, we use
the values of stock market capitalization and financial intermediation as share of
GDP. We also include a variable for flexible exchange rates to control for the exchange rate regime. It is a binary indicator constructed from Ilzetzki, Reinhart
and Rogoff (2008) by distinguishing between fixed and adjustable fixed rates
(categories 1 and 2) from managed and fully flexible exchange rates (categories
3 and 4). We also use other version of this variable, notably the original ordinal
variable and binary indicators for each category, but the results are the same.
Summary statistics are shown in table 1.
Table 1: Summary statistics
Variable
Trade balance
Current account
Wage bargining centralization
NFA
∆RER
Fiscal balance
Stock market capitalization
Financial intermediation
Flexible XR
Dependency ratio (old)
Dependency ratio (young)
4.2
Mean
Std. Dev.
Min.
1.01
-0.236
0.391
-11.503
0.272
-2.822
42.025
4.74
0.156
21.644
29.309
4.975
4.653
0.183
36.864
9.686
4.677
101.052
3.516
0.364
3.781
5.622
-20.201
-15.039
0.083
-165.441
-25.018
-30.616
-1189.316
-28.088
0
12.342
20.229
Max.
18.915 714
17.457 714
0.978 735
139.035 672
29.518 714
18.787 734
317.037 714
14.474 714
1
735
36.928 735
52.862 735
Empirical strategy
We study the effect of wage bargaining systems on the trade balance and the current account in two ways. In the first part, we focus on the medium- and longterm equilibrium following the strategy of Chinn and Prasad (2003). Recall that
15
N
it is our expectation that countries with highly centralized wage-bargaining institutions will have a tendency towards current account and (in particular) trade
surpluses. This effect should be evident primarily in the long run. External
balances tend towards a mean, but fluctuate around it due to exogenous shocks.
To this end, we examine how the key variables, trade and current account
balances and changes in the real exchange rate and wage bargaining centralization, are empirically associated over the whole period of analysis. First, we take
the averages of these variables for each country from 1977 to 2011 and estimate and plot the bivariate relationships between these variables. This shows
whether the general patterns predicted by our theory exist during the 35 years
of our analysis. Second, we present the results from panel estimations with 5year averages. This approach allows us to assess the robustness of the empirical
relationship between centralization and current accounts when we control for a
series of variables. Since our key variable hardly varies over time, we do not
use country fixed effects, but we estimate models with time dummies.
In the second part, we examine a simple dynamic panel model of annual
trade balances and current accounts. This analysis has two purposes. First,
we can reexamine the effect of wage bargaining centralization by splitting the
sample into high- and low-centralization countries. In particular, we examine to
what extent the long-term time series equilibrium differs across subsample. The
long-term equilibrium is the unconditional expectation of the time series around
which the series fluctuates in the long term. If the series deviates from this
equilibrium, e.g. because shocks pull the trade balance up or down, the series
gradually readjusts to this equilibrium value through the autoregressive process.
The second purpose, therefore, is to model this dynamic equilibration process
and examine how it differs for countries with low and high wage bargaining
centralization.
4.3
Results
Figures 3 to 5 present the estimation results for the cross-section analyses regressing 35-year averages of each of the main variables on averages of the others.6 Figure 3 explores the empirical relationship between the trade balance
(left column) and the current account (right column) and the degree of wage
bargaining centralization. The figure shows that the trade balance is systematically greater for countries with a more centralized wage bargaining system.
Countries with the lowest degree of centralization are predicted to have an average trade balance of around -2.5%; countries with a mean level of centralization
are predicted to have an average trade balance of roughly 0; and countries with
the higher level of centralization are predicted to have an average trade balance
6 Following
Iversen (1999, 151-152) we exclude Austria because its wage-setting is centralized, but the distribution of wage increases throughout the economy is highly particularistic.
16
of approximately 2.5%. This is consistent with the main implication of our argument.
We see a similar pattern for the overall current account, although this pattern
is weaker than for the trade balance. Again, greater wage bargaining centralization, on average, leads to positive current account balances. The relationship
between current accounts and wage bargaining is less pronounced and less precise than for the trade balance because net foreign transfers, the second component of the current account, are not necessarily related to wage bargaining.
They therefore add noise to the empirical relationship. This becomes evident
when examining the position of particular countries that deviate from the general pattern. Switzerland, for instance, has a high level of net foreign assets
and therefore receives a significant net inflow of capital from returns on foreign
investments.
17
18
Trade balance (% of GDP)
−5
0
5
●
GBR
●
USA
0.2
●
FRA
●
●
0.3
PRT
●
GRC
ESP
●
ITA
●
CHE
●
0.4
FIN
●
●
BEL
●
●
IRL
DEU
Wage bargaining centralization
●
CAN
NZL
JPN
●
y = −4.61 + 15.5 ⋅ x
(1.76) (4.28)
●
AUS
0.5
●
DNK
SWE
●
●
NLD
●
NOR
−5
0
5
0.3
●
0.4
●
0.2
●
PRTGRC
●
ESP
Wage bargaining centralization
NZL
CAN
GBR
ITA
●
IRL
0.5
●
AUS
●
NLD
●
NOR
SWE
●
●
●
●
BEL
DEU
DNK
●
FIN
●
●
●
USA
●
CHE
FRA
●
●
JPN
●
y = −3.55 + 9.14 ⋅ x
(1.86) (4.78)
Figure 3: Trade and Current Account Balance and Wage Bargaining Centralization
Current account balance (% of GDP)
19
Trade balance (% of GDP)
−5
0
5
SWE
●
−0.5
DEU
●
FIN
●
NLD
●
0.0
USA
●
●●
BEL
CAN
●
FRA
●
DNK
PRT
0.5
GRC
●GBR
AUS
ESP
●
●
●
JPN
CHE
●
●
●
IRL
●
ITA
●
●
1.0
NZL
y = 1.96 − 3.48 ⋅ x
(0.94) (1.74)
∆ PPP exchange rate relative to the US
NOR
●
−5
0
5
●
SWE
−0.5
●
DEU
●
FIN
●
NLD
0.0
●
USA
AUS
●
●
●
PRT
0.5
GRC
●
●
ESP
●
●
IRL
GBR
●
●
DNK
FRA
●
JPN
●
CHE
CAN
●
BEL
∆ PPP exchange rate relative to the US
●
NOR
y = 0.62 − 3.16 ⋅ x
(0.62) (1.41)
●
ITA
Figure 4: Trade and Current Account Balance and Change in the Real Exchange Rate
Current account balance (% of GDP)
1.0
●
NZL
Figure 5: Change in the Real Exchange Rate and Wage Bargaining
Centralization
y = 0.99 − 1.97 ⋅ x
(0.30) (0.77)
●
NZL
1.0
●
∆ PPP exchange rate relative to the US
ITA
●
GBR
● ●
CHE
ESP
●
JPN
●
PRT
0.5
●
IRL
●
GRC
●
AUS
●
●
DNK
FRA
0.0
●
●
USA
●
CAN
BEL
●
●
NLD
FIN
●
DEU
●
NOR
−0.5
●
SWE
0.2
0.3
0.4
0.5
Wage bargaining centralization
To further examine the mechanism that we postulated, figure 4 shows how
the trade balance and the current account are related to changes in the real exchange rate between 1977 and 2011. Higher values mean that a country’s real
exchange rate, on average, appreciated more quickly relative to the real exchange rates of other countries. The figures show that countries with faster
appreciation of the real exchange rate have lower trade balances and current accounts. This relationship is again more pronounced for the trade balance than
for the current account, although only slightly. It confirms that the speed of real
exchange rate appreciation significantly affects the competitiveness of domestic
firms in the world economy.
Finally, figure 5 shows how real exchange rate appreciation and wage bar20
gaining are empirically related. It shows that countries with more centralized
wage bargaining systems experienced a lower, average appreciation of the real
exchange rate in the post Bretton Woods era. Together, the graphs support the
argument in the previous section: greater wage bargaining centralization affects
the competitiveness of domestic firms in the international economy through
slower real exchange rate appreciation than in countries with less centralized
systems. Slower real exchange rate appreciation, therefore, leads to a trade surplus, which translates into a current account surplus.
21
Table 2: Medium-term patterns in trade balance and current account (5-year averages)
DV: Trade balance
Centralization
7.681***
(1.925)
NFA
∆RER
Fiscal balance
Stock capitalization
Financial intermediation
Flexible XR
Dependency ratio (old)
Dependency ratio (young)
Constant
Time dummies
Adj. R2
F
p
N
-4.570***
(1.106)
Yes
0.13
3.99
0.001
147
DV: Current account
7.034*** 6.790*** 4.283***
(2.006)
(2.186)
(1.537)
0.044*** 0.029***
(0.009)
(0.008)
-0.203
-0.035
(0.132)
(0.070)
0.465*** 0.440***
(0.098)
(0.103)
0.010*
0.011**
(0.005)
(0.005)
-0.065
0.074
(0.154)
(0.136)
-0.927
-0.626
(0.684)
(0.656)
-0.148
-0.060
(0.122)
(0.110)
0.236**
0.081
(0.104)
(0.112)
-7.182
-1.717
-3.602***
(5.025)
(5.689)
(0.838)
Yes
No
Yes
0.43
10.00
0.000
147
0.35
10.14
0.000
147
0.03
2.67
0.013
147
Robust standard errors in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.
22
3.868**
(1.545)
0.077***
(0.008)
-0.110
(0.099)
0.347***
(0.069)
0.010**
(0.004)
-0.174
(0.115)
-0.376
(0.560)
0.066
(0.083)
0.160**
(0.078)
-7.981**
(4.027)
Yes
3.758**
(1.612)
0.068***
(0.008)
-0.016
(0.060)
0.325***
(0.070)
0.011***
(0.004)
-0.096
(0.108)
-0.213
(0.532)
0.088
(0.084)
0.059
(0.084)
-3.561
(4.347)
No
0.57
16.56
0.000
147
0.54
21.87
0.000
147
Table 2 examines the key relationship between wage bargaining centralization and, respectively, the trade balance and the current account in greater depth.
We follow the general strategy of Chinn and Prasad (2003) and use panel models
to estimate the medium-term relationship between wage bargaining centralization and the current account variables. The panel approach also allows us to
control for a number of factors that have been identified as important determinants of the current account. Since our main variable, the wage bargaining
system, varies only little or not at all over time, we do not use country fixed
effects.
The results show that wage bargaining centralization has a strong and robust
effect on both the trade balance and the current account. The effect is positive
and statistically significant for all specifications: Greater centralization leads to
higher trade and current account balances. To interpret the effect substantively,
when moving from the lowest to the highest level of wage bargaining centralization, the trade balance increases by approximately 6 percentage points. This
effect alone amounts to most of the long-term difference between the current
account surpluses and deficits of our cases of persistent imbalances. In the cross
sections, the effect of wage bargaining on the current account is smaller. The
current account balance increases by about 3.5 percentage points when moving
from the lowest to highest level of centralization.
The estimated effect of real exchange rate appreciation is not statistically
significant. However if we exclude the centralization variable, the negative coefficient is statistically significant, suggesting that greater real exchange rate
appreciation leads to a lower trade balance. This indicates that a sizable amount
of the medium-term effects of the real exchange rate on the trade balance is due
to differences in wage bargaining centralization. The two variables therefore, to
a significant extent, reflect the same mechanism with the centralization variable
being logically prior to the real exchange rate variable.
The results on the control variables are largely consistent with previous research. The initial stock of net foreign assets is an important determinant of our
current account variables. Greater levels of foreign assets lead to a higher value
of the trade balance and the current account. Our estimates of the coefficient
on the current account are almost identical with those from Chinn and Prasad
(2003) for industrialized countries, although the time period of our datasets only
partially overlaps.7 The other main control variable is the fiscal balance, suggesting that greater fiscal surpluses lead to greater current account surpluses, or
vice versa that greater fiscal deficits lead to increased current account deficits
(Chinn and Ito, 2007, 2008). The effects of the other variables are less pronounced or not robust. Interestingly, and consistent with previous research, the
coefficients of the demography variables are not statistically significant. This
7 Their
estimate of the coefficient on net foreign assets is 0.074 (Table 3, third column),
compared to 0.077 in our analysis. Their dataset starts 6 years earlier and ends 16 years before
ours.
23
implies that socio-economic developments like the ageing of industrialized societies are not among the likely causes of the long- and medium-term current
account imbalances that we seek to explain.
Table 3 shows the results from a simple dynamic panel model with country fixed effects for both the trade balance and the current account balance.
The models capture how the current account variables equilibrate after a shock
that pulls the trade balance and the current account balance away from their
long-term time series equilibrium. In the first step, we estimate the model for
the whole sample and add the wage bargaining centralization variable. As expected, the coefficient of this variable is not significant because the variable
barely changes over time. The results also indicate that the long-term equilibrium of the trade balance for all countries is close to zero because the constant
is close to zero.8 Table 4 presents the estimated long-term equilibrium values
for the full sample without the centralization variable in the second column. It
confirms that the estimated value for the trade balance is very close to zero.
8 The
long-term equilibrium, i.e. the unconditional expectation of the time series process, in
α0
an AR(1) model of the form yt = α0 + α1 yt−1 + εt is 1−α
.
1
24
25
0.853***
(0.046)
0.298
(0.940)
0.155
(0.390)
0.76
693
0.271***
(0.045)
0.76
693
0.853***
(0.047)
0.688***
(0.185)
0.81
330
0.869***
(0.057)
-0.214**
(0.068)
0.62
363
0.799***
(0.063)
Low
0.837***
(0.021)
-0.807
(1.327)
0.360
(0.518)
0.71
693
All
Robust standard errors in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.
Adj. R2
N
Constant
Centralizationt
yt − 1
All
Trade balance
All
High
0.046***
(0.005)
0.71
693
0.837***
(0.020)
0.355***
(0.027)
0.76
330
0.852***
(0.031)
Current account
All
High
-0.278***
(0.035)
0.64
363
0.814***
(0.027)
Low
Table 3: Dynamic models of trade balance and current account (annual), by wage bargaining centralization
Table 4: Estimated long-term equilibrium of the trade balance by wage
bargaining systems
Trade balance
Current account
Full sample
High centralization
Low centralization
0.28
[0.19; 0.43]
1.84
[1.55; 2.87]
5.24
[4.37; 9.66]
2.40
[2.01; 3.29]
-1.06
[-1.07; -1.04]
-1.49
[-1.56; -1.46]
Estimates based on dynamic models in table 3. 95% confidence interval
in brackets below point estimate.
When the model is estimated for two separate subsamples, one for highcentralization countries and one for low-centralization countries, we find that
the long-term equilibrium differs considerably for the two subsamples. The
estimated constant is positive for high-centralization countries, and negative for
low-centralization countries. It is statistically significant for both subsamples
and for both dependent variables. This means that the long-term equilibrium
of the trade balance and the current account is negative when wage bargaining
centralization is low, but positive when wage bargaining centralization is high.
Table 4 again shows that estimated equilibrium for the subsamples. The point
estimates differ by 6.33 percentage points for the trade balance and by 3.89
percentage points for the current account. As the confidence intervals show,
these differences are statistically significant.
To illustrate the substantive effect on the dynamics of the current account,
we simulate the equilibration process for low- and high-centralization countries.
In the simulation, we set the starting point of the trade balance at the mean of
the full sample, which is almost exactly 1%. Absent any other shocks, the trade
balances then gradually adjusts to its long-term equilibrium over time through
an autoregressive process. As figure 6 shows, the trade balance of the highcentralization country moves upwards towards the positive, long-term equilibrium, which is denoted by the upper dashed line in the figure. The trade balance of the low-centralization country moves into the opposite direction. It
approaches its negative, long-term equilibrium, which is denoted by the lower
dashed line in the figure.
26
6
Trade balance
-2 0
2
4
0
2
4
6
8
10
Time
High centralization
Low centralization
Figure 6: Simulated equilibration process for different wage bargaining systems; starting value is the mean trade balance in the
sample (1% of GDP); 95% confidence intervals were bootstrapped.
5
Case Study: Germany After Reunification
Although our quantitative evidence is robust, our ability to make causal claims
is necessarily limited if our central independent variable varies only slowly over
time and we also lack a suitable instrumental variable. We therefore follow
Lieberman (2005) and investigate a case “on the regression line” in detail to
provide further evidence of our causal claims. We focus on Germany, as the
country offers unusual within-case variation on our dependent variable over
time. West Germany produced consistent current account surpluses until 1989,
but then experienced nearly a decade of current account deficits. Following a
period of considerable structural adjustment, the now reunified Germany’s current account swung back into surplus. As noted earlier, the relationship between
the current account surplus and the nominal value of the currency is weak. The
Deutsche Mark appreciated vis-á-vis the USD during the latter half of the 1980s,
yet West Germany’s current account surplus continued to grow and peaked at
five percent of GDP in 1989. Given its floating exchange rate, (West) Germany
until 1990 therefore represents the archetypical persistent-surplus economy in
our framework.
What permits us to examine our causal mechanism is the exogenous shock of
German reunification in 1990. Although East Germany’s productivity was only
27
a fraction of West Germany’s level, the Treaty on the Währungs-, Wirtschaftsund Sozialunion, or union of currency, economy and social systems agreed upon
by West German Minister of Finance Theo Waigel and his East German counterpart Walter Romberg stipulated an exchange rate of 1:1 for wages, salaries,
pensions, as well as rents and other regular payments. Savings were exchanged
at par up to 6,000 East German Marks for pensioners, 4,000 East German Marks
for adults and 2,000 East German Marks for children under the age of 14. Critically, at the insistence of West German unions, East German wages would be
adjusted rapidly to about 80% of the West German level, and the West German
collective bargaining system expanded to the newly admitted provinces (Carlin
and Soskice, 1997).
For German Chancellor Helmut Kohl, the introduction of the DM promised
to stabilize the DDR and to allow for an orderly process of reunification, although conveniently, it also secured his re-election in the first pan-German
polls. The president of the Bundesbank, Karl-Otto Pöhl, and leading economists
warned (correctly, it turned out) that this decision would devastate East Germany industry and cause mass unemployment, so that a population exodus was
at best delayed, a prediction that also turned out to be correct. Perhaps the only
workable proposal—to introduce the DM but to delay the levying of corporate
taxes in East Germany by several years—put forth by the leader of the liberals,
Otto Graf Lambsdorff, was quickly swatted down by West German unions and
employers alike (Lehmbruch, 1994).
In consequence, Germany suffered an increase in the real effective exchange
rate of about 20% within five years, coupled with a demand shock that boosted
West German GDP growth to 4.6% in 1990. Overall inflation was low at 2.8%,
but this figure obscured high wage settlements in key industries in West Germany in response to soaring business profits. Recognizing that demand exceeded non-inflationary output possibilities, the Bundesbank raised interest rates
first to 8.5% by the end of 1990, then 9.2% in 1991, and finally 9.5% in 1992.
With the surge in demand subsiding, German employers in East and West
faced wage settlements that either exceeded (in the West) or were wholly unrelated (in the East) to productivity gains. The centralized wage bargaining
system, in which the leading export industries become the yardstick for wage
increases throughout the economy, including the public sector, implied an additional fiscal burden. Unemployment soared to unprecedented levels of over ten
percent, while real economic growth averaged only 1 percent, earning Germany
the title of the "sick man of Europe." The need to fulfill the Maastricht criteria
for public debt and deficits enforced a pro-cyclical fiscal policy and exacerbated
the 1992-3 recession, already the deepest on post-War German history. Since
unemployment insurance in Germany is a payroll tax, rising levels of unemployment also meant greater contributions by employers and employees, which
widened the wedge between gross and net labour costs and further damaged the
competitiveness of German companies.
28
The solid parliamentary majority of the conservative-market liberal CDU/
CSU-FDP coalition responded with several supply-side reforms throughout the
1990s. However, their main thrust was to make labour markets more flexible,
and in particular to increase the number of low-wage jobs to reduce structural
unemployment. Economists frequently proposed an opening of the service sector, in particular the protected crafts, but these reforms were not implemented
until after 1998, when the Green Party-Social Democrat coalition abolished the
requirement of a “master craftman’s” certification, and even then only for a
limited number of professions including brushmakers and tilesetters. In particular within the ostensibly free-market FDP there was considerable resistance
against eliminating barriers to entry into these occupations, especially during
times of high unemployment. This is at least anecdotal evidence in support of
our interpretation of a political coalition that combined wage compression with
service sector protection. If implemented, the macroeconomic effect of such reforms would have been a decline in the savings rate relative to consumption, an
approximation to the Anglo-Saxon countries, and hence make current account
surpluses even less likely in the future. This is not, however, what materialized.
Instead, faced with a relatively loss of competitiveness, of which the unprecedented current account deficit close to 2% was emblematic, German employer associations sought lower wage settlements. This reflected the usual conditions of coordinated wage bargaining, in which wage increases are primarily
related to the price signals that firms receive from international markets, as we
outline above. In Germany, the metalworking sector unions and employer associations representing globally oriented machine tools and vehicle industries set
the pace for the rest of the economy (Iversen, 1999, 160), which in the 1990s
meant that real wage increases were ruled out if employment was to be preserved. Moreover, the role of “works councils” consisting of representatives
of unions and employers increased, as firms and employees sought consensual
decisions on wages relative to productivity (Carlin and Soskice, 2009, 72).9
Nonetheless, as the German wage bargaining system rests on considerable
union strength, it took time for information on international competitiveness to
feed through the system. Manufacturing employment decreased by almost 15
percent between 1991 and 1994 (Carlin and Soskice, 1997, 61). The last excessive wage settlement (from the point of view of an appreciating real exchange
rate) was reached in February of 1995 after a two-week strike in the metalworking industry. Only in 1996 did the two-year collective agreement lock in
considerable wage moderation in exchange for job guarantees, a bargain praised
by employers and IG Metall (the metalworking union) General Secretary Klaus
Zwickel alike. In addition, employers and unions struck "Pacts for Employment
9 Note
that works councils do not bargain over wages or employment conditions, but they
play a crucial role in facilitating the information flow between management and unions, since
works council representatives on the company board have access to all the firms’ accounting
data.
29
and Competitiveness" (betriebliche Bündnisse zur Beschäftigungs- und Wettbewerbssicherung). More than half of these agreements in the 120 biggest German
manufacturing companies entailed income cuts and retrenchment of bonuses,
and in many cases longer working hours (Hassel and Rehder, 2001, 8). Remarkably, many companies increased employment in Germany and abroad in
their overseas subsidiaries around the same time (Deutsche Bundesbank, 2006),
as enhanced competitiveness at home also benefited subsidiaries abroad through
supply-chain effects.
These developments are evident in the evolution of Germany’s real exchange
rate and the current account as shown in Figure 7. The wage compression phase
that began in 1995-6, shown in the upper panel, helped reduce the real exchange
rate by almost 40%. The Germany current account shown in the lower panel
moved from close to -2% to a historical high of 7.5% between 2000 and 2007,
even though the Euro appreciated over 44% against the USD over the same
timeframe. This underscores that the link between the nominal exchange rate
and the current account balance is tenuous. In fact, much of the increase in
Germany’s real exchange rate after 2003, despite ongoing wage compression,
may be attributed to movements in the Euro’s external value.
Currrent account (% of GDP)
PPP/XR of GDP output, USA in 2005=1
Figure 7: Germany’s real exchange rate and current account balance,
1976-2010
Real Exchange Rate
1.2
1.0
0.8
Wage compression phase
0.6
0.4
1980
1990
2000
2010
2000
2010
Year
Current Account
7.5
5.0
2.5
0.0
1980
1990
Year
The German case therefore provides direct evidence of our central claims.
Countries with centralized wage bargaining institutions tend to run persistent
30
current account surpluses in their institutional equilibrium. Given an exogenous
shock to competitiveness, the same institutional mechanism also allow for wage
compression that restores competitiveness and thus moves the current account
back into surplus. The consequence is, of course, that such countries must export their way out of recessions, since wage compression delays an increase in
domestic demand until export earnings feed through the economy.
6
Conclusion
This paper sheds new light on the origins of international financial imbalances,
notably current account deficits and surpluses. These imbalances are often mentioned among the most important determinants of international financial crises
and therefore present one of the most urgent policy problems of the current
liberal world order. In this debate, analysts often see surplus and deficit countries as mercantilists or overspenders (or both), who manipulate exchange rates,
promote too little or too much consumption or too much or too little savings.
Although the studies identify very different policies as decisive , a common
theme of all analyses is the focus on short- or medium-term policies that the
government could modify at any time.
As our paper emphasizes, such imbalances are not a temporary phenomenon,
but have been characteristic of the international economy for a very long time.
To account for these highly persistent current account deficits and surpluses, we
concentrate on the long-term effects of the domestic political-economic system,
which determines how relative prices among OECD economies evolve. In short,
countries with a more centralized wage bargaining system are able to moderate
price changes in response to economic shocks more effectively than countries
with a more decentralized system. This means that a continuously slower increase in relative prices translates into a favourable trade balance and therefore
current account when the wage bargaining system is more centralized.
This theoretical logic implies that economic developments, which are often classified as mercantilist, are not the result of specific, short-term policies
that a government chooses on a day-to-day basis. Instead, they have their origins in the deeper differences in domestic institutional setups among countries,
which facilitate or impede the government’s opportunities for a mercantilist economic strategy. In that sense, current account imbalances are “built-into” the
international economic system, in which countries have complementing roles
as creditors, debtors, producers and consumers in economically tranquil times.
Problems arise when this variety of institutions is amended with a rigid international institutional framework, like the Euro system, which ignores the distinct
adjustment capacity that each domestic institutional setup has.
31
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