Much has been said in the debate surrounding the stimulation of economic growth. There is clearly an equity/efficiency trade-off, but many commentators reach differing conclusions about the nature of this trade-off or where societies should land. Amongst ever more prevalent government deficits and stagnant growth, a premium has been placed on economic policies which provide stimulation and minimisation of equity concerns. Aggregate supply and labour market reforms have often been offered as a solution. However, the empirical results of such programs have not provided definitive conclusions but have rather served to inform the debate between austerity and fiscal stimulus, which continues to this day. The contrasting experiences of Germany and Greece serve as good examples of this trend. For the purposes of this chart, the UK serves as a helpful benchmark from which to analyse the developments at both the top and the bottom of the EU spectrum of labour productivity and market reforms.

What does the chart show?

The series plotted on the chart represent gross domestic product per hour worked, measured in nominal US Dollars for Germany (Blue), the United Kingdom (Orange), and Greece (Grey). GDP per hour worked is a measure of productivity focusing on labour inputs. GDP is divided by total hours worked in an economy and the result is a measure of the marginal productivity of one hour of labour. Labour productivity can be affected by numerous variables. Prominent factors which augment labour are human capital (skills), technology and access to appropriate capital goods (machinery). Even though it is a helpful measure of productivity, it is because of these augmenting exogenous variables that GDP per hour worked only reveals a partial narrative in terms of productivity and its contributing factors.

Why is the chart interesting?

Implemented in early 2005, the German Hartz reforms were a controversial change in Federal Employment Agency practices which saw unemployment benefits reduced and the nature of job-finding and employment contracts altered – the overall goal being the decrease of real wages and increasing employment. As a result of these reforms, it was hoped that the German labour market would become more robust, boosting production as well as decreasing costs to firms. Theoretically, this would result in greater consumption of German goods domestically and internationally. Overall, these reforms have been regarded as successful by many economists and other experts. In the wake of the reforms, the job finding rate increased, driving down unemployment to the lowest levels in decades. Indeed, the German labour market was so robust that it was able to effectively ride out the recession. The unemployment rate temporarily rose by around 1% before continuing its decrease, recovering much quicker than other prominent western economies. Among larger indicators, economic growth has remained strong vis-à-vis other western nations. Impressive German economic performance is often attributed to goods production and strong exports. The Hartz labour market reforms seem to have contributed greatly to this, as a decrease in real wages alongside an increase in labour supply allowed firms to simultaneously decrease the relative prices of their goods and increase production. This contributed to the creation of a very competitive, robust goods-driven economy. With the increase in overall work hours compounding a rising GDP; the measure of GDP per hour worked has displayed strong growth for Germany post-2005. In general, from an employer and growth perspective; the reduction in worker protections and the rollback of the safety net did much to improve the German labour market and labour productivity.

Given this apparent success, the effective implementation of these sorts of policies elsewhere should stimulate economic growth without having to resort to costly fiscal stimulus packages. Following the Greek Debt Crisis, as a condition of continued bailout support, the so called ‘Troika’ of the ECB, the IMF, and Germany required that Greece implement similar labour market reforms in order to increase aggregate supply. Many experts believed that the Greek labour market had become widely stagnant due to overbearing union action, employment protections and higher than competitive wage rates. Another issue identified by the Troika was a level of public spending they deemed wasteful. When Greece accepted its bailout package, it committed to a host of labour market reforms such as lowering the minimum wage, reducing employment protections, reigning in unions and drastically reducing public spending. It was thought that this would have a similar effect as in Germany a decade earlier. Troika leaders touted increases in productivity and an increase in export competitiveness as allowing Greece to ‘save itself’ from depression through production of relatively cheaper goods for export and domestic consumption. In the wake of the reforms, total hours worked in Greece increased to well above the OECD average due to lower labour costs and decreased levels of social insurance. Real wages also fell substantially, allowing firms to take advantage of lower labour costs and decrease the prices of their consumer goods. However, GDP has not seen the analogous increase, leading to the continued erosion of the measure as displayed in the chart. This runs contrary to the results from the German reforms and, coupled with a rise in poverty rate to 40% among other profound social costs, has elicited harsh critique from some commentators.

Many point to the phenomenon of debt deflation as contributing significantly to the failure of such policies in Greece. It is not insignificant that Greece was in the midst of a large public and private debt crisis when the bailout deal was reached. Not only did the government have a high level of debt-to-GDP, but many citizens were also heavily indebted, outweighing a relatively smaller proportion of net savers in the economy. If the intention of aggregate supply reforms were to stimulate the economy through falling prices, debt becomes a key factor. This is because any fall in the real price level and in real wages, increases the relative size of all debt burdens. Savers will be better off under these conditions, because their savings can go further in terms of the quantity of goods they can purchase. Contrastingly for those in debt, the burden begins to loom larger and becomes harder to pay off in real terms. Following the reforms, a Greek worker would have to work more hours and a Greek producer would have to sell a larger amount of goods to overcome the same debt burden. Since debtors consume more on average than net savers (and there were relatively more debtors in the Greek economy), their larger debt payments meant that the net effect of the aggregate supply reforms was a reduction in consumption. This plunged the Greek economy further into recession, the opposite of the intended effect of the bailout package requirements. The overall effect is now known as a ‘debt-deflationary spiral’. Falling prices lead to a decrease in spending due to an increase in the real value of debt and debt payments. Decreases in spending lead to a reduction in GDP. A reduction in GDP then leads creditors to enforce ever more severe austerity measures and aggregate supply reform. This again leads to falling real wages and prices, restarting the cycle.

If anything is to be learned from the contrasting experiences of Germany and Greece, it is that there is rarely a policy in economics which is always correct or universally applicable.

Week 11, 2019

Posted by Aimée Allam