Friday, March 26, 2010

Why Christine Lagarde is right about Germany

Greece’s recent fiscal travails have, slightly unexpectedly, thrown the spotlight on Germany’s current-account surplus. In mid-March, France’s finance minister, Christine Lagarde, urged Germany to do more to boost domestic demand – a call echoed by the European Commission’s president, José Manuel Barroso. The German government and media are bemused and indignant. How can it be, they ask, that corruption and profligacy in Greece has turned in to a trial of German discipline and rectitude? Anyway, what right do French politicians – and, for that matter, Anglo-Saxon commentators – have to lecture Germany? Wouldn’t they be better advised attending to their own countries’ manifold economic problems?

On one thing, everyone agrees. Germany’s current-account surplus is vast. In 2009, it amounted to $169 billion – or 5.2 per cent of German GDP. In absolute terms, this was the world’s second largest current-account surplus after China’s. Measured as a share of GDP, Germany’s surplus was even larger than China’s. A number of countries have even larger external surpluses relative to the size of their economies than either China or Germany. These include European states like Sweden and Switzerland, Asian ones like Malaysia and Singapore, and oil-producing countries like Norway and Saudi Arabia. But because the absolute size of their surpluses is larger, China and Germany have inevitably attracted the most attention.

At issue is what these current-account surpluses represent – and what, if anything, the countries that run them should do about them. Many policy-makers and commentators in Germany believe that their country’s external surplus reflects the ‘competitiveness’ of its economy. A Bundesbank official likened Germany to a country holding top spot in a football league. Pursuing the same analogy, Germany’s finance minister, Wolfgang Schäuble, said it would never occur to him to ask an opposition team to weaken its side to make life easier for the one he supports. And the FT Deutschland’s response to British commentators who expressed sympathy with Lagarde’s position was to ask what on earth Germans were being expected to import from the UK: Walkers crisps, Doc Martens boots or Marmite?

A few years back, a former chief economist of the OECD, David Henderson, coined the term “do-it-yourself (DIY) economics” to describe “firmly held intuitive economic ideas and beliefs which owe little or nothing to textbooks, treatises or the evidence of economic history.” DIY economics, Henderson believed, was ubiquitous. It was as likely to inform the world view of political figures, top civil servants, chief executives, commentators and eminent professors as that of the general public. DIY economics remains as prevalent as ever, as recent German responses to Lagarde’s intervention surely prove. These responses are permeated with assumptions and beliefs that sound plausible to the uninitiated, but are just flat wrong.

The most pernicious of all – because it is the source of so much nonsense – is the tendency to think of countries as if they were companies, and of trade balances as if they were profit and loss accounts. The German economy, on this view, can be thought of as if it is Volkswagen. And its trade surplus shows that Germany is winning the ‘battle for global market share’. But it takes only a moment’s reflection to realise why this is an absurd way of thinking about the matter. One of the world’s most productive economies, the US, runs a large external deficit, while some of the most dysfunctional and least productive, from Russia to the Democratic Republic of Congo (DRC), run surpluses. No one is surely suggesting that the US should make itself more ‘competitive’ by emulating the DRC.

Far from being signs of external strength, countries’ current-account positions can be symptoms of domestic weakness. And here’s the rub. Many of the countries that have run large current-account surpluses over the past decade have suffered from weak domestic demand. One of these countries is Germany. If it had been a closed economy, it would have been in a prolonged slump. As it was, Germany was rescued by the profligacy of foreigners. Between 1999 and 2007, 70 per cent of the growth in its GDP was accounted for by net exports. However, the foreigners that kept the German economy afloat are now mired in debt. In many countries, households and governments are over-extended and need to ‘deleverage’. The question now is whether Germany accommodates this process or resists it.

For the time being, the German government shows every sign of resisting it. It rightly urges the deficit countries to become ‘more German’. But it fails to recognise that this is an impossible task if Germany does not become ‘less German’. This does not mean, as Wolfgang Schäuble claimed, that Germany is being asked to reduce the quality of its products so that other countries can ‘compete’ (a ludicrous move that would only lower the living standards of foreigners who bought German products). It does mean that fiscal consolidation and private-sector deleveraging in previously profligate countries must, as a matter of arithmetic, be accompanied by a fall in Germany’s external surplus. The odd thing about Germany’s domestic debate is that few politicians or commentators seem to recognise this.

The notion that trade and current-account surpluses are badges of economic success is deeply pernicious – not just because it is false, but also because it damagingly portrays international trade as a zero-sum competition between countries. The world economy suffers from huge macroeconomic imbalances that need to be corrected. It should be obvious that this cannot happen if countries like Germany (but also the Netherlands and Sweden) are not prepared to allow their external surpluses to decline. Germany was not to blame for the recklessness of countries like the UK. No-one is asking it to reduce the quality of its excellent manufactures. But Germany must stop fetishising its trade surplus and accept that the chronic weakness of its domestic demand is a problem for itself and the world economy.

Philip Whyte is a senior research fellow at the CER

Tuesday, March 09, 2010

What should NATO’s new strategic concept say about Russia?

by Tomas Valasek

Since the fall of the Berlin Wall, NATO has strived to reduce mutual suspicions with Russia and to build a more co-operative relationship. So it is vexing that 20 years on, Russia continues to view NATO as a hostile alliance. Moscow competes with NATO for influence in Eastern Europe, it seeks to halt NATO’s eastward enlargement and its recent security proposals for a new European security architecture were aimed in part at weakening NATO's role in European security. Moscow’s policy worries the Central European members of NATO, who have been demanding that the alliance draft defensive plans for the unlikely, but not unthinkable, possibility of a conflict with Russia.

The alliance's new strategic concept - its key guiding document, an update of which is due in the autumn – will not fundamentally change Russia's views. But many speakers at a recent seminar which the CER co-organised with NATO's public diplomacy division concluded that the document could be instrumental in unifying the allies' views on Russia, and in clarifying NATO's intentions towards Moscow.

The document should make two important points regarding Russia, several speakers argued. The first message is one of reassurance to the Central and Eastern European members of NATO who worry about Russia, especially after the war in Georgia in 2008. Their anxieties are eroding solidarity in NATO. Some are seeking bilateral security assurances from Washington in the form of US bases on their territory - but this would leave the 'have-nots' more vulnerable than the ‘haves’. It would therefore be better if the strategic concept sent a clear message that the alliance's mutual defence clause – Article V – remains as valid as ever. NATO should also underpin this message with the minimum necessary military planning and exercises.

The second message concerns Russia itself. No NATO ally wishes a conflict with Russia – least of all those on the alliance's eastern fringes, who know they would be more secure if Russia enjoyed a co-operative relationship with NATO. The alliance has repeatedly made this point in its communiqués, to little avail. But some speakers at the CER seminar argued that NATO should try again, and that this time the allies should go for a full ‘reset’: that is, tell Moscow that NATO is open to Russian membership, should it decide to join and meet the accession criteria. This would allow the Russian military – historically focused on a possible conflict with the West but now in the midst of deep reforms – to pay greater attention to the far more real threat of terrorism on its southern border, in the North Caucasus. It would also strengthen the hand of those in the Russian government who argue for an economic and political modernisation of Russia and for a closer relationship with the West.

In essence, NATO would follow a two-pronged approach: showing strength and solidarity vis-à-vis Russia but, at the same time, sending a message of inclusiveness to Moscow. The idea is not novel; the alliance pursued a similar ‘dual track’ approach for most of the 1970s and 1980s. But would it work in this day and age? Can the twin messages of reassurance and reset be reconciled?

Several speakers at the CER seminar argued for a positive answer, though they acknowledged the difficulties. The Russian government would view any new reassurance measures such as military exercises in Central Europe as a sign of ill intent. That would weaken the effect of any positive words the strategic concept may have for Russia.

Other speakers emphasised that reassurance measures should calm the relationship. By increasing solidarity among the allies, NATO would take away the opportunities – and the incentives - for the Russian government to pit one NATO member against another, as it has been doing in recent years. Moreover, reassurance measures would make the new allies feel more secure and therefore more willing to support a bold new outreach to Russia. Reassurance, several speakers said, is a precondition for reset.

Would a message of inclusion change Russia’s view of NATO? It is a tall order: the newly released Russian military doctrine calls the enlargement of NATO the most significant danger to the country's security. The Russians seem more and more concerned about NATO; the number of those worried about a conflict with ‘a major country’ – presumably western – has increased 12 per cent year-on-year in 2010 in one respected poll (though this could also reflect rising anxiety about China).

NATO’s ability to change this mindset is limited. The alliance carries so many negative associations in Russia that its capacity to aggravate tensions far outweighs its ability to induce positive change in Russian thinking. Nor is it obvious that the current government in Moscow is unhappy with the current situation – as one speaker at the seminar suggested, it suits some Russian elites to paint NATO as an enemy: doing so stimulates nationalist sentiment that may strengthen public support for the government.

Even so, a clear offer of reset from NATO could bring long-term benefits. The economic crisis has made Russia less certain and self-assured. While the regime is too inflexible to change in the short term (as Katinka Barysch argues in her recent CER policy brief, it also seems more introspective than at any time since the boom years of the mid to late 2000s. As Dmitri Trenin argues in his recent study http:// today’s bluster often hides uncertainty about the country’s economic and political future.

To overcome the mistrust between NATO and Russia, the country’s leaders would have to rethink some of the most fundamental bases of their foreign policy. NATO by itself cannot bring about that change. But it can create space for Russia’s independent thinkers and for the more reform-minded parts of the government to entertain the possibility of a future without a hostile relationship with the West. That could be a significant benefit of NATO’s new strategic concept carrying a message of reset.

Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.