The European economy seems to be at a turning point. In the aftermath of the Great Recession, the member states of the Eurozone, especially those in the periphery, are trying to develop and deploy growth strategies in order to press the starting button for economic recovery. This is certainly not an easy task. In the first place, policy makers in these countries face the task of correctly identifying why their economic model lost ground or even collapsed outright. As discussed in our previous dispatch, most economists now agree that the underlying cause of the Eurozone crisis was the preceding decline in productivity and competitiveness in periphery countries, as manifest in large asymmetries in current account balances (i.e. largely exports minus imports). Our second review of current debates among economists (in this case, of scholars in the political economy tradition) focuses on growth models.
The varieties of capitalism school, and its limits
Scholars in the Varieties of Capitalism school of thought have tended to see the way the Eurozone crisis evolved as an inevitable consequence of the inherent differences in the organization of the domestic political economies of core vs. peripheral member states. Northern economies are better equipped with institutional arrangements (wage bargaining, education and training, and so on) that allow them to operate export-led growth strategies successfully. On the other hand, southern countries lack the kind of institutions conducive to productivity and competitiveness at the disposal of their counterparts. Before the creation of the single currency, their demand-led growth model often led to inflationary pressures. Unable to address the resulting loss of competitiveness by rebuilding their political economy institutions in a sustainable fashion, countries like France and Italy (and Spain and Portugal, let alone Greece) had no other option than frequent recourse to devaluation. Since the introduction of the euro, even where national governments refrained from following an expansionary fiscal policy (as e.g. in Spain), cheap credit flows from the North, where trade surpluses had built a savings glut, fuelled the expansion of domestic demand.
This account, however persuasive, is vulnerable to the criticism of paying excessive attention to the supply side. Domestic demand may actually play a more significant role in stimulating high growth, and do so without necessarily damaging a country’s export performance. As Baccaro and Pontusson have pointed out, the crucial distinction is whether domestic consumption demand is wage-led or credit-financed. The authors’ research compares Sweden, Germany, Italy and the United Kingdom before the onset of the crisis. They find that in 1994-2007 growth in the UK was consumption-led, with household consumption financed not only by credit but also by rising real wages. In contrast, exports contributed significantly to the growth of both Germany and Sweden. However, these two countries diverged significantly with respect to the role of household consumption: Germany relied on the repression of wages and household consumption in support of an export-led economy, while Sweden represented a hybrid growth model, combining robust consumption growth with export growth. As for Italy, the authors view it as proof that “there is nothing inevitable about countries finding substitutes for the Fordist wage driver. The Italian case illustrates […] that persistent stagnation is always an option.” (187)
Baccaro and Pontusson argue that for wage-led growth to be compatible with a high export performance, demand for the goods the country in question exports must not be price sensitive. It is worth quoting their summary of the evidence they have presented:
German growth in 1994–2007 was pulled by manufacturing exports and that German exports were quite sensitive to relative price differences with international competitors. Germany exemplifies a manufacturing-based, export-led growth model, which depends critically on keeping domestic costs down and hence on repressing domestic consumption. At the other end of the spectrum, the United Kingdom represents a consumption-led growth model. Exports do not constitute a large portion of British GDP and the high-end services in which the United Kingdom has a comparative advantage are not very price-sensitive. Thus consumption-led growth has not constrained the expansion of British exports. Sweden in the period 1994–2007 can be characterized as a distinctive model in which exports and household consumption both contributed significantly to overall growth. This growth model involved—and, we believe, critically depended on—an ongoing shift toward greater reliance on exports of high-tech manufacturing and high-end services, making Swedish exports, overall, less vulnerable to price competition than German exports. Finally, Italy resembles the German case in that its exports are price-sensitive and domestic consumption grew very sluggishly from the early 1990s onward. In contrast to Germany, however, Italian export industries failed to make sizable gains in world-market shares. The reasons for this failure arguably have to do with Italy’s sectoral specialization in labor-intensive manufactures, the emergence of new competitors in these industries, and the negative consequences of Eurozone membership for the ability of Italian producers to compete on the basis of price (191-92).
In a paper rich with ideas, they point out that “consumption-led growth is more likely to boost real wages than export-led growth, [and] this holds particularly for the wages of low-skilled workers” (194). This demonstrates that growth patterns have political implications. In countries with export-led models, core constituencies—regardless of their ideological orientation—will be keen to support governments that opt for restrictive policies to boost cost competitiveness. In contrast, in countries with demand-led growth models, core constituencies will vote for political parties that pursue expansionary policies to stimulate demand.
Baccaro and Pontusson maintain that their research poses a serious challenge to the Varieties of Capitalism tradition. In their response, Hope and Soskice defend that tradition by viewing the growth models approach, vital to the contribution of Baccaro and Pontusson (whose significance they acknowledge), as “supporting recent developments in varieties of capitalism rather than undermining them” (211). They insist that coordinated market economies “are driven strategically by export orientation”:
[A] large proportion of high-value-added employment comes directly and indirectly from the export sector. The success of the export and related high-value-added sectors depends on research and development in knowledge-based companies, on close two-way links with the technical university and research systems, and on the system of vocational training at all levels, including increasingly the tertiary. Equally, the success of these systems depends on the capacity of the export sector to meet long-term profitability goals, especially as the cost of product and process innovation increases. This is a powerful and central positive feedback system in which the successful and growing knowledge base and accumulated skill formation are core drivers of exports, and in which success in export growth is critical—via the resources it provides for advanced companies to make the necessary investments in the relevant systems—for high levels of research and skill formation (214).
Hope and Soskice go on to examine the argument about price sensitivity, and find it wanting. Specifically, their data show that, while cost competitiveness improved in Germany during the period, price competitiveness did not, suggesting that German firms used their cost savings to support investment and innovation rather than cut prices. Crucially, most of that investment actually took place outside Germany: “While German domestic investment languished over the sample period, German investment in production facilities in Central and Eastern Europe grew rapidly, creating approximately 700,000 new jobs in the area (216). They wrap up by neatly reiterating a key insight from the Varieties of Capitalism approach:
The comparative political economy literature has underlined the interdependence of growth models during the sample period, both within the Eurozone and in the wider global economy. The growth models were indeed deeply symbiotic; the consumption-led economies bought goods from the export-led economies and the export-led economies encouraged this spending by lending freely to the consumption-led economies. The current account imbalances that emerged during the sample period reflected the flow of goods and capital between countries. The consumption-led, current account deficit countries received net inflows of goods and capital from the rest of the world, whereas the opposite was true in the export-led, current account surplus countries (222).
This debate provides an interesting angle from which to view the apparent inability of European policy makers to come up with an effective and coherent response to the crisis. Since each government is committed to a different growth model, and conditioned by the preferences of domestic constituencies to promote a different policy response, compromises between member states will be difficult to achieve. Meanwhile, the quest for a sustainable recovery in the Eurozone continues. For more on how the relevant debate among economists evolves, watch this space.
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Also published on Medium.