Stiglitz contra Merkel

profil (Austrian weekly): The debt brake advocated by Angela Merkel and Nicolas Sarkozy is the wrong way?

Stiglitz: Yes, absolutely.

So speaks Joseph Stiglitz, Nobel laureate and former economic advisor to Bill Clinton. The recipe is amazingly simple. If a patient is in danger of dying from hunger or thirst you will provide him with eating and drinking. Obviously we don’t need to be enlightened by a chief economist to find such an advice quite convincing.

Joseph Stiglitz takes his position with customary verve and he may count on many partisans. Greece’s economy is strangled by drastic cost-cutting measures. In Italy, real estate taxes, VAT on everyday consumer goods, gasoline taxes etc. have increased dramatically. The working population is bled with increasing severity. Nevertheless, these measures proved to be largely inefficient: The “Spread” – that is the higher interest premium on Italian government securities in comparison with German ones – has again risen. The government of Mario Monti, in its early days still celebrated as a great agent of reform, is now held by many Italians responsible for the strangulation of their country. Economic growth is simply not in sight. The Italian economy continues on its path of decline.

Even more dramatic is the economic decay of countries like Hungary, Spain and Portugal. The austerity measures imposed by Merkel and Sarkozy drive these countries in leaps and bounds towards economic abyss. „With its austerity plan Europe heads towards suicide,“ says Stiglitz, „it’s the wrong sequence: First there must be growth and afterwards deficit reduction. Austerity will not work. There is no single instance where a large economy has been successful with savings programs.“(1)

Does Angela Merkel, the German chancellor, lightheartedly direct Europe towards economic suicide, by forcing the southern periphery to enact a policy of radical austerity?

The beneficial effect of investments – a truism

The accusations of Joseph Stiglitz against the German chancellor seem quite obvious at first sight, because everybody knows that a hungry man needs food and a thirsty one needs water. A sick company may be rescued by good investment – and this is quite true for states as well. If these use the capital of savers in a judicious way they may produce growth that largely exceeds the invested amount. This is a basic fact of industrial economics as proved by the last two hundred years. As such it is known to laymen as well as to economic laureates.

The benefits of investment – a conditional truth

Like most too simple and too obvious truths, it needs qualification. It only applies to wise and proper investment. For fifty companies that are successful with their investments, you will find at least an equal number that squandered the money of investors. And for a single state investing loans advantageously you will get at least a dozen ones who fail because of over-indebtedness as they did not make forward-looking investments but only financed political gifts and social benefits. I guess it is more than just angry voices whispering for quite a time already that our European welfare state was built largely on borrowed money.

The countries of the South already had their chance!

Unfortunately, Joseph Stiglitz when recommending generous investments in southern States (to be paid mostly by Germans), omits an important fact. He seems to forget that his therapy is by no means new. It was already largely practiced since the time when the Euro was introduced. As long as the Mediterranean countries still had their own currencies they had to pay high interests to get credit. This changed entirely once they got the common currency, for then credits were lavishly showered on them at almost no cost. For several years they enjoyed exactly those conditions that Stiglitz now recommends to resolve the crisis. Cheap investment capital form the North flowed into the southern periphery.

At that time Stiglitz’ therapy already proved to be wrong

The outcome is no secret. But it is not at all the one envisaged by Joseph Stiglitz. This lavish flow of money and the debt caused by it are at the bottom of Europe’s present malaise. For those funds were not invested wisely and properly. So they they failed to produce any significant growth. The crucial condition for the success of meaningful investment has been neglected.

Can we simply put aside this failed first experiment and decide that the North should embark on a second one, blessing the European South again with the cornucopia of cheap credit? This is what Stiglitz has in mind. Or should, as others think preferable, the common European Central Bank ECB provide them with fresh money through Euro Bonds? (2)

It seems to me that Joseph Stiglitz did not really convincingly answer those questions though they are crucial issues for the future of Europe. Why does he assume that cheap money will be invested wisely and correctly this time? Previously, southern countries behaved just like a bad company: They largely squandered the money entrusted to them. What reasons make Stiglitz believe that this time they will miraculously embark on the path of growth instead of merely accumulating bad loans?

Even Italy is about to collapse

Such a miracle seems rather doubtful. After all, even a „technical“ government composed of economic experts like that of Mario Monti seems quite incapable of liberalizing the Italian economy in order to lay a foundation for greater competitiveness. This inability to reform raises serious questions. If even Italy, economically by far the strongest state of southern Europe, a state furthermore led by a government of experts, is unable to achieve a breakthrough, how do we dare hope that countries such as Spain and Portugal will flourish as soon as Germany again looses the strings of its purse? This hope is based on wishful thinking, which is no more convincing by the fact of being upheld by a Nobel laureate.

Either cheap money or dire austerity?

However, those who doubt that Stiglitz’ recipe of the redemptive power of money will produce a turn in European affairs do not necessarily approve the politics of austerity as demanded by Germany and international creditors. „Anglo-Saxons simply reject this policy as sheer madness. This procedure has been adopted because of German pressure,“ writes the Handelsblatt. (3). If not A, then B – that is the logic of short-sightedness. As far as I look, I do not see any economists advocating anything else besides these two textbook alternatives. Either harsh methods of austerity are required, „in order to appease the markets“ (so that investors get their money back) or fresh money is hailed as the real solution. This money should come directly from German taxpayers or from the ECB’s printing press (where again Germans shoulder the heaviest burdens as in the course of time their savings will be devalued).

Or rather cheap money plus austerity?

Of course you may also combine the two. The elites of Europe, led by the European Commission in Brussels, favor a mix of both therapies. They have obviously realized that borrowed money does not produce growth unless invested wisely and correctly. So they look at that part of the Union, where investments are the most successful: They look at Germany. There, the two approaches were simultaneously in use. On the one hand, German industries opted for growth-enhancing investments, that’s what bestowed innovative strength on the leading industries of the country. On the other hand, the so-called Agenda 2010 initiated by German Chancellor Gerhard Schröder, forced harsh austerity on Germans. Had Germany not thus reacted to competitive pressures exerted by the emerging Asian countries, it would still be the „sick man“ of Europe. Only because and only after Gerhard Schroeder imposed this drastic cure on the German economy, did the „sick man“ turn again into a successful exporter. Austerity combined with fruitful investment was the tandem, to which Germany owed its amazing recovery.

Should and can the German model be imposed on the rest of Europe?

Austerity and wise investments – that seems to be the policy to drag Europe out of its present quagmire. But how do we ensure that southern countries when enjoying a second round of cheap money, will act much more responsible than before? In other words, how do we solve the main problem of right and good investment? Germany being the main source of money, will it send its commissioners not only to Greece, as it does at present, but will they soon swarm out to Italy, Spain and Portugal as well so that Germans can be sure that their money is used according to their wishes? The response to such paternalism will not be long in coming. In Greece, Angela Merkel is already depicted with a Prussian-type spiked helmet. Hatred is cooking up against the German taskmasters. If we want to destroy Europe, the surest way to do this is certainly to make it obey to German demands – no matter how well intentioned the latter may be.

Problems for which there is no (conventional) solution

Mathematicians long know about certain equations for which there is no solution by any existing method. Economists should finally realize that this is also true for the field of economy. There are problems which resist all ready made solutions of previous economic wisdom. Rigid austerity may kill an entire economy leaving it a shamble for years. However, in a majority of historical cases cheap money is just as dangerous. Instead of producing growth it burdens a nation with ever growing indebtedness which in its turn makes creditors call for rigid austerity… and so on and so forth. And this dilemma applies to a mix of the two cures as well. For economic science has all but overlooked a basic truth: In specific situations, wise and good investment will simply be impossible!

No future for southern states under present conditions

This case is far from theoretical; in Europe we are just now confronted with a similar emergency. In the southern periphery the potential for wise and proper investment is virtually exhausted. Or should investors go to Greece or Italy dumping their money in traditional or low-tech industries like the textile sector? Certainly not. These branches already died quite a time ago as a result of competition from Asia (I don’t count the competition from Eastern Europe as it doesn’t make Europe as a whole any poorer, but only contributes to a more even distribution of wealth within Europe itself). Portugal enjoyed a viable textile production, but it was almost completely destroyed because of the liberal economic policies of the European Union. The large-scale destruction of traditional low-tech industries applies to the whole of Europe, and for a common reason. Germany may not sell its high-tech products to Asia, especially to China, unless it accepts payment in low-technology goods. For China cannot pay with raw materials (apart from a few exceptions such as Rare Earths). It is therefore no exaggeration to assert that the destruction of traditional industries in southern Europe is a direct and inevitable effect of German industrial policy.

Let Greece or Portugal invest in advanced technologies!

Under the prevailing conditions of international competition traditional industries once destroyed have certainly no chance at all to be reborn in Southern Europe. Even in Germany itself, they largely disappeared. All attempts to use cheap money in order to revive non-competitive branches would only cause further bad investments and lead to still higher indebtedness. Cheap money would not alleviate Europe’s plight, but make it still more intractable.

And what about the alternative to low-tech industries? Will low-interest loans from northern Europe or cheap money from the ECB lead to good and wise investment provided it is used to establish high-tech enterprises in places like Greece, Portugal or Hungary?

The innovative backwardness of the South

I think an important fact should be stressed at the outset. Even Germany has to incur utmost efforts in order to stand up to international competition. Its industries will remain competitive only if they continue having a clear innovative edge. Cars, airplanes, machine tools, chemicals and pharmaceutical products have long since been produced in Asia as well and they too are sold on world markets. With its own offer and assortment Germany will be successful only if and only as long as it offers either better quality or equal quality at lower prices. But this outlook is rather doubtful if we look into the future. Given the increasingly rapid imitation of existing products subsequently dumped into markets by low-cost providers which furthermore rely on a nearly unlimited workforce, it seems unlikely that Germany will retain its current advance for more than a quite limited time.

If this is true for Germany, how much hope is there for countries like Greece, Portugal or Spain to catch up in terms of high-tech industries?

Conditions for innovation

And there is still another crucial factor to be reckoned with. In order to produce highest quality, a country needs an army of well trained engineers and researchers who have gone through a highly developed education system, the latter having grown over several decades. Now, the quality of such men and of such an educational system may at least approximately be gauged by the number of patents submitted. In 2009, Germany produced 209 patents per one million inhabitants, Switzerland as many as 492. Italy only achieved one-tenth of this value, namely 45, while France occupies a rather modest position with 118 innovations. Greece, Portugal and Spain produced 3, 2 and 8 patents respectively. In terms of innovative strength they are virtually non-existent. But with 233 patents to its credit Japan is already overtaking the Germans in innovative force. And China, which in all respects moves in the footsteps of its Asian neighbor, has already secured for itself an enviable place as number six on the global scale of patent output.

In light of such figures it is hard to agree with economist Joseph Stiglitz that investments – even in advanced technologies – will in any way improve the situation of the southern countries within the next few years. Of course, there is a fundamental difference in behavior between people and physical bodies. The course of the stars may be accurately predicted, the future of individuals and nations will never be calculated in a mechanical way. No one can rule out the possibility that one hundred years from now Germany will be reduced to an agricultural country while Greece will be the most innovative state on earth. Nevertheless, one thing may be said with a probability verging on absolute certainty. Within the next decade, that is during the very lapse of time when the European Union may be destroyed by the current crisis, this will certainly not happen!

The recipe prescribed by Stiglitz will bring no relief to the patient

The preceding considerations are equally devastating for an approach à la Merkel and Sarkozy as for a recipe according to Joseph Stiglitz. As far as the southern periphery is concerned, we may not expect right and good investments, leading to growth, either in traditional or in advanced industries. Nay, under present conditions such investments do not even seem to be possible. This means that a second cornucopia of cheap money poured by the states of the North over southern countries – for instance in the form of a “Marshall Plan” – will only produce more indebtedness and thus lead to a further worsening of the crisis. Since the main burden of providing the extra money will remain with Germany, the only lasting effect of such a misdirected policy will be bad loans and a much higher debt for Germany itself. And that will ruin the German economy too.

Joseph Stiglitz: We are in the midst of crisis

Both strategies – rigid austerity as well as easy money – will lead Europe to nowhere or, to put it more concretely, they will tear the Union into pieces and conjure social turmoil. Europe, however, cannot afford anymore futile and harmful policies, as it finds itself currently in the very midst of a second „Great Depression“. Even if there are always moments of hope, the accuracy of this statement remains beyond doubt. „The period from 1929 until the Second World War was called by historians ‘Great Depression’ only after the fact,” Stiglitz notes. „But even during the Great Depression, there were always ups and downs. Now we are in the same situation. In 30 years from now, historians will speak of a great depression in 2008. And they will say that time and again green shoots were sprouting, which afterwards turned brown. Perhaps we see just now such a green shoot. But the probability that all is already over, is equal to zero.“ (4).

Beyond conventional wisdom

The above analysis demonstrates the ineffectiveness and even harmfulness of both textbook recipes. We must be ready to admit that under certain conditions governments just have no chance to resort to correct and good investment. (5). That is why even a Nobel laureate like Joseph Stiglitz has no viable solution to offer for getting out of the present European predicament. In order to find such a solution we must look beyond conventional wisdom.

As soon as we put conventional economic textbook wisdom aside, we do find indeed, that there is a cure for the European disease. We are moving toward a real solution, if we are ready to admit that the pressure exerted by the world market on southern countries – a pressure making good and proper investment all but impossible – is no fatality at all, even if many people believe it to be just that, and even if economists are likely to cling more than others to this misconception. The ravages of globalization, where „mankind is caught up in a deadly struggle against itself” as Konrad Lorenz once aptly remarked, are even less fateful. A strong and united Europe may very well get rid of that pressure.

For this to happen, the continent just needs to reflect on its inherent strength. Just as Europe need not access the world market for a sufficient supply in food, it may be quite as independent from imports with regard to its industrial needs. Once Europe has managed the transition to renewable energy, it will no longer depend on imports of crude oil, natural gas or uranium. The first step in this direction was made by Germany. With their impending independence from nuclear energy supply, the Germans are about to create an ecological model. The next step on this way would not be good for either Germany or Europe if it makes Germany bleed to death by keeping southern states artificially alive with transfer payments – payments to no effect because the world market just doesn’t need non-competitive industrial goods.

Instead Germany should take a quite different path. It should put an end to an industrial policy so destructive to the rest of Europe. Certainly, this renouncement will at first cost Germans power and prestige. Leading German industries would on avarage forgo up to a third of their markets and Germany as a whole would initially suffer a loss of wealth. But its markets in Europe would be permanently secured, and the overall prosperity of Europe would no longer be threatened. It would, on the contrary, take an enormous upsurge.

For under such conditions good and proper investments are again possible. Traditional industries in Greece, Spain, Hungary and Portugal will be revived and gradually evolve to higher levels. All products supplied by these countries would immediately achieve much higher prices as they need no longer compete against the rest of the world. Is it too much to ask Germans to gradually renounce their non-European exports in order to prevent the disintegration of Europe? Germany should understand that the alternative may be much harder to bear. Once Europe dissolves again into national states, Germany will shrink to insignificance. (5)

1 See interview with J. Stiglitz at:

2 The various rescue packages are no help to the cause of growth, because they mainly serve to satisfy the claims of creditors. This also applies to indirect government funding by the ECB.

3 „The revolving door effect of debt crisis,“Handelsblatt, 13.04.2012.

4 See the above interview with J. Stiglitz.

5 These conditions may consist in a general lack of interest in science and technology, as characteristic of many so called traditional societies. It is, of course, expressed in their education systems up to most recent times. Just as difficult to cope with are external conditions such as a significant global overproduction in key export sectors, or unbeatable low-cost production from emerging economies. The blindness of orthodox Economics for the predictable collapse of national economies under similar conditions is quite surprising. After all they do quite well understand that meaningful investments may at times be quite impossible in private companies. A company goes bankrupt if it lacks productive ideas or if its competitors simply have more or better ideas. No investors will then provide it with additional capital.  In the private sector this is a fact of everyday life.

6 My latest book “Von der Krise ins Chaos” (from crisis to chaos) develops these ideas in much greater detail.