Political Economy of the Euro Crisis: Did Wage Moderation in Germany Matter?

Comparative political economists studying the Euro crisis argue that German wage moderation played a primary role. In the impossibility of nominal exchange rate adjustment, wage moderation caused a reduction of relative unit labor costs in Germany and a depreciation of the German real exchange, which in turn stimulated German net exports. In addition, structural imbalances caused cross-border financial flows which fueled asset bubbles in peripheral countries. Some authors, however, deny that there was any wage moderation In Germany or that German exports are positively stimulated by a decrease of relative unit labor costs (see Storm and Naastepad 2015). Based on an econometric analysis of the relationship between German bilateral trade flows and bilateral relative unit labor costs, this paper makes four points: 1) There was indeed wage moderation in Germany, not just compared with the periphery but also vis-à-vis other coordinated market economies. 2) Wage moderation of such an extent is a relatively novel phenomenon for the German political economy and should not be seen as an intrinsic feature of coordinated labor markets. 3) Wage moderation, and not labor productivity, was the primary cause of the German competitiveness gains in the EZ. 4) Contrary to “elasticity pessimism,” German exports to EZ countries are sensitive to ULC movements and benefited from the competitiveness boost. Instead, German imports from the EZ are not ULC-sensitive and are instead primarily pulled by increases in German domestic demand, particularly investments, which makes the prospect of rebalancing unrealistic without an expansion of domestic demand in Germany.