18 Sinn after Böhm-Bawerk - uni-hohenheim.de...Eugen von Böhm-Bawerk (1914: 508) 1 Introduction Member countries of the European Monetary Union (EMU) have become enmeshed in a quarrel

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18 Sinn after Böhm-BawerkIncome distribution, capital flows and current account imbalances in EMU

Hagen M. Krämer and Peter Spahn

The capital balance commands, the trade balance follows, not the other way round.

Eugen von Böhm-Bawerk (1914: 508)

1 IntroductionMember countries of the European Monetary Union (EMU) have become enmeshed in a quarrel over the distribution of capital losses that most probably will accompany the debt crisis in some economies: should the banks, being the creditors, write off a large part of their claims? Or should the burden be loaded upon the taxpayers? More to the point: the taxpayers of creditor or debtor coun-tries? The outcome of that debate might also depend on the assessment of the distribution of the overall EMU welfare effects so far. With regard to the latter question, the answer appears obvious for many observers: Germany profited the most from EMU by means of its huge export surplus, which cannot be reduced any longer by exchange rate devaluation of trade-deficit countries (as practised from time to time in the fixed-exchange-rate European Monetary System). Also German governments tend to side with this assessment, which in turn quite naturally adds to the justification of Germany’s net-payment position in Europe. Of course, one country’s export surplus indi-cates no political privilege, calling for compensation fees, as all EMU members are allowed to strive for enhanced competitiveness. Questionable, however, is whether persistent trade success really creates gains in economic welfare. Taking up this issue, two well-known economists have argued otherwise. Both base their views on capital exports that − keeping in mind the basic logic of the balance of payments − necessarily go along with a trade surplus.

Foreign Investment lowers the standard of living of the lending country, because, if the resources were not exported they would be used for capital development or for consumption at home. Foreign Investment is a process by which rich countries spread the proceeds of their wealth over the world, and thus is internationally desirable.

(John Maynard Keynes)

255_18_Macroeconomics.indd 231 11/1/12 12:40:22

232 H.M. Krämer and P. Spahn

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The terms ‘current account surplus’ and ‘capital export’ have different semantic connotations that tend to confuse politicians and the media, but for all practical purposes they mean exactly the same thing. Germany lost a huge amount of capital under the euro even though it urgently needed the capital to rebuild its ex-communist east. In fact, in recent years, Germany was the world’s second biggest capital exporter after China and ahead of Japan. The outflow of capital has benefited other countries.

(Hans-Werner Sinn)

The first statement was given by John Maynard Keynes in 1929 (Fleming 2000: 142), the second in recent years by Hans-Werner Sinn (2010: 15). Most observ-ers (presumably including Harald Hagemann, as the Vice Chairman of the German Keynes Society) will not see both economists as belonging to the same camp. Thus it might be tempting to ask how the apparent similarity of their views is to be explained, and how far the area of their common beliefs could be stretched. Looking at growth-rate data across EMU, with Germany until recently persistently faring at the lower bound compared to other member countries, it appears that both economists are right not to confuse export success with gains in overall economic welfare. But it is advisable to have a closer look at the inter-dependence of trade and capital flows, particularly under the conditions of a monetary union.

2 A digression into the history of economic thoughtBöhm-Bawerk’s (1914) above quoted assertion is widely seen as a path-breaking view on causality in open-economy relations.1 The supposed dominance of capital movements should not be understood as an early hint to the modern phe-nomenon of ‘financialization’ (Epstein 2005); Böhm-Bawerk, of course, as one of the founding fathers of neoclassical economics, stressed the real-barter foun-dation of international relations that required trade flows to be finally ‘paid’ by a transfer of resources. Rather, his statement intends to highlight the macroeco-nomic nature of trade imbalances, emphasizing that saving and investment, and fiscal and monetary policies with their impact on interest rates, are the key deter-minants of export and import flows. Argued from the perspective of the history of economic thought, the link from capital movements to trade flows represents the open-economy implication of the quantity theory of money. For Mises (1924: 164), this proved the triumph over the mercantilist school:

a feat of classical economic theory [. . .], by delivering the evidence that transnational money flows are not the consequence of the shaping of barter, rather, that they are the reason, and not the result, of a favourable or unfa-vourable balance of payments.

Capital movements bring about the necessary transfer of purchasing power that allows trade-deficit countries to consume the resources of net-exporting economies.


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Sinn after Böhm-Bawerk 233

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This line of reasoning also was at the centre of the 1930s debate on transfers and reparation payments. In that debate, Ohlin was said to take a Keynesian stand as he pointed to income creation in the capital-importing country that enabled additional imports of goods, whereas − quite ironically in a more neoclassical style − Keynes mentioned lower wages as a precondition in the exporting country for increasing its surplus. However, it should not be overlooked that Ohlin explicitly assumed a given income in both countries, thus truly analysing a transfer of income (Riese 1988). The neoclassical view of a zero-sum logic in the transnational distribution of investment also characterizes the debate in EMU. Before discussing this issue, it is important to extend the usual two-country analysis. According to Keynes, in a multi-country setting the capital export of one particular economy does not directly imply a concomitant trade flow via the income channel:

It is commonly argued that Foreign Investment represents an export of goods, and therefore home industries are helped to be prosperous by greater markets. The foreign investment of a country is determined by the relative rates of interest at home and abroad. But the foreign borrower decides where he will buy his goods by the relative levels of prices, and not of interest. Therefore there is no immediate connection between the lending of capital abroad and the export of goods.

(Keynes, quoted after Fleming 2000: 142)

Of course, the indirect mechanism still works: if the borrowing economy buys goods from third countries, Keynes, in his 1929 analysis, expects wages in the lending economy to fall, thus inducing net exports to other countries via the real-exchange-rate channel. Thus it is interesting to see that Keynes in his Treatise period, though empha-sizing income creation abroad by means of foreign investment, still seems to implicate inverse changes of income in the capital-exporting country, predicting deflationary wage pressure from increased foreign investment. Obviously, this reasoning must rest on some implicit assumption on the amount of capital that can be invested at home or abroad. Alluding to some full-employment flow of saving would be the neoclassical way of closing the model. The General Theory-based Keynesian view, however, would point to the endogeneity of saving and insist on the primary role of credit creation, so that foreign investment is not necessarily realized only at the cost of reduced capital accumulation at home.

3 Germany on its way from a ‘bazaar economy’ to EMU’s major creditorIts export surplus has most of the time been one of the characteristic features of the German economy since the Second World War. Whereas this used to be explained by favourable exchange rates and the high quality of products ‘Made in Germany’ in combination with cautious wage policies of German trade unions, Sinn (2006: 11) in recent years turned conventional wisdom on its head



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by propagating the view that the export surplus was the − not at all advantageous − result of excessively high wages:

Economic benefits cannot be derived from the export boom, particularly because Germany actually turned to more exports as a means of escape from its policy of high wages.

As it stands this is hard to swallow, as the competitive effect of high wages should hamper trade success. In Sinn’s world, however, this is not at all contra-dictory. According to his view, German companies are competitive due to importing intermediate goods from low-wage countries or shifting their produc-tion into these countries, whereas German workers are not, due to their high wage demands. Hence the first component of Sinn’s story is the famous ‘bazaar effect’: in order to defend their shares in foreign markets, German producers substitute imported intermediate products for expensive domestic labour, so that, in extreme cases, work in domestic factories is confined to assembling and packing products of foreign labour. Basically, this is part of the ongoing process of the division of labour, an element of structural change, which is particularly important in high-wage countries. But the balance-of-payment implication − due to increased imports of intermediate products − should be a lower export surplus.2

Therefore, Sinn (2006: 15) relied on a second argument to propagate his message of ‘wage excesses promoting German exports’, setting the focus on capital exports, which for accounting reasons equal the trade surplus (ignoring other items, such as transfers, errors and omissions, not to be discussed in the current context).

A domestic trade surplus can only be donated or credited to foreign coun-tries. [. . .] In fact, any net capital and goods export from a country with rigid wages, impeding technical substitution processes, measures the removal of jobs to trade partners abroad.

Hence, it appears that German investors, on their escape from demanding wage claims at home, move their capital abroad, which eventually helps to maintain employment by producing export goods instead of domestic goods.3 Actually, this second part of the Sinn story seems more important than the first, as the bazaar effect yields ambiguous results on the trade balance. Thus it is not sur-prising that this effect is hardly mentioned any longer in Sinn’s recent writings on Germany’s trade performance in EMU. Here, Sinn (2010: 18) recognizes that German wage costs are low, as compared to its competitors, so that the real exchange rate contributes to current account imbalances; but still his story is that this is the consequence of capital flows:

Real devaluation was not a sign of strength and taking advantage of other EU countries’ demand policies [. . .], but an implication of Germany’s


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internal weakness resulting from its capital exports that helped finance the boom in other euro countries. A country that experiences economic stagna-tion internally can only increase its prices and wages moderately. The result-ing improvement in competitiveness stimulates the export sector, but this is only an induced countervailing effect that is unable to overcompensate the negative primary effect by which it was caused. Had German savings been invested at home rather than in Greece, Spain or Ireland, Germany would itself have grown and the increasing labor and goods demand would have increased its wages and prices, reducing its external competitiveness.

The reason for the surge of Germany’s foreign investment can easily be discov-ered: the opening-up of the euro capital market without any exchange-rate risk in 1999. As admitted EMU members ostensibly passed an entrance examination in terms of meeting the criteria of the Maastricht Treaty, further risks were obvi-ously neglected,4 so that market forces quickly eliminated the spreads of long-term interest rates after 1995 (Figure 18.1). There were many economists who, like Sinn, described this adjustment process as being brought about by capital flowing from low-interest to high-interest countries, although, from a theoretical point of view, asset prices can adjust without any transactions at all. Actually there were substantial capital

SPAGREIREITAPORGER

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2

20011995 1998 2004 2007 2010

Figure 18.1 Long-term interest rates in selected EMU countries (data source: ECB).



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flows from rich to poor EMU countries, which were interpreted as a most welcome development, enhancing convergence and welfare. The Feldstein-Hori-oka Puzzle, i.e. the finding of a strong correlation between domestic saving and investment, finally seemed to be solved. Foreign investment aiming to level out differences in capital endowment across Europe generated a boom in capital-importing countries that was judged to be driven by fundamentals. Shortly before these dreams burst, it was happily proclaimed that ‘financial markets have become more efficient in allocating capital across Europe’ (Schmitz and Hagen 2009: 5; cf. Blanchard and Giavazzi 2002). According to the Lawson Doctrine, macro and trade imbalances that resulted from private sector decisions and thus − for many observers − were rational by definition did not require any economic policy intervention (Corden 1994: 92; Blanchard 2008). However, capital import and credit expansion generated a ‘soft budget constraint’ in recipient countries, produced higher growth, built up unsustainable asset bubbles, undermined com-petitiveness and worsened the trade balances.

4 Capital re-allocation and income distributionThe transfer of capital within EMU from richer to poorer countries had substantial economic (and social) consequences. On the one hand the increased capital supply fuelled the economies of southern European countries; on the other hand it had major implications for income distribution to the advantage of capital owners. According to Sinn (2010), a substantial misallocation of capital occurred in EMU and income was shifted between the different owners of the factors of production. Capital re-allocation within EMU is illustrated by Sinn in a stylized way using Figure 18.2 – a modified Kemp diagram. It is constructed on the basic assumption of a given and fixed amount of capital in EMU, given by the length of the horizontal axis. The distribution of capital between the two EMU sub-regions GANL and ROE is then explained on the basis of neoclassical marginal productivity theory. GANL stands for the ‘solid’ EMU states which, before EMU came into existence, formed the hard currency ‘Deutschmark zone’, namely Germany, Austria and The Netherlands. ROE (Rest Of EMU) comprises all the other EMU member countries. The diagram thus contains two marginal productivity of capital (MPC) curves for GANL and ROE. As usual, the marginal productivity curves are downward sloping as more capital is employed (for GANL measured from the right to the left axis; for ROE from left to right). In the neoclassical paradigm, the MPC curves represent the demand schedules for capital, since firms demand more capital for their investment projects until the marginal productivity of the invest-ment is equal to the prevailing interest rate. The area below the MPC curves is equal to the total output (or the sum of capital and labour income) of the respec-tive region. The interest rate i is the nominal interest rate controlled for the expected rate of currency devaluation vis-à-vis the Deutschmark zone, or for the expected default loss per unit of capital, respectively. This variable is therefore called the ‘effective interest rate’ (Sinn 2010: 13).


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Point B represents an optimal allocation of capital. Before the introduction of the common European currency, nominal rates in ROE were higher than in GANL due to permanent depreciation expectations of ROE currencies vis-à-vis the Deutschmark zone and/or relative higher default risks. The distance between A and C, therefore, represents the risk premium of an ROE investment over an investment in the GANL region before EMU. However, the introduction of the euro generated the (erroneous) belief that inflation rates of all EMU member states would converge to a low value and default risks would vanish (or converge to the same level). This prompted capital to move from the low-yield region (GANL) to the high-yield area (ROE) where the marginal productivity of capital was higher (DE in Figure 18.2 represents the shift of capital from GANL to ROE). Capital could now flow into the most

A

B

F

KG

C

D E H

i GANL

i ROE

i*

MPCROE MPCGANL

GDP lossfromoverheating

C ROE C GANL

Figure 18.2 Excessive capital import and the bubble (Sinn 2010: 13).Notes.MPCGANL: marginal productivity of capital in Germany, Austria and The Netherlands, MPCROE: mar-ginal productivity of capital in the rest of the euro countries, iGANL: interest rate in Germany, Austria and The Netherlands if the euro had not been introduced, iROE: interest rate in the other euro countries if the euro had not been introduced, i*: uniform interest rate in all euro countries after the introduc-tion of the euro.



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profitable uses, thus inducing a growth spurt in ROE. The gain in income in the ROE region can be read out from the area ADEB. The accompanying loss in income in GANL is represented by the area CDEB. Yet the net effect, given by Harberger’s triangle ABC, is positive. Hence, welfare in overall EMU increased in the first instance thanks to the (apparent) disappearance of devaluation and default risks. Due to the additional capital supply from GANL the nominal long-term interest rate of the ROE countries declined (from point A to B) and finally reached (nearly) the same level as in GANL, where the interest rate increased (from point C to convergence in B). As already mentioned, the crucial point on which Sinn’s whole argument finally rests is his assumption of a given amount of capital in Europe, fixed at least in the short run and therefore making the whole story in terms of capital a European zero-sum game:

Growth in European productive capacity, which results from a given invest-ment volume, will reach its maximum extent when the marginal return of real capital of different countries is brought into equilibrium.

(Sinn and Koll 2000: 31; emphasis added)

What happened in reality, however, was that after the introduction of the euro national rates of inflation did not at all converge. As a matter of fact, for most of the time the price level rose at a higher pace in ROE compared to GANL, therefore causing an increasing implicit devaluation risk in ROE.5 Since nominal interest rates were nevertheless the same for a long time, effective interest rates diverged. The effective interest rate in the ROE countries plummeted (in Figure 18.2 from point B to point G), whereas it rose in the GANL area (from B to F ). This was, according to Sinn, the decisive factor that again triggered huge capital transfers from GANL to ROE.6 It corresponds to a shift from point E to point H, indicating capital exports (imports) of the GANL countries (ROE countries) to (from) the other region. Contrary to what happened in the transition period from pre-EMU to EMU, according to Sinn, this time the shift in capital from North to South resulted in a misallocation of capital which reduced overall welfare in Europe. Again, the change in total output of the respective area can be studied with the help of Figure 18.2. Since total output corresponds to the area below the respective MPC curves, the gain in total income of ROE is reflected by the area BGHE. However, concerning overall income this process is not a zero-sum game, since the loss of income in GANL is equal to the larger area BFHE. Thus, the loss of overall income in the euro zone – from ‘overheating’, as Sinn calls it, – can be identified as the shaded area BFG.7 Since the beginning of the EMU crisis in early 2010, however, nominal inter-est rates between the core and the periphery of EMU have differed: iROE increased, whereas iGANL decreased, bringing back effective interest rates to the so-called ‘efficient level’ which prevailed in pre-EMU times. Hence, Sinn expects that GANL’s capital exports to Spain and the other ROE countries will come to an end soon. Consequently, he explains the German upswing in


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2010–11 with the ending of capital exports and the redirection into domestic investment projects, and predicts that, ceteris paribus, the German economy is heading for a bright future. Sinn’s EMU story is in principal accordance with his notion of the general impact of globalization on the distribution of income. In many of his writings, Sinn holds a clear-cut view about winners and losers of globalization, in which, due to the reallocation of capital towards poorer countries, wage earners in the advanced nations will generally lose in income whereas the owners of capital will enjoy higher earnings. Globalization, he argues, helps capital owners in the advanced nations to ‘rake in the total gains from trade plus an extra revenue through the redistribution of income’ (Sinn 2002: 6). Following Sinn, globalization is both unstoppable and desirable in general. Since he also thinks that capital cannot be taxed in an open economy, his policy advice is that wage earners should start to save a relevant part of their income, accumulate capital and become shareholders of companies in order to comple-ment their inevitably shrinking wage share with capital income. Sinn (2002) regrets that the German trades unions do not share his sympathy for the idea that workers in Germany become (partial) capitalists. However, the shifts in income distribution do not only occur when an advanced nation of the north trades with a developing nation in the south of the globe. Sinn sees basically the same mechanism within the EMU at work – to the disadvantage of workers and the owners of other factors of production which are no complements of capital in the advanced countries:

The only people in Germany who may have benefited from the outflow of capital were the rich, who enjoy higher returns on investment – provided of course that they get their money back. The rest of the German population suffered.

(Sinn 2010: 15)

However, there are severe problems with Sinn’s use of the Kemp diagram (Figure 18.2) for analysing the effects of a reallocation of capital (Sinn 1984; Sinn and Koll 2000). The first is that one cannot, without additional assumptions, make a statement about how the factor shares are affected. The Kemp diagram may be helpful in visualizing shifts of labour between regions, as applied in the popular textbook by, for example, Krugman and Obstfeld (2011, Ch. 7).8 In the short run, it makes sense to assume a given supply of labour – for instance between home and abroad. However, Sinn carries this analysis over to capital, thereby implying that the stock of capital is fixed. As a consequence, one country or region is only able to apply more capital if the other country or region applies less capital.9 This idea is derived from Sinn’s awkward concept of capital, assuming that capital is a fixed quantity which can therefore be treated as an exogenous variable in EMU current account analysis. Additionally, there are other inconsistencies in Sinn’s reasoning concerning current EMU issues. Parts of his arguments are not even supported by empirical evidence, as will be demonstrated next.



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5 Does the Sinn story fit the facts? Confusing saving and financeThe concept of the current account being the mirror image of the capital account is obviously true in a stylized two-country setting, but cannot simply be expected to be found in EMU data. Looking at Germany’s regional balance of payments in relation to the GIPS countries (Greece, Ireland, Portugal, Spain), we find large gaps between capital and trade flows in many years (Figure 18.3). In all these cases German foreign investment was larger than its exports, implying that GIPS

Figure 18.3 Germany’s current account (CA), capital account balance (CB, +: capital inflow) and its difference (D) vis-à-vis the GIPS countries (Greece, Ireland, Portugal, Spain) and Italy (data source: Deutsche Bundesbank).


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countries drew their imports from other sources. This third-country effect, men-tioned above by Keynes and others,10 does not necessarily undermine the logic of Sinn’s story. But a disaggregation of the data prompts further issues:

• Italy did not receive a steady share of German capital export, and its growth rate remained low, although the incipient interest rate spread according to Sinn also should have motivated foreign investment. This shows that there are other factors besides interest rates that drive investment and portfolio decisions.

• The Sinn story does not fit with regard to Ireland, which showed a small trade surplus vis-à-vis Germany throughout the whole period and which was responsible for a massive repatriation of German funds in 2010.

• Surprisingly, German (mainly portfolio) investment in Greece increased since 2007, even after the outbreak of the debt crisis.

• Capital flows to Greece and Portugal were rather volatile; only Spain, with increasing trade deficits and capital imports, gives an example for the sce-nario described by Sinn.

The question mark becomes even larger if we compare gross investment in GIPS with capital flows from Germany (Figure 18.4). Regardless of whether these flows are measured in gross or net terms, at the peak of the boom German capital exports contributed only about 10 per cent to capital forma-tion. Surely, the boom was not built on money funds, collected by savers from Germany and other EMU surplus countries. But this is what Sinn (2010: 18) tells us:

Figure 18.4 Gross investment and saving in GIPS, German capital export to and capital balance with GIPS (+: capital outflow) (data source: AMECO, Deutsche Bundesbank).



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What actually happened was that German, Austrian and Dutch savers, i.e. households and firms, brought their savings to the banking system, which then invested them in different kinds of securities, including, for example, US mortgage-backed securities, Greek government bonds, asset-backed commercial papers issued by Irish special purpose vehicles, or Spanish bank bonds issued to finance the country’s gigantic construction boom.

The flow-of-funds difference between domestic gross investment and the current account deficit, which for the sake of argument may be taken as being equal to capital imports, is gross domestic saving. But even if Sinn had complemented the above quotation by mentioning the GIPS savers, his argument would still be flawed: it is the old fallacy of interpreting bank deposits as ‘funds that are provided by savers through the banking system’ (Sinn 2005: 36). He fails to see that banks do not lend out money that was previously collected from savers; bank credit does not represent a substitution of items on the asset side of banks’ balance sheets, but a lengthening of their balances. Thus credits make deposits; what is needed is euro reserves that are easily available from the central bank, particularly under the modern regime of monetary policy-making where base money is provided without quantitative restrictions (Spahn 2010). Of course, the banking system also draws liquid reserves from the public via selling deposit claims, but it should be clear that

for the purpose of restoring liquidity consumption is as good as saving. [. . .] When income is created by the expenditure of the ‘finance’ it is a matter of indifference in this connection whether the recipients save or spend it.

(Keynes 1938: 276)

Basically, Sinn adheres to the old Treasury View according to which saving con-stitutes a given stock of finance that limits the amount of investment. Credit expansion is autonomous, however; in the case of the GIPS countries it produced an expansion of income that induced goods imports from other countries. There should not be any doubt that German companies, due to their competitiveness, made large profits in this demand expansion. The rise of export production increased income and savings in Germany. The latter have to be interpreted in two ways: in real terms, they represent goods that the Germans forego to use (but which, without the foreign demand impulse, might not have been produced in the first place); in monetary terms, they add to the stock of private financial wealth that can be allocated at will. Sinn believes that investing (at least some of ) these funds in GIPS countries constituted a financial capital shortage in Germany, and thus arrives at an overly simple explanation of Germany’s stagnation in the mid 2000s:

The current account measures the amount of financial funds that flow from the domestic capital market to agents using them abroad, and that cannot any longer be used at home.

(Sinn 2005: 35)


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Capital, invested in a foreign country, is lacking at home. [. . .] From 2002 to 2009, Germany has lost 67% of its savings in form of capital and money outflow, and only 33% has been invested in domestic machines, buildings, infrastructure and other real assets.

(Sinn and Carstensen 2010: 6)

Surely funds invested in GIPS cannot at the same time be invested in Germany, but it is not true that foreign investment necessarily implies a pro tanto reduction of German capital formation. There are many reasons why German investors actually might have preferred Spanish over German assets, but if expected rates of return in Frankfurt were as high as in Madrid, additional domestic investment would hardly have been thwarted by a lack of finance. It is not reasonable to assume that the banking system would have turned down additional, well-founded credit demand.11 Hence, as a consequence, German savings, being the result of investment-induced additional income, would have been higher. A case in point is China: here, obviously, substantial goods and capital exports do not at all impede strong domestic capital formation. Based on a zero-sum logic of investment distribution, Sinn (2010: 18) emphasizes the diverging forces in EMU:

Over the business cycle one country’s boom implies that the other country experiences a boom too, because it buys this country’s goods. This is the Keynesian contagion effect. The economies move in the same direction, and the capital flows adjust endogenously. However, when capital flows are the driving forces, because a watershed between capital markets has been removed or policy measures have changed the countries’ relative location

Figure 18.5 German private gross investment, total capital balance and capital balance with GIPS (+: capital outflow) (data source: Deutsche Bundesbank).



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qualities, the countries move in opposite directions. [. . .] The country to which capital flows blossoms and the country it flows out of wilts. Such is the law of capitalism.

But it is questionable whether the data allow such a strong statement. Weak investment in Germany cannot be explained by a GIPS boom, because debt-financed investment decisions do not follow a zero-sum logic.12 This can also be seen from macro portfolio allocation in Germany (Figure 18.5): contrary to Sinn’s assertion, there was no sign of a trade-off between investment spending and capital outflow, i.e. total and regional capital balance, except for a short period around 2001.

6 Paying import bills in a monetary unionDoes a monetary union make a difference? Up to now, the relationship between capital and trade flows has been analysed in the standard open-economy approach where a non-zero trade balance appears to be financed by capital move-ments. The basic balance-of-payment equation ∆R = Ex – Im + CapIm – CapEx also allows for a change in foreign reserves ∆R as the counterpart of trade imbal-ances; in that case, for example, the domestic central bank pays foreign-exchange import bills by running down its stock of currency reserves. In a monetary union, payments between trading partners resident in different member countries are made in terms of the common currency, and the most natural way to conceive of these transactions is a transfer within the commercial banking system. A goods export from Germany to Spain thus leads to a euro transfer from a Spanish to a German bank. Accordingly, the former loses, and the latter gains, euro reserves (∆R). Note that there is no necessity for any private non-bank capital movement. The shift of net wealth is now brought about by the redistribution of euro reserves between both banks. It is hardly realistic to assume that both banks simply adjust their existing stocks of free euro reserves because banks do not usually hold excess base money, but invest such funds in the money market. On the other hand, liquidity is borrowed when needed, either on the money market or directly from the central bank. The upshot is that, in the above example, a Spanish trade deficit vis-à-vis Germany finds its counterpart in a short-term capital export of the German banking system. Nevertheless, it indicates a long-term problem for Spanish banks because interest costs accumulate as the trade deficit persists. This argument helps to understand the logic of mercantilism: irrespective of any advantageous welfare effects, trade deficits constituted a major threat for the commercial banking system of any member country in the classical gold standard. A special case, although of increasing importance in EMU, arises if euro transfers are executed within the balances of multi-national commercial banks that operate in several EMU countries. Bank branches located in trade-deficit countries may then be exposed as less profitable than others (because they


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continue to lose euro reserves that have to be procured), but it is improbable that decisions are taken to withdraw from the banking business in deficit countries. If capital movements thus are recorded within the books of transnationally operat-ing entities, capital balance data of monetary unions are difficult to obtain and to interpret – just like intranational capital flows in federal states like Germany. Trade imbalances appear to have no clear-cut counterpart in intra-monetary-union balance of payments. In EMU until 2007, it was hardly necessary for commercial banks in trade-surplus countries to finance GIPS trade deficits, as there was plenty of private non-bank foreign investment originating from surplus countries, which set in motion euro transfers towards commercial banks in GIPS, thus covering the lat-ter’s primary liquidity deficits. As a consequence of the worldwide financial crisis, and all the more after the outbreak of the GIPS public debt crisis, private capital flows to GIPS shrank, and commercial banks in surplus countries also felt less inclined to extend short-term credit to the GIPS banking system. A solution to the impending liquidity problem, however, evolved from the improved EMU-wide system of transfer payments (TARGET2). Stripped of all technical details: commercial banks are able to unload their bilateral credit and debt positions; bank transfers from deficit to surplus countries incorporate the national central banks, so that, for example, the Spanish central bank’s account with the Eurosystem is debited, and the Bundesbank’s account is credited. Its external position roughly mirrors the indebtedness of GIPS countries that arose from their still negative trade balances after 2007 (Figure 18.6).13

It appears obvious to interpret that these huge accumulated claims of the Bun-desbank as a credit to GIPS countries enable the maintenance of current account

Figure 18.6 Net external position of the Bundesbank in EMU (data source: Deutsche Bundesbank).



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and budget deficits (Sinn and Wollmershäuser 2011). These imbalances within the Eurosystem, however, pose no specific risks for national creditor positions (Deutsche Bundesbank 2011): if a debtor party, for example the Spanish central bank, should be unable to settle its obligations, the concomitant loss is distrib-uted among all member central banks according to their ECB capital share. Therefore, financing export surpluses via the Bundesbank is much less risky for Germany than traditional reliance on private capital exports. Whereas in Sinn’s writings these TARGET2 imbalances are denounced as an improper use of, and a strategic exploitation of, European payment technology, they actually represent an element of completion of a monetary union: payment flows reflecting a cross-border transfer of resources no longer require compen-sating private capital flows, i.e. an exchange of assets, as in the case of open, but separated economies; rather, payment flows can simply be booked within the integrated central-banking system. In a trade-deficit country, at least one market agent is indebted to the banking sector; in the surplus country, another agent holds a claim against its bank; but there is no necessity of holding cross-border claims among non-bank agents. As long as private bank-customer contracts are non-defaulting, there is no need to balance credits and debts within the central banking system. Such a demand, as made by Sinn, ‘contradicts the core constituting element of a mone-tary union − namely that one euro is equal to one euro − across the entire mone-tary base’ (Bindseil and König 2011: 25). For the Bundesbank, it makes no sense to insist on a reduction of TARGET2 balances; a positive account with the Eurosystem represents the possession of the ultimate means of payment in EMU − this is different from the case in the gold standard, where national central banks for obvious reasons wished to settle mutual claims on gold deliveries. Sinn rightly complains about the weak ‘budget constraint’ in GIPS countries where commercial banks directly or indirectly − by using government bonds as collateral in central bank refinancing operations − continue to support deficit spending.14 But he also argues that credit extension in GIPS comes at the expense of countries like Germany, where the scope for the creation of money and credit would be restricted. This is obviously not true from a monetary point of view, as the liquidity position of German banks even improves when receiv-ing payment transfers from other countries (Buiter, Rahbari and Michels 2011). But again, Sinn sticks to his inapt zero-sum view of saving and investment:

Somewhere else another use of the credit must be crowded out when addi-tional credit is given via the central bank system to the GIPS countries, because with the given stock of money and given savings, a loan for one use can only be provided at the expense of another use. [. . .] Even in an ideal market, in which everyone can borrow as much as he or she wishes, a strict aggregate budget constraint applies in the sense that the sum of the invest-ments that can be financed on credit (or other forms of capital, especially equity capital) is limited by the sum of savings.

(Sinn and Wollmershäuser 2011: 25)


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This statement is qualified as being valid only in a long-run, full-employment constellation. Granted that this proviso is correct, one may wonder in what respect the European economy in recent years resembles that scenario; the relev-ance of Sinn’s analysis for contemporary EMU problems thus appears to be low. But the key point is that even in a full-employment monetary economy, bank credit is not limited by market agents’ saving − a decades-old fallacy that has lingered on since the badly understood contributions of Wicksell and Keynes (Borio and Disyatat 2011).

7 ConclusionsThe primacy of capital movements in determining trade balances has been a key topic in the recent world financial crisis. Sinn is right to underscore these macr-oeconomic basics also in the EMU crisis, which can be explained neither by inflexible labour markets (a formerly often-heard neoclassical topic) nor by rampant speculation on financial markets (the modern favourite in various camps). But the question is whether Sinn gets these basics right. Throughout his analysis, he discloses his preference for a ‘real-barter’ view of international and intra-union economic relations. Of course, welfare in EMU depends on the production and distribution of resources; with ruthless candour, in an almost Marxist style,15 Sinn elaborates on how capital reaps the profits of globalization, leaving labour with the burden of adjustment. On the other hand, the inclination to identify the exports of German goods with German foreign investments, and saving (non-consumption) with credit extension, leads the argument onto the wrong tracks. For Sinn, capital exports consist of, for example, construction equipment that supports production in trade-deficit coun-tries, while limiting it in surplus countries; German employment in the mid-2000s thus appears as supply constrained. Sinn fails to grasp the autonomous power of banking systems to create credit, whereby the production of resources becomes an endogenous variable, driven basically by the demand side. Supply constraints given by natural resources, energy and labour are far from being binding in the European context. The EMU current account and debt crisis has let Sinn learn that trade flows between national member economies in a full monetary union no longer depend on private capital flows, as they are simply paid by booking entries in the integ-rated central banking system. After all, he is to praise for the warning that sub-stituting central-bank for private financial claims on debtor countries implies a politicization of market budget constraints that might well lead to disaster.

Notes 1 Literally, he speaks of the balance of payment determining the trade balance, but read

in modern terminology, it is obvious that he is referring to the capital balance. 2 This statement might be qualified in various respects: additional imports will increase

income abroad, so that a small repercussion can be felt in domestic export data; also, if substitution of domestic labour leads to unemployment, import of consumption



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goods might fall. But it seems highly improbable that both effects outweigh the primary negative impact of increased intermediate products on the domestic trade balance. Finally, Sinn fails to mention that some share of imported intermediate goods is produced by using not only cheap foreign labour, but also German capital goods that had been exported in the first place.

3 If German competitiveness had been low, EMU member countries should actually have used German capital exports to buy goods in third countries.

4 An alternative interpretation is that market agents anticipated transfers or bail-outs in case of a financial crisis.

5 Some economists see diverging unit labour costs at the root of the persistent inflation differentials between EMU members (Krämer 2010). They deduce the necessity of wage coordination in the EMU, or at least a strict orientation of national wage hikes in line with labour productivity growth (Horn, Niechoj, Tober, van Treeck and Truger, A., 2010), something that is dismissed by Sinn and other mainstream policy advisers in Germany (Sachverständigenrat 2010, Ch. 3).

6 According to Sinn and Koll (2000: 31), this effect could in principle also be explained by a higher inflation rate in the ROE region due to the Balassa effect, resulting in lower real interest rates and hence attracting capital into these countries. It is not clear, however, why lower interest rates (!) should attract investors. The origin of this vagueness, presumably, is that Sinn does not at all differentiate between physical and financial capital, and therefore implicitly equates the return of investment (a physical magnitude) and the rate of interest (a monetary variable).

7 In Sinn’s diagram the gain through EMU (the triangle ABC) is much larger than the loss through ‘overheating’ in the course of EMU (triangle BFG), suggesting a positive net effect of the euro despite the over-accumulation in the south. However, besides the existing interest-rate spreads before and after the euro introduction, this result mainly depends on assumptions about the slopes of the respective MPC schedules.

8 See Feenstra and Taylor (2008, Ch. 5) for a similar figure. They apply this kind of analysis on the gains from FDI through capital reallocation, as well.

9 Landmann (2011) has already pointed at the strange assumption that German invest-ment is impeded by the ‘borrowing spree’ in southern Europe despite globalized capital markets and given GIPS’s relative small size in relation to the world capital supply.

10 ‘Bilateral trade relations appear to be a poor proxy for bilateral financing relation-ships’ (Waysand, Ross and de Guzman 2010: 17).

11 As a minor qualification, it has to be conceded that some agents might be liquidity- or wealth-constrained, which implies limitations for their effective credit demand via the collateral channel.

12 A distinct topic is the ex-post realization of investment plans. In case of binding supply constraints, increased investment spending might result in higher inflation. But obviously, this scenario was not relevant with regard to Germany.

13 More precisely, TARGET2 imbalances reflect any net payment flows between EMU member countries, of any origin (purchasing goods or assets), that are not covered by voluntary credit relations between private banks.

14 National central banks even issued euros on their own account in order to save their commercial banks from severe liquidity problems. This is EMU’s ‘Emergency Liquidity Assistance’ facility, hardly known in the public, which can only be abol-ished by a two-thirds majority of the ECB board (Buiter, Rahbari and Michels 2011).

15 Few know that Sinn once wrote his Diploma Thesis on the Marxist topic of the tend-ency of the rate of profit to fall.


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Documents

18 Sinn after Böhm-Bawerk - uni-hohenheim.de...Eugen von Böhm-Bawerk (1914: 508) 1 Introduction Member countries of the European Monetary Union (EMU) have become enmeshed in a quarrel