Economics / History

Aggregate Demand Dominance: Berlin’s Favelas

I’m not kidding—the disparities in Germany have become so acute that Berlin is ringed with favelas. The German media already recognizes this disturbing development:

The Cuvrybrache: Berlin Favela

 Between ... Silesian road, Cuvrystraße and Spree has arisen this winter a shanty town. Drop-outs meet up with refugees and migrant workers. Photo: William Veder

Between … Silesian road, Cuvrystraße and Spree has arisen this winter a shanty town. Drop-outs meet up with refugees and migrant workers.

Photo: William Veder

I witnessed these signs of incredible German disparity firsthand, even before entering Berlin’s city limits. Taking the ICE train from Frankfurt to Berlin, my interests in all things economic and historical led me to keep a keen eye out for the differences after the train crossed over the former location of the Inner German Border—the 866 mile long fortification that separated East and West Germany until 1990. Something told me I would be seeing quite a bit of this:

As soon as the train crossed over the IGB, burned out and abandoned buildings became a noticeable sight even as ICE travels at over 200 km/hour. Granted, I couldn’t determine what the buildings I saw were or why they were abandoned, but beyond the appearance that the former country of East Germany used the same drab building design for absolutely everything the fact that these photos come from a site entitled should set off alarm bells in the minds of economists as Berlin is suffering from an acute shortage of affordable housing.

As the train entered the outskirts of the sprawling city of Berlin, tiny houses far smaller than the mobile American versions that pervade trailer parks became the norm. Most strikingly, the paths between these minuscule German homes were all dirt paths—no pavement was in sight other than the frontage roads along the train line. The tiny houses look very ad hoc; almost as if the residents had been forced to throw together what passes for lodging in an overcrowded, supremely expensive city.

I suspected this wasn’t an isolated occurrence, which was confirmed when the same abandoned buildings became ever-present on the train ride out of Berlin and giving way to the tiny ubiquitous wannabe trailers surrounding the city of Leipzig. Upon further research, the whole of the former DDR appears to be blighted:

In the former German Democratic Republic (East Germany), many towns have simply never recovered from the post unification economic collapse of two decades ago.  The landscape east of the Elbe River and especially along the East German Baltic coast is now dotted with virtual ghost towns where very few inhabitants and almost no economic activity remain.  Numerous abandoned buildings are falling into ruins, as in Detroit.

What is the cause of the East German blight, one might ask? Or is it not a what, but a who? The answer sends shudders through millions of Germans—Volkswagen’s former personnel director, Peter Hartz.

Hartz IV

Dean Baker of the Center for Economic and Policy Research (CEPR) has a high opinion of the German experience with work sharing:

Work sharing has been used successfully elsewhere. Germany’s unemployment is 1.5 percentage points lower today than it was at the start of its recession. This is not due to Germany’s growth performance, which actually has been somewhat worse than the U.S. Rather, the difference is that Germany has been successful in persuading employers to keep workers on the job, even when this has meant a shortening of hours.

I hate to rain on Baker’s parade, but it appears that work sharing in Germany has a dark underbelly:

The German low-wage sub-economy has a name: it is called Hartz IV, named after the former personnel boss of the Volkswagen concern, and enacted into law under the auspices of the former Social Democratic Chancellor Gerhard Schröder — with massive complicity from the neo-corporatist German trade unions — and successively amended several times, thus accounting for the IV.  German working people have just completed their eleventh year under the yoke of Hartz, which came into full effect in January 2003, and has been expanded and perfected by Europe’s reigning austerity enforcer, Christian Democratic Chancellor Angela Merkel.

Dr. Webster Griffin Tarpley doesn’t mince words in describing Hartz in no uncertain terms:

Hartz wanted to prevent these millions of unemployed workers from collecting their full jobless benefits over an indefinite period, as was often the case before 2003.  His response was to design a system which shunted unemployed workers off the unemployment insurance rolls and onto the welfare rolls after about one or two years, depending on their age, and to impose a stringent low-wage workfare requirement on these welfare recipients.  Workfare means that welfare victims are required to work for their benefits, often functioning as strikebreakers, and always contributing to a race to the bottom in labor conditions.  The workfare requirement, in the opinion of some, amounted to the institution of a kind of slave labor.

Slave labor—that’s kind of harsh, isn’t it…

As Hartz IV currently functions, even a unionized worker making a decent wage of €30-€40 per hour will, if laid off, within one to two years find himself or herself as a social welfare (Sozialhilfe) case, and therefore no longer counted among the unemployed.  At this point, the worker in question is, if single, eligible to receive a monthly basic payment of €391 per month.  But this allowance is means-tested, and requires proving that personal assets are below a mere €3,100.  In addition, between €200 and €300 in housing allowances may also be available.

In exchange for these meager payments, the unemployed worker comes under the control of the local Agentur für Arbeit or labor agency.  These labor agencies, unlike the old Arbeitsämter or employment offices are no longer primarily government institutions, but now represent for-profit private companies functioning as what could be called labor brokers.  The Hartz IV recipient is, within certain limitations, required to take any job which the labor broker demands be filled.  If the recipient refuses, this can lead to a total denial of future benefits.  The labor broker can also demand that the recipient do certain things to become more marketable, such as taking training courses to acquire certain salable skills.  Jobs obtained in this way are not likely to be permanent employment, but are rather more frequently so-called mini-jobs or midi-jobs.  Any wages arising from such substandard employment are partially subtracted from the basic monthly maintenance payment, and are also subjected to taxes and insurance payments.  In any case, these wages are likely to be very low.  Incredibly enough, Germany still has no law establishing a minimum wage.

Well, it’s not like a minimum wage is that useful when powerful labor unions set wages…

These profit-driven labor brokers work closely with the Werkleistungsfirmen, which are low-wage subcontractors of the corporate sector.  These subcontractors have entered into agreements with private corporations to provide certain services.  The subcontractors work for the famous names of German export industry like Volkswagen, Mercedes Benz, BMW, Siemens, and many others.  Sometimes these subcontractors occupy specially designated spaces inside the plants of the larger corporations, and these special low-wage areas are often marked off by a yellow line.  This is doubly ironic, since yellow is associated in many European languages with scab labor and other antiunion tactics.  Workers inside these yellow zones are not represented by trade unions, and are more or less at the mercy of whatever the subcontractor wants to demand.  It might be more accurate to say that the inmates of the yellow zones have been abandoned by the trade unions.

This arrangement often leads to a situation along the lines of the following hypothetical example.  Let us assume that a famous German company pays its unionized workers €40 per hour. At the same time, this company contracts with Hartz IV subcontractors on the basis of €20 per hour for the labor of Hartz IV recipients.  The subcontractor deducts a commission of five euros per hour from this €20 per hour fee. The labor broker then deducts another five euros of commission.  The Hartz IV worker is then left with €10 per hour, from which applicable taxes and various fees then have to be deducted.  To complete the cycle of exploitation, whatever the Hartz IV worker is paid results in a reduction of the €391 basic monthly payment.

What an ugly, cruel, criminal, inhuman mess:

According to the most recent statistics for early 2014, the German unemployment rate is officially about 5.1%.  This is great public relations, but it is also completely deceptive.  The simple fact is that no one really knows how many of those who are actually unemployed and underemployed have simply disappeared into the Kafkaesque labyrinth of Hartz IV.  Estimates from knowledgeable observers gathered by the present writer range from 11,000,000 to 18,000,000 victims of Hartz IV.  This is Merkel’s Gulag.
Given the immense size of the Hartz IV human junk heap, it is not surprising that this system has contributed much to the pessimism, despair, and anger which have played an increasing role in German politics.  Hartz IV has distorted German society in ways which will not be easy to roll back.  One area of long-lasting damage is the sharp increase in income inequality and disparity of economic incomes, a question which is in the center of public attention in many countries right now.  An April 2012 OECD report found that “Germany is the only [EU] country that has seen an increase in labor earnings inequality from the mid 1990s to the end 2000s driven by increasing inequality in the bottom half of the distribution.”

In other words, Germany’s economy is rapidly becoming Americanized, and not in a good way. The relentless drive to suppress wages has introduced Germany to the American concept of temp agencies, only worse. I would say that this system has the potential to foment insurrection and revolution:

Just 29 million of Germany’s nearly 42 million workers have jobs with full social benefits. Some 5.5 million men and women work part time, and 4.1 million earn less than €7 an hour. There are 4.5 million people dependent on Hartz IV, including 1.4 million who have work but still cannot earn enough to cover their living expenses.

The low-wage sector in turn serves as a lever to drive down wages in the rest of the economy. In the last decade, increases in unit labour costs in Germany have been minimal; the country is at the bottom of European tables in this respect.

A question does arise—where does the drive to suppress wages come from? I turn back to Dr. Webster Griffin Tarpley for the answer:

These high jobless levels are themselves a reflection of the slowing of world economic progress in the decade after the demolition of the highly successful 1944 Bretton Woods system, which was terminated by Nixon and Kissinger on August 15, 1971.

Do Economists Know Economic History?

No, not really. What is it with economists and the wrong dates? Bretton Woods came crashing down between 2 March and 19 March 1973, not in 1971. Why, pray tell, did Bretton Woods crash? Mark Thoma?

The classic story for how this works comes from the 1970s, a time when workers had much more bargaining power than they have today, and a time when the Fed that didn’t understand the nature of the wage-price spiral problem. In this story, unions would demand higher wages, and this would slow the economy and increase unemployment.

The Fed would respond by expanding the money supply sufficiently to reverse the employment losses, and the expansion in the money supply would drive prices higher. As prices increased, the gains that unions had obtained for workers were reversed, and unions responded by demanding even higher wages to regain what had been lost. At this point, we are back to the beginning of the story and the process repeats itself.

Ah, the classic wage-price spiral. Nope. Wages had nothing to do with the inflation spike in 1973:

What no one understood at the time was that economic conditions had undergone a profound and dramatic change. The cycle of wage-driven price hikes had been broken during Phase II. But government and private forecasters uniformly failed to recognize that demand had begun putting such severe pressure on supplies that within a matter of months, prices of virtually all commodities — food-stuffs, minerals and petroleum — would explode, reaching historic highs. The rate of inflation shot up to 11% by the summer of 1973, leaving Phase III in shambles.

Phase II, by the way, ended 11 January 1973, two months before Bretton Woods collapsed. If the “wage-price spiral” (what I’m about to mention will demonstrate the concept is a disastrous myth) didn’t kill Bretton Woods, what did? Singapore? Will you do the honors?

There was hope that the Smithsonian currency alignment in December 1971 would work for some time.  The U.S. dollar gained strength in the second half of 1972.  Unfortunately, after a heavy speculative attack on the dollar it was suddenly devalued on 12 February 1973 for the second time after World War Two.  This time, it was devalued by 10 percent, as the official price of gold was increased from US$38 per oz fine to US$42.22.  Soon after the second devaluation, there was another heavy speculative attack on the dollar so much so that foreign exchange markets all over the world had to be closed from 2 March for seventeen days.  When the exchange markets were reopened, the major currencies of the world including the US dollar,  Deutsch Mark, Japanese Yen, Pound Sterling, French Franc, Dutch Guilder etc. were all floating.  The world was now in a floating exchange rate system  as a revolt against the IMF fixed exchange rate system.

The gold standard collapsed under its own weight. Specifically, it was fatally flawed from the outset. The British-enforced gold price control of £4.25 per troy ounce lasted 228 years, unchanged, from 1717 to 1945. The severely undervalued price of gold only rose significantly above the controlled price during specie suspension from 1797 to 1821 due to the Napoleonic Wars and the full-on suspension continued by all belligerent powers except the United States after World War I before almost every nation on Earth “abandoned” the gold standard during the Great Depression. “Abandoned” is in quotation marks because the price control didn’t disappear–the United States revalued gold in 1933, setting the new world standard for price controls.

Bretton Woods codified the American gold price control of $35 per troy ounce (set in 1933 over the previous $20.67 per troy ounce control set in 1834). Bretton Woods broke under the weight of the most massive bombing campaign in history–the United States Air Force, Marine Corps, and Navy dropped 7.6 million tons of ordnance on Cambodia, Laos, and Vietnam from 1964 until 15 August 1973. Just for reference, the U.S. military expended 2.1 million tons of ordnance combined on Germany, Italy, Japan, Axis-occupied territories and the Axis Powers’ military units during World War II.

So…how does this lead to a general drive to suppress wages worldwide? There could be any number of reasons, but the “wage-price spiral” myth might be a good place to start. What better way to avoid (phantom) inflation driven by wage-based price increases than to never permit wages to rise? I’d argue not imposing centuries of ill-advised price controls and engaging in Earth-shattering warfare might be a better method to control inflation; but to prove that I might need to go into more detail…


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