I recently wrote a letter to the firm’s clients (see also my October 17^th blog post) in which I derided Germany’s longstanding antipathy towards any kind of fiscal expansion to help spur growth in the eurozone.  Germany’s economic strategy (and yes, it is Germany that sets the zone’s overall strategy) consists of encouraging structural reforms, tight fiscal discipline and modest monetary easing.  It is not working.

To be fair to Germany, structural reforms are needed in the eurozone, especially as they relate to labor market reforms. France currently has 10.4% unemployment rate and Italy and Spain are not far behind.  Youth unemployment in these countries is far worse, topping almost 50% in Spain. This is a travesty.

What are structural reforms as they relate to the labor market? They basically consist of changes to labor market policies and regulations to increase the productivity of workers, facilitate more robust hiring (and firing) of employees and improve the overall functioning of the labor market.  Germany argues that they undertook a series of labor market reforms, the so-called “Hartz reforms”, introduced between 2003 and 2005, which they and many others attribute to the country’s relatively good recent labor market performance. The unemployment rate in Germany is only 4.9%, for example, despite very weak GDP growth.

How did this happen?  Martin Wolf of the Financial Times points out in a recent excellent article (see “Reform Alone is No Solution to the Eurozone”) that the labor market reforms “encouraged the sharing of a large negative shock across the population via stagnant or even falling real earnings”.  In plain English, the reforms helped German companies keep their employees employed during a time in which it might have been easier to simply shed workers.

Wolf goes on to point out that while the reforms have helped to keep German unemployment from exploding, they did not create dynamic aggregate demand.  Between the second quarter of 2004 and the second quarter of 2014, Germany real domestic demand grew and a compound annual rate of only 1 per cent. In fact, during this period, Germany became heavily dependent on foreign demand, running ever-higher current account surpluses (i.e., exporting more than importing).  This cannot be a recipe for growth for the entire eurozone as the rest of the world would not allow the eurozone as a whole to run such an enormous current account surplus.

I agree with Mr. Wolf that labor market reform is needed throughout the eurozone (in Italy, you practically have to go to court to lay off a person), but that a better bargain is needed between more reform and more fiscal stimulus.