How can Export Success be Bad for a Country

An interesting working paper on German export boom; The Pathological Export Boom and the Bazaar Effect - How to Solve the German Puzzle by Hans-Werner Sinn;

“Germany is the laggard of Europe, yet the country is world champion in merchandise exports. The paper tries to solve this theoretical and empirical puzzle by diagnosing a “pathological export boom” and a “bazaar effect”. Excessively high wages defended by unions and the welfare state against the forces of international low-wage competition destroy too big a fraction of the labour intensive sectors and drive too much capital and labour into the capital intensive export sectors, causing both unemployment and excessive value added in exports. Moreover, excessive wages induce too much outsourcing of upstream production activities which implies that export quantities grow too much in relation to value added contained in exports. Finally, excessive wages cause capital flight resulting in a too large current account surplus.”

The latest 'Selected Issues' on Germany from the IMF gives a summary of the paper;

“Sinn’s thesis is that rigidities cause a suboptimal allocation of resources and especially labor underutilization. Globalization represents a competitiveness shock but with wages and labor markets sluggish to respond, labor intensive exporting sectors (such as textiles) fail, releasing surplus labor into the market and causing unemployment to rise. (These failures also free up capital hitherto employed in these sectors.) At the same time, capital- and skill-intensive sectors (e.g. engineering) also replace labor with capital or outsource or offshore standardized production layers to abroad, further contributing to labor surplus.

The freed-up labor in either sector is not absorbed in the services sector because wage costs are too high and labor mobility tends to be too low. High domestic unemployment therefore causes downward pressure on wages and slow domestic consumption and other household demand (such as for residential construction). Capital from failing companies or new investment in capital intensive sectors largely moves abroad to be combined with less expensive labor there.The large current account surplus thus does not so much reflect exceeding export prowess, but rather domestic weakness and the export of capital. Because adjustment in the domestic labor market is drawn out, specialization in capital-intensive/exporting sectors overshoots, and investment and employment in domestic service oriented sectors undershoots. In this view, the large current account surplus is a sign of insufficient opportunity for profitable investment in the nontradable sector.”

See also the following op-ed by the author (hat tip to Mahalanobis);

“Astonishingly, many interpret Germany’s export boom and current-account surplus, which measures these capital exports, as an indicator of the strength of Germany as an investment location. But, according to the Bundesbank, net investment abroad (including financial investment) has already roughly matched domestic investment in recent years…”