It’s the geography, stupid

Central and Eastern European economies aren’t doing well. German IFO business confidence tanks, on expectations of poor export orders. These two facts are related.

It’s been said before that the central core of economics failed to predict the great recession (or damn, can’t we call it a depression already? It’s been four years and it’s depressing enough) and that only a few key groups of people noticed anything unusual. Followers of Hyman Minsky and Charles Kindleberger saw the classic pattern of confidence, mania, panic, and crash unfolding. People who understood the economy as a system of accounts saw a number of huge imbalances in the flow of funds. Marxists considered that the source of the imbalances was the super-exploitation of Chinese workers and the maldistribution of the proceeds of growth in the West.

But I’m not sure if economic geography has been given enough credit. One economic geographer who predicted the crisis is of course Paul Krugman. From a geographical perspective, the CEE economies are part of a huge automotive engineering cluster rather like the US rustbelt or the West Midlands in the UK, reaching over from the Cologne area to Slovakia. (Actually, they always have been since the Industrial Revolution – here’s a beautiful 1938 Tatra and a much less beautiful 1914 Skoda 305mm mortar and caterpillar tractor.) From an industrial economics perspective, they are part of the German motor industry’s global supply chain, whether as upstream suppliers of parts and sub-assemblies or as downstream final assembly contractors. You can argue whether geography or functional specialisation determines this, but that’s not really relevant right now.

To put it another way, they aren’t exporters to “the German locomotive” but rather to the German economy’s customers, at one remove. The determining factor of their order books is how well the final products sell, and in the German economy’s historical default state as an industrial exporter, that depends on somebody somewhere buying more German goods than they sell goods to Germany.

A deflationary adjustment of the eurozone trade balances will be deflationary all the way along the supply chains. This is broadly what I was worrying about in May, 2010. The problem is not quite the same as it was for Keynes in the original Economic Consequences, a book which contains a lot of economic geography – back then, if the Germans were ever going to pay off their debts, Keynes pointed out, the rest of Europe had to let them export enough stuff. Now the boot is on the other foot. If the Greeks are ever going to get out of their debt crisis, the Germans have to let them export enough stuff. And if the Czechs and Hungarians and Baltics are not going to slide back into the mud, the Germans have to import enough stuff from them. Nobody imagines that the Greeks will be importing as many BMWs as they used to, so what can the answer be?