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08.02.2007
Some empirical evidence in support of the bazaar economy theory
In 2005, Hans-Werner Sinn, head of the Ifo economics, published his theory about the bazaar economy in the form of a bestselling book. According to this theory, Germany export success is not the result of an innate strength but a pathological phenomenon, as it reflects a persistent rise in the value-added of German exports accounted for by intermediate imports. Germany has thus developed into a bazaar, where most of the goods are imported, a relatively minor amount of value-added applied, and exported at a profit. What appears to be a competitive export market is in reality nothing but a reflection of Germany's industry's increasing use of oursourcing and offshoring. With this theory, Sinn also tried to explain why there has been negative employment growth in Germany's manufacturing industry despite the rise in exports. As intutitive the theory may be, it is has not been supported by much empirical evidence so far. This working paper is to our knowledge the first serious contribution that claims to have established solid empirical evidence in favour of Sinn's theory.
In trying to address the question of what has caused Germany's rise in export market share since 2000, the authors look at four potential explanation that are widely cited in the debate about the German economy's economic performance.
For each one of them there are some intuitive reasons to suggest that they may well explain why German exports have grown so strongly. Wage moderation is probably the most frequently heard argument. German wage costs per unit of output began to decrease sharply in 1995, and remained at a low level since 2000. Average hourly wage costs have declined persistently until 2003, and have remained at this low level since.
The second explanation relates to the geographical distribution of German exports. In 2005, exports to Asia reached 11% of total exports. German export to oil producing countries were also very strong, which meant that Germany benefited strongly from a recycling of petrol-dollars.
The third potential explanation is a structural shift towards investment goods. If this was the case, Germany would stand to benefit from such a trend, as Germany is a traditional exporter of capital goods. There are indeed some statistics supporting the notion that such a structural shift has taken place.
As far as Sinn's bazaar economy theory goes, the authors note that since the mid-1990s, the share of imported inputs in the export sector increased from 28% to over 42% in 2005, while the share of domestic value-added inputs fell correspondingly. As Germany is geographically closer to the east European markets, it is possible – in the words of the authors – that “to the extent that Germany has taken advantage of this opportunity at a faster pace than other industrial countries, it could have improved productivity and increased its export market share.”
The authors point out that the four possible explanations are not mutually exclusive and may complement each other.
The empirical analysis consists of several time series models of German goods exports, using information on relative cost competitiveness, export demand, capital goods demand, and the structure of production in the export sector. The authors used quarterly national accounts data from 1992 as inputs, and a number of well-specified econometric models using standard inference and estimate methods. I am not going into the technical details, see the paper itself for the econometric analysis.
The results of this analysis are surprising. Wage moderation and the structural shift in export demand, possibly the most widely cited arguments in the policy debate, play only a minor role in explaining the growth of Germany exports. The authors argue that “the prolonged effort in containing costs through wage moderation was significant, but diluted by the appreciation of the euro.” As a result, wage moderation may explain an increase of German exports within the euro area, but not in general. Furthermore, the data show German exports increased both in the euro area and elsewhere in a roughly similar degree, so that something else must have driven Germany's export performance.
The authors are more cautious when it comes to the structural shift. This may well have to do with the fact that the data series under investigation may not have fully captured this effect.
The two dominant factors – in their analysis l – are Germany's strong relationship with fast growing emerging economies, which explains about 40% of faster export growth, followed by Sinn's bazaar effect, which explains 15-20%. The latter is a significant figure, which has led the authors to claim that “the empirical link between value-added and export growth can be viewed as evidence for a more decentralised production process. This interpretation also helps explain why the recent surge in exports did not translate into a significant employment growth in German industry.”
This is obviously not the end of the debate. More empirical evidence is needed to give sustenance to the bazaar theory effect. Also, the most recent in employment growth in the German economy are relative encouraging, despite the fact that in 2006, net exports continued to be the driver of economic growth.
The bazaar economy theory always had attraction that it was both intellectually plausible, and appeared in line with anecdotal evidence from individual companies. This paper has made a serious contribution underpinning this theory with some empirical evidence.
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