Three weeks ago, The Economist diagnosed a „German problem“. The newspaper tends to know my home country quite well. A few months after I had called Germany “the sick man of Europe” on the cover of a research report, The Economist made the label stick by putting it on its own cover in June 1999. But today, contemplating the surge in German Ifo business confidence to a new record high while a sleek ICE train is whisking me from Berlin-Spandau to Hamburg in just 91 minutes, it takes an effort to detect a German problem. Record employment, rising living standards, price stability, a small fiscal surplus, dull political stability and a rebounding birth rate to boot – except for an unusually rainy summer, Germany itself seems to be in decent shape. Of course, The Economist refers to Germany’s current account, arguing that an excessive German penchant to save “is damaging the world economy”. As a result, the newspaper asks the German government to “help by spending more”.
WHAT DRIVES THE EXTERNAL SURPLUS?
Let us start with the basic facts. After a swing from a current account deficit of 1.8% of German GDP in boom year 2000 to surpluses of 1.3% in 2003, 5.5% in 2008 and a record 8.9% of GDP in 2015, the partial rebound in oil prices and stronger import growth has narrowed the balance to 8.3% in 2016 and an estimated 7.4% of GDP in the first half of 2017. Whereas Germany’s surplus with other Eurozone countries has come down from a record 4.1% of German GDP in 2007 to 1.9% last year, the surplus with non-Eurozone countries has risen sharply.
Taken together, the three major sectors of the German economy – households, companies and the public sector – are spending less than they earn and saving more than they invest at home. Who is the main culprit?
• Overly prudent households who just don’t know how to enjoy life are not to blame. With a savings rate of 9.7% of disposable income in the last two years, German households are saving as much as they have done on average for the last twenty years (9.8%).
• The government sector is part of the story. Taking the OECD definition of general government finances, the German fiscal balance has swung from a deficit of 4.0% of GDP in 2003 to a surplus of 0.8% in 2016 whereas the OECD as a whole merely improved its fiscal balance from -3.6% to -3.0% of GDP over the same period.
• That leaves the corporate sector. Stronger corporate balances explain at least half the change in Germany’s current account since the early 2000s. German companies are spending less at home than they earn.
Among the components of aggregate demand, the strength of corporates shows up in an increase of net exports from 3% of GDP in 2003 to 6% in 2016 whereas the share of consumption fell from 59% to 55% while the share of investment held roughly steady at around 20%.
ARE THESE PROBLEMS FOR GERMANY?
Arguably, the lower share of consumption in GDP could be seen as a problem for Germany. Its consumers could enjoy a better life today if they were to spend more. However, record employment, political stability, ongoing gains in real wages and today’s rise in GfK consumer confidence to a post-2001 high do not suggest that German consumers or workers believe that they are making the wrong choices, or that government has made the wrong choices for them. The Agenda 2010 reforms of 2003/2004 turned Germany into a much better place to create jobs. In the subsequent rebound in employment, German workers did not always ask for wage hikes fully in line with the improving outlook. That allowed companies to strengthen their balance sheets and create more jobs. But the implicit deal between labour and corporates cut both ways: when German GDP tanked by 5.6% in 2009, few workers were fired. Financial cushions and some well-targeted public spending helped companies to take the hit without letting workers feel much pain. As a result, workers do not tend to see their choice, namely enhanced job security in return for not fully exploiting any short-term leeway for higher wages, as being bad for them.
On the corporate side, the German surplus could potentially be seen as a German problem if the penchant of German companies to spend some of their surplus abroad would be hurting Germany. However, it is hard to find much evidence of macroeconomic relevance for that. On top of record employment, the rise in GDP per capita as the broadest measure of productivity by 15.5% since 2005 far exceeds the 9.7% average gain in the OECD. Ever since the Agenda 2010 reforms started to work, companies have invested enough in Germany to deliver above-average results for the German population. In this sense, the German economy does not suffer from an investment shortfall.
Observers urging the German government to embark on deficit spending today duck one major question: what’s wrong with a small fiscal surplus when the economy is expanding at an above-trend rate? Isn’t that exactly what Keynes would have recommended? Berlin does not see the fact that the US and the UK are pursuing a less prudent fiscal policy as a problem that Germany has to address. Of course, the contrast between deficit-funded demand abroad and a sustainable fiscal policy in Berlin is reflected in the current account. Incidentally, Germany’s fiscal gains since the early 2000s are not primarily the result of any harsh austerity. Instead, they mostly reflect the major upturn in the labour market caused by the “Agenda 2010” reforms: as the number of people earning enough to pay into the welfare system has surged by 22% since early 2006, the fiscal accounts have swung into a small surplus. For all those who love these incomprehensibly long German words, check the statistics on “sozialversicherungspflichtige Beschäftigung”.
Whether or not the German government is spending enough on infrastructure is the subject of a heated debate between economists from the left, the right and the centre. Spending two thirds of my working time travelling through Germany, Europe and the US, I can only add one observation: the public infrastructure in Germany does not seem to be in worse shape than elsewhere. To give an extreme example: the World Bank even ranks Germany as No. 1 out of 160 countries for the quality of trade and transport-related infrastructure in its 2016 Logistics Performance Index. An alleged systematic underspending on public infrastructure cannot explain Germany’s fiscal balance and its current account surplus.
WHAT’S WRONG WITH CREATING JOBS ABROAD?
So far, I have argued that the state of the German economy including a current account surplus that seems to have peaked anyway is not a problem for Germany. But is it a drag on global growth, as The Economist argues? More precisely, is it such a global problem that the German government ought to override the apparent preferences of its citizens for fiscal prudence and job security and force a public deficit and higher labour costs down their throats?
If the world suffered from an acute shortfall of global demand, a German reluctance to add to demand through counter-cyclical policies could be a genuine global concern. If Germany hadn’t embarked on a well-targeted fiscal stimulus in 2009, the world would have had a genuine reason to complain. However, with full employment in the US, the UK, Germany, Japan etc, the world does not seem to be stuck in such a Keynesian situation today. To improve the global economic performance, we need to focus on supply more than on demand.
The domestic financial surplus of the German corporate sector means that, on top of creating a record number of jobs at home, German companies are also investing and creating jobs abroad. Many of these jobs are well-paid manufacturing jobs. What’s wrong with that? German companies add to supply abroad. Would the US, the UK or Spain really be better off if German companies were to invest their surplus at home, adding to the German employment boom, instead of investing abroad? If German car companies were to erode their surplus by paying their German workers much higher wages at home, some German tourists may indeed part with even more money in Disneyland or on Mallorca. But would that really benefit US workers, for whom German car companies may create fewer jobs if they have less savings to export? Also, if Germany saves less, borrowing cost for Spain and other countries might rise.
Germany’s current account surplus looks set to shrink over time anyway:
• We expect the advance in real imports (up 4.0% on average per year in the last four years) to continue to outpace export growth (3.3% per year during that period).
• The rising number of German retirees will likely draw down some of the savings they have stashed abroad over time.
• Reflecting the comparatively strong German labour market, labour costs in the German business economy have risen by a cumulative 15% from 2010 to 2016, far outpacing the 8.8% gain elsewhere in the Eurozone.
As the adjustment seems well underway, the case for accelerating the process artificially looks weak. Germany has to absorb roughly a million recent arrivals. Any advice that the government should intervene in the private sector wage setting process to artificially raise labour costs and hence barriers to labour market entry for those often unskilled people should be taken with a big pinch of salt.
A CASE FOR MORE PUBLIC SPENDING?
Of course, the German government could usefully spend more on infrastructure, the digital economy, defense, child and nursing care. However, Berlin is already doing so. Every country has some problem areas. In Germany, the real infrastructure issues are typically on the regional and local level (bumpy local roads, leaking school roofs and the like). The federal government is not in control of such local spending. Over recent years, Berlin has already diverted further tax receipts to the federal states to enable them to spend more and pass on more money to the municipalities. The real bottleneck in Germany is not lack of money. Instead, lengthy bureaucratic procedures needed before projects can be started prevent a faster pace of infrastructure spending. Significant sums of money that have been designated to projects are not actually spent because of time-consuming procedures.
All in all, Germany is already stepping up its public spending. For example, nominal government consumption has risen by an average of 4.3% in the last four years, well ahead of the 3.2% average gain in nominal GDP. That Germany is raising public spending gradually over years rather than in a sudden surge has two advantages. First, it doesn’t bust the budget as it can be financed by rising tax receipts stemming from strong employment gains. Second, the money is more likely to be spent well if projects are examined on their merit instead of being approved simply because the extra outlays would help to attain a fiscal deficit.
THE REAL GERMAN PROBLEM
It’s not the current account. The real German problem is different: success breeds complacency. Reaping the rewards of its “Agenda 2010” reforms, Germany has not introduced many further pro-growth reform since the 2010 decision to gradually increase the pension age to 67 masterminded by then SPD-minister Franz Müntefering. Germany continues to enjoy a golden decade. But like a top athlete who is no longer training as diligently as she used to in the past, Germany will likely fall back slowly but surely over time. Instead, we expect France to deliver serious reforms similar to those that cured Germany’s erstwhile malaise from 2004 onwards. If so, France can overtake a complacent Germany and a Brexit-stricken UK as the most dynamic major economy in Europe in a few years and enjoy a golden decade in the 2020s.