21 October 2014

Germany: the Wunderkind is ageing


Germany was rightly considered the “sick man of Europe” when the Euro was launched in 1999. But when the Euro-banking-debt-competiveness-crisis broke out, the German economy miraculously emerged as a “Wunderkind”. After a short and deep decline of production in 2009 employment kept increasing to record highs; exports to emerging markets were back on the fast track and the treasury for the first time in decades registered a budget surplus.

The German economy looks still comparatively robust – but only comparatively, and perhaps not for that much longer. Finance ministers and the unemployed young in Greece, Portugal or Spain still have reason to look at Germany with a mix of envy and respect. Politicians from Italy and France still look at Germany with a mix of bitterness and reproach. But they all (together with ECB chief Mario Draghi) are anxious for the German economy to remain strong, not only to pull the entire Eurozone into prosperity but also to keep standing by as guarantor of the European bail-out funds.

If the EU were the old communist Council for Mutual Economic Assistance (Comecon) the German economic planning board could be told to buy more goods from the European “brother nations” and Siemens could be told no longer to compete with EU partners. But we live in 2014: with European businesses competing for profits world-wide and European politicians competing for votes in their domestic constituencies.

These basic issues seem to be ignored in political debates that imply a collectivistic view of the economy and society, and that relies on Germany’s economic power for medium and long term support. There are many reasons why Germany may not really be and remain the “fit man of Europe”. Some have to do with domestic policy, some with demography, and others with international economic dependency.

The German economy already now shows clear signs of weakening. The second quarter of this year saw a 0.2% decline in GDP; German business sentiment fell for a fifth straight month in September to its lowest level in 17 months and manufacturing orders dropped 5.7pc during August to the lowest level since May 2013. Most observers put these difficulties down to geopolitical tension, in Ukraine, Russia and the Middle-East. While this surely explains the dramatic 5.8% slump in exports over August, problems started before the situation in Ukraine really flared up. And they are going to stay and grow stronger.

Much of the resilience of the German economy during the last years can be attributed to harsh reforms of labour markets and social security, introduced by the social democrat chancellor Gerhard Schröder in 2003. The new “grand” centre-right/centre-left coalition lead by Angela Merkel has rolled back many of these reforms by reintroducing early retirement schemes, extra pensions for mothers and installing a legal minimum wage €8,50/ hour in all sectors and regions of Germany.

The German government has just been forced to admit that the “one-size-fits-all” minimum wage will increase labour costs by €10 billion. How many jobs will be lost next year remains unclear, but many regions in East Germany and occupations such as taxi-drivers, hair-dressers or florists will be hit.

The new pension benefits come with an overall price tag of around €200 billion (until 2030); early retirement already now takes around 250,000 elderly off the job market at a time when skilled and experienced labour is becoming increasingly scarce and valuable.

Demographic decline will be Germany’s greatest challenge in the long run: the coming decades will see Germany’s workforce shrink by about 200,000 (more than all inhabitants of lovely Heidelberg) every year. The old-age dependency ratio (between those older than 65 and those of working age) could rise from 31% in 2013 to 57% in 2045 (EU Commission 2002). Net-migration of around 400,000 per year could help avoid the dramatic demographic decline, but it remains politically unrealistic.

So where else does Germany’s future economic growth – bitterly needed to pay pensions and somehow rescue the Eurozone – need to come from? The answer is: productivity, innovation and smart investment. Labour participation, productivity and ingenuity need to increase dramatically.

However, Germany’s productivity growth is lagging behind almost all other economies in the world (it was a mere 0.3% a year from 2007 to 2012; compared to 1.5pc in the US according to OECD).

The established German Mittelstand and some big exporting firms are still good at innovations. However, Germany holds a dismal 111th place in the World Bank’s ranking for “ease of starting a business”; Germany’s service sector is critically underdeveloped and overregulated, and the country’s education system fails to produce enough matching skills.

The IMF, the European Commission, the ECB and many others are rightly complaining that there is far too little public and private investment in Germany.

That does not mean that the German government should abandon its balanced-budget “austerity obsession” and adopt a Keynesian policy of “chopping up the apple trees for firewood” instead. The Merkel government needs only the courage to re-allocate public expenditures from consumption (welfare) to investment (education, research, infrastructure), provide better regulatory and tax environments for private domestic investment and lower barriers to entry to its service sector.

Why is there so little private investment – when interest rates for investors are at a record low? There are many reasons. One is a macroeconomic truism: the German export surplus is only possible because of excess domestic savings that go abroad and are not invested at home. Another is that German exports are not really great in terms of domestic value-added – large parts are produced in other parts of Europe and the world with less regulatory and tax burdens.

Domestic industrial investment is also increasingly discouraged by the government’s romantic folly of the “Energiewende” – a “lonely revolution” to wean the country off both fossil and nuclear energy. This may cost consumers, tax-payers and business up to one trillion euro over the next two decades, according to Peter Altmaier, the former environment minister. German average electricity costs are now more than double those in the U.S, despite the fact that German greenhouse emissions have increased.

German entrepreneurs are perhaps more conservative, cautious and long-term-oriented than their Anglo-Saxon competitors. They see a German government resting on its laurels, being too conservative, cautious and short-termist. This is why they  look for better places in the world, where in the future there will be more skilled labour, productivity and economic freedom.

To sum up: Germany is doing fine – comparatively and still. But this is unlikely to last. Do not bank on Germany!

Michael Wohlgemuth is an economist and Director of Open Europe Berlin