13 October 2014

Sick German economy is dysfunctional, divisive and dangerous


When Germany lifted the World Cup this summer, the whole country rejoiced to “Deutschland über alles”. Its sporting triumph seemed to mirror its economic success: insofar as there really is a “global race”, Germany seemed out in front. Politicians and pundits of all stripes praise the Rhineland model. In Britain, Labour leader Ed Miliband’s economic strategy seems to consist of trying to emulate Germany. Even Conservatives who normally look to Washington for inspiration have turned to Berlin, with the government introducing German-style apprenticeships.

German policymakers believe the hype. Finance minister Wolfgang Schäuble boasts that Germany has Europe’s most successful economy. Upon her re-election last year, Chancellor Angela Merkel declared: “What we have done, everyone else can do.” Not just can do, must do: Germany is using its clout over EU institutions to try to reshape Europe’s economies in Germany’s image. But far from being successful, Germany’s economy is dysfunctional – and trying to impose its model on the eurozone is dangerous for Europe and damaging for the rest of the world.

If you drive a Volkswagen or an Audi and have a house full of Bosch (or Miele) appliances, it is easy to leap to the conclusion that Germany’s economy as a whole is a hot ticket. But appearances can be deceptive. Germany also suffers from stagnant wages, broken banks, insufficient investment, poor productivity growth, dismal demography and sluggish growth. Merkel’s mercantilist growth model, which involves suppressing wages to subsidise exports, is beggaring Germans as well as their neighbours.

Back at the euro’s launch in 1999, Germany was dismissed as the “sick man of Europe”. Bloated, overtaxed and overregulated, its economy was stagnant, with four million unemployed. The German myth is that thanks to Chancellor Gerhard Schröder’s labour-market reforms a decade ago, it has become a world-beater. But while it is true that unemployment has plunged as millions of Germans found low-paid, often part-time “mini-jobs”, the rest of its economic record is unimpressive.

Germany’s economy shrank in the second quarter and data since then suggest it remains poorly. Since the crisis struck in early 2008, it has grown by only 3.6%, a bit more than France or Britain, but only half as much as Sweden, Switzerland and the United States, the epicentre of the financial earthquake. Since 2000, GDP growth has averaged only 1.1% a year: 13th out of the 18 countries in the eurozone and behind Britain (1.5%) and America (1.7%) too.

Germany has not become more dynamic since the sick-man era; it has simply cut costs. Businesses have stopped investing and so has the government. Investment has plunged from 22.3% of GDP to 17% in 2013: lower even than in Italy. After years of neglect, infrastructure is crumbling: highways, bridges over the Rhine, even the Kiel Canal, a crucial trade artery that connects the North Sea to the Baltic. The education system is flagging too: the number of its much-vaunted apprentices is at a post-reunification low, the country has fewer young graduates (29%) than Greece (34%), not to mention Britain (45%) and its top-rated university ranks 49th globally.

Handicapped by underinvestment, Germany’s sclerotic economy struggles to adapt. Despite Schröder’s reforms, it is harder to lay off a permanent employee than anywhere else in the OECD. Starting a business is a nightmare: Germany ranks 111th place globally, behind Albania and Senegal, according to the World Bank’s Doing Business rankings. Its big firms are all old and entrenched; there is no German Google; its nearest equivalent, SAP, in business software was founded in 1972. The services sector – over three-fifths of the economy – is particularly hidebound. Productivity in those sectors – everything from transport and telecoms to retail and restaurants – is often dismal, not least because they tend to be tied up in red tape. Regulation of professional services is stricter in Germany than in all but five of twenty-seven countries ranked by the OECD. In the liberal professions, which account for a tenth of the economy, rules dictate who may offer what sort of service, the charges allowed for professionals and how they may advertise. For example, only qualified pharmacists can own a pharmacy, and they are limited to four. Other shops may not compete, even for non-prescription drugs. The government has also become complacent, introducing fewer pro-growth reforms over the past seven years than any other advanced economy, according to the OECD. The upshot is that productivity growth has averaged only 0.9% a year over the decade, less even than in Portugal.

German workers have paid the price for this poor performance. Starting with a corporatist agreement between government, companies and unions, wages have been artificially held down. Thus while German workers’ productivity has advanced by 17.8% over the past 15 years, their pay has actually fallen (after inflation). Perversely, Schäuble and others celebrate this wage stagnation as part of Germany’s superior competitiveness. But countries are not companies: while a business owner may wish to minimise wage costs, for society as a whole wages are not costs to be minimised but benefits to be maximised, provided they are justified by productivity. Suppressing wages also harms the economy’s longer-term prospects, because it erodes incentives for workers to upgrade their skills and businesses to invest in going upmarket.

Stagnant wages sap domestic demand, leaving Germany reliant on exports to grow. And they have done, doubling since 2000, subsidised by Germans’ artificially low wages. The euro has also provided a triple boost: it has been much weaker than the Deutschmark, it has prevented French and Italian competitors from devaluing and until recently it provided booming export markets in southern Europe. Germany has also been lucky: its traditional exports – capital goods, engineering products and chemicals – are precisely those that China has needed during its breakneck industrial development since the turn of the century.

But with southern Europe now in a slump and China’s growth slowing and shifting towards services, the German export machine is sputtering. Exports fell by 1% in the year to August. Germany’s share of global exports is down from 9.1% in 2007 to 8% in 2013, as low as in the sick-man era. Since cars and other exports “made in Germany” now contain many parts and components produced in central and eastern Europe, Germany’s share of global exports is at a record low in value-added terms.

Germany’s export obsession has resulted in a whopping current-account surplus of $278.7 billion in the year to July, dwarfing even China’s ($164.8 billion in the year to the second quarter) and approaching 8% of GDP. Schäuble and others view this as emblematic of Germany’s superior competitiveness. But if Germany is so competitive, why don’t businesses want to invest there?

This huge surplus is in fact a symptom of a sick economy. Stagnant wages swell corporate surpluses, while subdued spending, a stifled service sector and stunted start-ups suppress domestic investment, with the resulting surplus savings often squandered overseas. A study by the DIW economic research institute in Berlin suggests that Germany lost €600 billion, the equivalent of 22% of GDP, on the valuation of its foreign portfolio investments between 2006 and 2012.

While compressing wages to subsidise exports is bad for Germany, it is disastrous for the rest of the eurozone. Far from being an “anchor of stability”, as Schäuble claims, Germany spreads instability. German banks’ recklessly bad lending of its excess savings to southern Europe financed property bubbles in Spain and Ireland, funded a consumption boom in Portugal and lent the Greek government the rope with which to hang itself, and since the bubbles burst Germany has exported debt deflation. Nor is Germany a “growth locomotive” for the eurozone: on the contrary, its weak domestic demand is a drag on growth elsewhere. Perversely, this makes it less likely that German banks and taxpayers will recover their loans to southern Europe.

Foisting the German model on to the rest of the eurozone makes matters worse. It is a myth that wages in southern Europe are too high: they fell as a share of GDP everywhere in the pre-crisis years. Slashing them depresses domestic spending and make debts harder to bear. With global demand weak, the eurozone as a whole cannot rely on exports to grow out of its debts. For struggling southern European economies whose traditional exports have been undercut by Chinese and Turkish competition, the solution is not to try to produce the same old products at much lower wages, but rather to invest in moving up the value chain and produce new and better products for higher wages.

Trying to turn the eurozone into a greater Germany is also harmful for the rest of the world – not least Britain, the eurozone’s biggest trading partner. Stagnant demand in the eurozone crimps Britain’s and other countries’ exports. The eurozone’s $318.2 billion (and rising) current-account surplus is also so vast that it risks a protectionist response. In the meanwhile, German capital that once gushed into southern Europe is now been sprayed more widely, with the country’s notoriously badly managed banks misallocating capital more broadly.

Germany’s economic model urgently needs an overhaul. Policymakers should focus on boosting productivity, not “competitiveness”, with workers paid their due. Unleashing competition and enterprise would be a good place to start. With a balanced budget, a AAA credit rating and a stagnant economy, the government should take advantage of near-zero interest rates to invest, and encourage businesses – especially start-ups – to do likewise. The country would also do well to welcome more dynamic young immigrants to stem its demographic decline.

That would be good for Germany, a better example for the eurozone and a welcome boost for Britain and the global economy.

Philippe Legrain is a British political economist and writer, and was former adviser to European Commission president José Manuel Barroso from 2011 to 2014