6 March 2015

The cost of Germany’s economic triumph


You go to a restaurant and treat everyone to lunch, but forget your wallet. The waiter kindly lends you the money to pay the bill, and you react by calling him a bully and walking out. That is how a majority of people in Germany see Greece. 54% of Germans in a recent poll for ZDF think the fiscal targets for Greece are appropriate and a further 13% say they do not go far enough.

Compare this to the situation in Greece, now the 5th most miserable country in the world, where youth unemployment remains above 50% for the third consecutive year. Austerity and ‘internal devaluation’ were policies designed to raise Greek competitiveness and bring its sovereign debt under control. While they have had some success in boosting the export sectors in Italy, Spain and Portugal, the programme has been disastrous for Greece.

Most countries in the Eurozone are now running trade surpluses, which struggle to make up for depressed domestic demand. Greece is exceptional, however, in that almost all of the burden for reducing a trade deficit which measured 15% of GDP in 2008 fell on cutting imports. Consumer demand has collapsed as the proportion of families with children living in poverty has almost doubled since 2008. Prices have been falling since the middle of 2013. With deflation now at 2.8%, Greece’s public debt is stuck at above 175% of GDP, although this is calculated using the Maastricht definition, which doesn’t take into account time-to-maturity and long-term discounting that currently work strongly in Greece’s favour.

Shortly before Yanis Varoufakis became Greek Finance Minister and starting calling for the end of “fiscal waterboarding,” his German counterpart, Wolfgang Schäuble, was being lauded for implementing the Schuldenbremse – an article in German law which effectively forbids structural deficitsone year ahead of schedule. If Varoufakis sees Greece’s role in the crisis as the Victorian workhouse, he probably views Mr Schäuble’s programme of fiscal puritanism as a luxury afforded only to a country which has been able to free-ride on a cheap currency.

The language of waterboarding and puritanism is important because it operates at the heart of the two central problems affecting the euro. One is the cultural differences between North and South Europe. The other is what constitutes appropriate economic policy at different stages of the business cycle.

Gilberto Marcheggiano and David Miles in a study for the Bank of England last year found that given a choice between $3,400 today or $3,800 next month, 90% of Germans would prefer to wait compared to less than half in Greece, Italy and Spain. That a majority of Southern Europeans are willing to turn down a monthly interest rate of 12% in favour of jam today is instructive, particularly at a time when investors are willing to pay the German government to lend money.

Perhaps too much is made of the insinuation that because the German word for debt, schuld, is also used interchangeably to mean guilt, blame and fault, the institution of credit has always been something to avoid. The Fuggers of Augsburg had no problems using finance to power the economy of late 15th Century Europe, even before the Calvinists sought to legitimise usury. Nonetheless, German thrift is evident for anyone who has been to the country – cash is still preferred for most everyday retail transactions, and a confluence of a mild Protestant disinclination to spend money and the concerns over privacy prevents anything like contactless forms of payment being widely accepted.

Rightly or wrongly, a lot of people in Germany still see Greece’s parlous state as product of recklessness and fecklessness. We should not forget that despite promising to roll back government in 2003, Greece’s New Democracy party lost control of the public finances. During a six year boom, the country’s debt-to-GDP ratio rose from 97 per cent to 130 per cent, as Prime Minister Karamanlis added 150,000 new civil servants, and grew health spending by 40% and pensions to 13% of GDP, according to a review by Foreign Affairs.

But how much schuld should rest on the shoulders of Germany as creditor? Another way of looking at the euro crisis is one of excess savings. Germany produces more than it consumes, partly by preference but mostly because of a policy between business, government and trade unions that has effectively frozen pay in real terms since 2000. International financial markets then became glutted with cheap money for short-sighted politicians and investors.

study by DIW, a Berlin-based economic research institute, suggested that Germany lost €600 billion, or 22% of GDP, on the valuation of its foreign portfolio investments between 2006 and 2012. That will need to improve because according to the IMF, the country’s International Investment Position (net) – the size of its claims on the rest of the world – rose from 24% of GDP in 2008 to 44% in 2013 with €2.36 trillion held in foreign investments.

In the long-term, most countries operate close to balance on their current and capital accounts, so Germany’s persistent current account surpluses, last year’s measuring 7.5% of GDP, suggest problems at home. Its national infrastructure is crumbling, and according to DIW the investment shortfall between 1999 and 2012 was 3.7% of GDP, the highest in Europe. To just maintain the status quo, the country would need to invest €103 billion a year more than it does today, according to Der Spiegel. Yet the investment ratio fell from 21% to 17% of GDP over the same period.

A lack of confidence in the nation’s young people, its transport arteries and data networks is driving big companies to invest overseas to grow their export markets. BASF, the world’s largest chemicals company, recently announced plans to invest $1.4 billion in a new complex off the Gulf Coast to convert shale gas into propylene. Less than 60% of Volkswagen’s €64.3 billion new investments in property, plant and equipment will be concentrated in Germany, while €22 billion has been earmarked for joint ventures in China.

The Financial Times reported last month that 3,000 ‘high-cost’ German workers at Siemens would be the target for a €1 billion annual savings programme, even though the company increased its global headcount by 11,000 last year. Ending wage moderation polices will have complex consequences. Domestic demand will increase but with high energy prices under the Energiewende, large companies could still react unfavourably and move operations overseas.

The famed Mittelstand, of modest, often family-owned companies, is also flagging. Only 28% of small or medium sized companies invest in new products and innovative processes, according to a report by KfW. Since the mid-2000s, innovation has dropped by 39% in companies that employ five people or fewer, exposing the industry to greater competition as other countries move up the value chain.

Of course, there is nothing wrong with balancing fiscal budgets or even running surpluses, and the fact it has taken Germany 45 years to do so is indicative of the bad management of public finances that afflicts most democracies. A study by Philippe Martin and Thomas Philippon showed that running fiscal surpluses during the 2000s in Greece would have lowered the interest rate premiums paid by these states on the bonds they issued, and offered greater space for stimulus after the recession.

Guntram Wolff at Bruegel looks at the performance of Bulgaria, a country with similar institutional characteristics to Greece, but which ran an average surplus of 1.3% of GDP between 2000-2008, compared to an average deficit of 6.1% in Greece. GDP per capita is now 8% above its pre-crisis peak in Bulgaria while Greek living standards have returned to levels last seen in 1999. Considering that Bulgaria was poorer than Greece in 1999, it is clear that bad economic management can incur serious costs to living standards.

Greece still needs to accept its fair share of responsibility but with the eurozone’s fortunes tied inexorably to each other, now is not the time for Germany to behave as if the AAA national credit rating belongs in the same realm as AAA batteries, locked away in the household drawer under the auspices of Frau Temperance. A more Prudent, Just and possibly even Courageous policy – going by the three other Cardinal Virtues – which takes into account responsibilities to the Eurozone, might see Germany end wage repression, rebuild infrastructure and countenance higher inflation – offering a timely reflationary boost across the region. In exchange, Southern Europe cracks down on cronyism and special interests.

On balance German business has benefitted most from a cheap euro, which effectively offers a subsidy to inefficient firms and boosts their market share. They are likely to be the main winners from the ECB’s €1.1 trillion quantitative easing programme as the currency weakens. Debt restructuring for Greece shouldn’t be seen as a deadweight loss but as the legacy cost of operating a deflationary Mercantilist trade policy.  The problem is, the German government is unlikely to do anything that violates the sanctity of the Schuldenbremse – an item as much of foreign policy as domestic – or price stability. But if Temperance remains the order of the day, the euro will surely collapse.

What I learnt from The Dress meme last week was that we remain vulnerable to naive realism, experiencing things through shades of prejudice; that for all the improvements in education and information, we might never leave Plato’s cave. Looking at a €2 Greek coin with Zeus carrying away Europa, after whom the continent of Europe is named, must appear a bitter perversion to the Germans and a cruel irony for the Greeks.

If the countries constituting the single currency can’t understand that each state has different needs, preferences and speeds of life; that a common venture requires compromise, risk sharing and solidarity; that national pride rarely offers the path to virtue, then we should start looking for the best way to call the whole thing off.

 Zac Tate is Deputy Editor of CapX