After years of frugality, German consumers are finally spending again, at a rate not seen since the dotcom boom of the 1990s. According to the FT, private consumption is growing at about 2% per annum, driven by high levels of employment, rising wages, and low inflation and interest rates. This is welcome, and not only for German growth. If sustained, it could help rebalance the economies of both Germany and Europe.
Germany is the largest economy in Europe, and a number of economists have argued that its large current account surplus, far from being a virtue reflecting a culturally frugal population, is the flip side of the large current account deficits in the Eurozone periphery which led to the crisis in 2010. In short, in order for countries in the periphery like Spain to recover and rebalance while sustaining growth and reducing unemployment, Germany’s economy also needs to rebalance. The latter should involve higher wages, consumption and investment and lower net exports driven by higher imports.
The sum of all the current account surpluses and deficits in the global economy must by definition sum to zero, even if in practice measurement errors mean that they don’t quite. Given this fact, it is no good preaching to Spain to reduce its current account deficit in the absence of its trading partners reducing their surpluses.
Of course, this kind of rebalancing can happen in different ways. Growth in Spain can fall, reducing consumption and imports and increasing unemployment. Reduced imports will reduce the exports of its trading partners, like Germany, and this will slow growth in Germany. This is clearly undesirable.
On the other hand, German domestic demand can increase via rising consumption, investment, imports and also increased public spending or tax cuts. Rising Germany imports will contribute towards rising Spanish exports, fuelling growth in the latter and hopefully reducing unemployment. This form of rebalancing is what the surplus and deficit economies of Europe should be aiming for.
The reduction of private and public debt would also be spurred on by this form of rebalancing, since foreign borrowing reflected in a current account deficit is mirrored by total domestic borrowing by the private and public sectors. If an external deficit for a particular economy does not fall as a share of GDP, then total domestic borrowing measured in the same way cannot fall.
Rising consumption in Germany is therefore welcome. The process of rebalancing would be helped along by increased public investment and tax cuts for lower income earners, who tend to spend a higher proportion of extra income than wealthier individuals. Despite its balanced budget rhetoric, the government seems to be heading in this direction, at least a little.
So what is good for the German economy is in this case potentially good for the Eurozone and wider European economy, despite poor growth figures in recent years. Rebalancing is essential to the resolution of the crisis, the restoration of decent growth rates, the reduction of unemployment across the region, as well as a falling GDP share of private and public debt.