The German government’s ‘record’ post-unification budget surplus of nearly 24bn euros was in the news this week. As a percentage of GDP it is a mere 0.8%, but compared to the UK’s deficit of just under 4%, they seem to be doing relatively well, at least in terms of the desire expressed by many politicians for governments to ‘live within their means’. And this surplus does not seem to have come at the expense of economic growth. The German economy grew by 1.9% in 2016, the fastest in the G7 group of the largest economies in the world.
So how is this possible? Quite simply, it is down to the competitiveness of German exporters, achieved at the expense of ordinary German workers over the last decade or so.
Firstly, the deregulation of the labour market put downward pressure on wages at the bottom of the scale, so that Germany now has record numbers of low-wage, insecure jobs.
Secondly, agreements between employers and trade unions kept wage growth negligible for a number of years, allowing German exporters to become much more price-competitive, at least relative to most of its eurozone neighbours. The result was a steady expansion in the trade surplus (the excess of exports over imports). In fact growth has not been spectacular, but given the country’s ageing population, it has been satisfactory. There has been a growth in overall GDP which has been faster than the growth in household incomes due to the squeeze on wages. Since GDP minus consumption (a proxy for household income) is equal to national saving, sluggish consumption growth has produced a rise in national saving, and this saving, reflected in the trade surplus, has been exported.
Since national domestic saving, public and private, is by definition equal to the current account surplus (which includes the trade surplus), the rise in domestic saving is reflected in a rise in the current account surplus, which is now around 9% of GDP. The public surplus, or government saving, is now 0.8% of GDP, as mentioned above. Net private (household and corporate) saving makes up the difference, which is therefore around 8% (9 minus 0.8).
This exercise in national accounting describes the German situation. Households have born the brunt of the restoration of German competitiveness in the 2000s. Corporate saving and profitability have risen, but due to the weakness in the growth of household incomes and consumption, there has been less incentive for firms to invest this larger surplus income in new capacity. So, until recently, domestic demand growth has been sluggish. This has reduced growth in imports, even as exports have boomed, at the expense of other members of the eurozone. These imbalances have been key causes of the ongoing eurozone crisis, and their unwinding is key to its resolution.
To quote from Michael Pettis, whose analysis this post draws on:
“Germany and the other surplus countries must abandon the policies that forced up their savings rates to artificially high levels. Only in this way can Spanish unemployment rates, and the employment rates of the other European deficit countries, automatically rise without requiring an abandonment of the euro. The surplus countries, in other words, are as responsible for the terrible European policies as are the deficit countries. They should share the burden of adjustment by reforming their own domestic distortions. If Germany does not adjust dramatically, Spain will have no choice but to leave the euro and default on its debt.”
Michael Pettis (2013), The Great Rebalancing, p.134
To be fair to the European Commission, Germany has come in for criticism over its imbalances, particularly its enormous current account surplus. They are right to suggest that a more rapid expansion of German domestic demand would shrink the surplus and help the rest of the eurozone. Germany needs a faster growth in consumption, as well as in private and public investment.
In terms of the eurozone core and periphery, both sides need reform. Without it, rebalancing can only come at the expense of the rest of world via a weak euro, which is known as a ‘beggar-thy-neighbour’ policy. This has already happened to some extent, and is part of the reason for Germany continuing to run a large current account surplus. These developments are not viewed favourably by foreign trading partners, and retaliation in the form of protectionism, or attempts to weaken their own currencies, are likely to leave global output below its potential as all sides attempt to gain advantages while failing to cooperate.
Germany has significant room for a shift in its economic policy. This needs to be dramatic, for the sake of ordinary workers across the eurozone and indeed the world. But the political will seems to be lacking. This is currently the key constraint on the necessary positive changes, rather than pure economics.