World - Germany: German Tiger or European Growth Engine?

Germany: German Tiger or European Growth Engine?
Jens Bastian

As the German economic situation continues to improve, well into the second year of an impressive recovery, the drivers of the country's economic growth are manifold and suggest sustainability over time. As the German economy motors forward, registering an unprecedented 6.1 percent first quarter 2011 gross domestic product (GDP) performance, the positive spillover effects on overall employment levels and declining unemployment are following suit.

The International Monetary Fund (IMF) is expecting growth of three percent this year, after the economy expanded by 3 1/2 percent in 2010. Other organisations are even more optimistic, forecasting GDP growth in Germany between 3.2 and 3.5 percent, Deutsche Bank and Commerzbank forecast, respectively. Consumer price inflation is not viewed as a major policy challenge and medium-term business confidence among corporates remains at record levels since months.

Moreover, on the back of such economic performance both the IMF and the Organisation for Economic Cooperation and Development (OECD) have encouraged German policymakers to use this tailwind for the implementation of comprehensive reform efforts, attempting to move from a cyclical recovery towards improving the underlying trend growth rate. Despite the recent rapid GDP rise, investment spending continues to remain below pre-crisis levels, and German productivity growth is impressive in sectors, such as manufactured goods, that make up most of the country's exports. But it continues to lag behind in the area of services.

To what degree that growth delivers short- to medium-term benefits for the rest of Europe, in particular for economies on the periphery of the euro zone - namely Greece, Ireland and Portugal - remains to be seen. What is increasingly apparent from the 2011 first half economic data in the euro zone is a widening growth gap between Germany and all other euro zone economies. The growth divergence (real GDP) is most pronounced between Germany on the one hand and Portugal, Greece, Spain and Italy on the other hand.

This widening gap is further illustrated in the dynamics of unit labour costs between Germany and peripheral euro zone countries during the past decade. While they only grew by 0.6 percent in Germany, they rose by 38.3 percent in Greece, 23.8 percent in Portugal and 13.1 percent in Ireland. Over the course of the past ten years, German employees and trade unions swapped growing job security and increased competitiveness for stagnant real wages. According to the International Labour Organization (ILO), real incomes dropped by 4.5 percent in Germany between 2000 and 2010.

Its economic consequences have yet to ascertain themselves, but the political implications are becoming more obvious as the sovereign debt crisis continues to impact any recovery process on the continent. Most importantly, there is a declining crisis perception in Germany among citizens and corporates, leading to increasing risk aversion and outright rejection of further euro zone rescue initiatives.

Two years after registering negative GDP growth in excess of five percent, the German economic revival is first and foremost the result of, but not anymore exclusively dependent on, the country's traditional export-led growth agenda. More specifically, Germany's trade surplus widened more than expected in May, underpinned by continuously strong demand for high-quality manufacturing goods from emerging economies, in particular from southeast Asia and primarily from China.

Germany continues to remain the world's second-largest exporter with ever growing current account surpluses. However, these have recently become a bone of contention among other euro zone member states; the flip side of deficit countries requires an appreciation of the adverse consequences of continuous traded surpluses, notably in Germany.

According to the country's Federal Statistical Office, in May 2011 Germany's surplus increased to 12.8 billion euros year-on-year from May 2010. Exports rose 4.3 percent month-on-month, reaching a staggering 89.5 billion euro. The interesting trend continuing to manifest itself in this overall development is the dynamic of trade according to regions. Exports outside the EU rose an unadjusted 23.8 percent year-on-year. Meanwhile, exports within the EU only increased by 16.1 percent.

This changing dynamic has taken place since early 2010, when the export-led recovery of Germany was strongly driven by rising consumer demand in southeast Asia, and Germany benefited disproportionately vis-à-vis its European peers from the Chinese stimulus packages. While sixty percent of German exports still go to other countries in Europe, the trade balance is increasingly shifting away from Germany's continental neighbours.

As German unemployment continues to fall during the first half of 2011, more and more companies from the public and private sectors are announcing their intentions to hire personnel. To illustrate, in early July Deutsche Bahn, the publically-owned railway company, tabled plans to increase employment levels by 5,000 to 7,000 new hirings in the coming years. What is striking in this approach is the fact that ever more German companies are seeking to take new personnel on board at all levels of expertise.

Unemployment has now contracted for 24 consecutive months. In June 2011 registered unemployment had fallen to 2,89 million people, corresponding to a rate of 6.9 percent. The critical threshold of three million was first breached in April of this year and constituted a 19-year low in Germany. The issue concerning many of these new labour market entrants or returnees is if and when these gains will also translate into substantial wage growth, and hence fuel household spending as a further underlying factor shaping economic performance.

Put otherwise, the emerging economic performance has yet to translate into rising wage agreements in collective bargaining. Most of these agreements are multi-year contracts and will only be renegotiated in 2012. While trade unions have already started to articulate a more assertive wage bargaining position, the devil remains in the detail since an ever-growing number of workers and employees in the private sector are not covered anymore by collective framework settlements, particularly in the eastern states of Germany.

However, we also have to take into consideration that what some, in their exuberance, are starting to term the next 'German economic miracle', are also the favorable and delayed spillover effects from a major reform initiative that started in 2003. More specifically, Chancellor Angela Merkel is now reaping the benefits of then-chancellor Gerhard Schröder (SPD) taking the unprecedented political risk for a governing social democratic party to push through a highly controversial 'Agenda 2010'. This reform agenda included a major re-positioning of the German welfare state, labour market reforms and regulatory change at the sub-federal level of governance.

Ever since taking office in September 2009, the centre-right coalition government of Chancellor Merkel has sought to chart a course of balancing the federal budget while seeking to identify the scope for comprehensive tax reductions for citizens and corporates.

Elected on a platform of tax reductions and simplifications, the Merkel government has repeatedly struggled to honour this pledge. Moreover, since taking office almost two years ago, considerable differences of opinion have frequently surfaced between the finance minister Wolfgan Schäuble (Christian Democratic Union) and the junior collation partner (Free Democratic Party) about the scope and timing of tax reductions.

But as opinion polls underline, the overriding majority of German citizens are opposed to tax cuts, even if they are presented as sweeteners to voters ahead of the next planned federal elections, which are due in September 2013. Instead, most Germans currently express a preference for the federal government to use the favorable economic environment and the increased intake in tax revenue to focus on cutting public debt at all levels of government.

The survey found that seventy percent of respondents emphasize the greater importance of reducing government borrowing, bringing down federal, regional and municipal debt levels. This perspective is further supported by business and industry leaders who argue that it would be wrong to cut taxes, while 78 percent said that it is unrealistic to expect tax cuts in 2011.

A key factor determining the sustainability of Germany's economic performance over the medium-term will be the manner in which the federal government, the corporate community and the population at large can adjust to the seminal decision to implement with immediate effect a comprehensive U-turn in environmental policymaking.

After receiving cross party support in parliament from all but one opposition party, the coalition government of Chancellor Merkel adopted the ambitious plan to close all of its operating 17 nuclear power plants by 2022. They are to be gradually replaced with renewable energy and gas-fired power stations. This decision comprehensively reverses an initial controversial decision taken by the federal government in 2010 to prolong Germany's nuclear phase out to 2036, a decision taken by the predecessor coalition government of Chancellor Schroeder a decade ago.

How retooling the country's energy supply will be financed will be of critical importance for the real economy and the support level achievable from? industry representatives in Germany who hold high investment stakes in nuclear energy - utilities such as EON, RWE and Siemens. Some cost estimates go as high as 90 billion euros over the span of a decade. What mix of financing will be provided by the federal government, supplemented by contributions from corporate entities and topped up by the European Investment Bank (EIB) still remains to be agreed upon in detail.

Finally, as many observers have noted over the course of the past 18 months, Germany's economic recovery has yet to translate into political leadership capacity in the eurozone. Chancellor Merkel is caught between a German public ever more skeptical about further rescue packages for profligate member states of the single currency area, and demands from across the international spectrum to show the leadership qualities necessary in resolving the ongoing crisis.

(Jens Bastian is a Visiting Fellow at St Antony's College, Oxford. He is also Senior Economic Research Fellow at the Athens-based think tank ELIAMEP.)

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