Sick man of Europe risks relapse

THROUGHOUT the 1990s and much of the 2000s, Germany was known as the sick man of Europe. Weighed down by the costs of reunification, suffocated by high taxes and labour regulations, and battered by the competitive pressures of globalisation – if you could name an economic torture, Germany suffered from it. Maybe that’s why the new crisis feels less urgent than it is.

Germany’s economy today is in a state of health that usually seems unattainable for old Europe. Real growth was 2.5% last year. Exports power a trade surplus of 8% of gross domestic product. Unemployment is at a post-reunification low of 3.7%.

But those happy numbers mask what is set to become a debilitating drag on the eurozone’s largest economy. Germany is in the grip of a productivity crisis. Without a solution, stagnation will return as entitlement burdens become crushing.

Germany’s reputation for efficiency is justified but misleading. The most productive industries are exporting manufacturers, and the most productive companies are large ones. But the clear majority of companies are smaller service firms, whose productivity increasingly lags.

Productivity for manufacturers employing more than 250 people grew on average 5% a year between 2009-2014, according to the Organisation for Economic Cooperation and Development (OECD). But the figure was only 2% for smaller firms. In services, productivity fell 0.1% a year in large companies and 0.4% in small ones.

Any discussion of productivity requires some caveats. Labour-law reforms in 20032005 encouraged employers to hire more workers instead of eking more production out of existing employees. This is especially likely to account for the decline in service productivity, since low-skilled service professions absorbed many of the workers pushed into the labour market by the reforms.

Yet that doesn’t fully explain German productivity problems. The OECD detects a widening gap between the most productive companies and the rest. The most efficient service firms are now around 20% more productive than in 2006; but the other 95% of service companies are 20% less productive. The most productive companies should pull others up as their new technologies and methods spread through the economy. Not in Germany.

That’s because German companies aren’t investing at home. Corporate savings (outside financial industries) have increased steadily for 20 years, the International Monetary Fund (IMF) noted this month, but investment is stalling relative to GDP.

Looking at the factors that influence overall labour productivity growth, the IMF finds that capital investment plays a smaller role in Germany than in any other major economy. Most of Germany’s middling productivity gains come from companies figuring out how to do more with existing resources. If German firms could combine that aptitude with the capital-investment growth of Belgium – yes, Belgium – Germany would lead the world in productivity growth.

Germany needs a corporate-investment boom, and there are plenty of ways to start one. One is to encourage startups, since entrepreneurial firms typically take the lead in developing and diffusing innovations. Yet the pace of business creation is low and slowing, in part because starting a business in Germany requires more red tape than in most developed countries.

Companies, especially smaller ones, may also be storing up cash to fund future research and development. The key is to make other sources of financing available so firms feel compelled to stockpile less savings. Financial reforms, such as privatising stateowned banks, might help stimulate more adventurous business lending, or encourage more venture-capital financing.

Instead, politicians and wonks are fixated on government investment. They imagine that if Berlin and state governments could spend more on roads, bridges, railways and fibre Internet connections, Germany could restore its productivity dominance.

But there’s no reason to think the German government can invest more wisely than private companies can. Worse, Berlin can’t afford this investment because it’s spending too much on social benefits.

That’s the conclusion of a report this week from the Ifo Institute, which finds that Germany’s social outlays – now roughly half the budget and higher than Scandinavia – are crowding out the ability to undertake public-works projects. Berlin could run a fiscal deficit, but the result would be an economy with more debt, unsustainable entitlements, white-elephant public-works projects, and slower long-term growth.

Berlin is headed in that direction anyway, since too many politicians now seem to want a public-works-and-entitlement blowout if only they can protest enough first to avoid looking reckless. Significant tax cutting, the one fiscal policy that would directly encourage the private investment Germany needs, remains the policy its ideologically confused and politically brittle government seems least likely to deliver.