In search of a third Ger­man eco­nomic mir­a­cle

Financial Mirror (Cyprus) - - MARKETS - By Ja­cob L. Shapiro

Ger­many’s econ­omy is in trou­ble. Ac­cord­ing to the Ifo In­sti­tute, a top Ger­man think tank based in Mu­nich, “storm clouds are gath­er­ing over the Ger­man econ­omy.” And like a storm, the prob­lems have ap­peared sud­denly. It was only a year ago that Han­dels­blatt, a Ger­man busi­ness news­pa­per based in Dus­sel­dorf, said that 2017 was to be a record year for the Ger­man econ­omy and that prospects looked good for the fu­ture. It was only six months ago that the In­ter­na­tional Mone­tary Fund marked up its fore­casts for Ger­man eco­nomic growth in 2018, and just five months ago that the Ger­man gov­ern­ment re­vised its own growth fore­casts up to 2.4% from 1.9%. And it was only four months ago that the EU pat­ted it­self on the back for its largest growth rates in a decade, cred­ited largely to Ger­many’s eco­nomic re­vival.

That all seems like a long time ago now. Die Welt, an in­flu­en­tial con­ser­va­tive daily, pro­claimed on June 19 that “the sec­ond Ger­man eco­nomic mir­a­cle is over.” The Ifo In­sti­tute re­cently cut its growth fore­cast to 1.8% from 2.6%; an­other Ber­lin-based think tank called DIW slashed its fore­cast to 1.9% this year and 1.7% next year. Of­fi­cial Ger­man eco­nomic data showed that growth in Q1 of this year was half the rate of the pre­vi­ous quar­ter. Q2 fol­lowed with de­creases in in­dus­trial pro­duc­tion and in­dus­trial or­ders – bad omens for the near fu­ture. On June 20, Daim­ler AG, one of Ger­many’s most vis­i­ble and im­por­tant com­pa­nies, “adapted” its earn­ings ex­pec­ta­tions. At least the Ger­man pen­chant for eu­phemism re­mains undi­min­ished.

The me­dia nar­ra­tive that has fast taken hold puts the blame on U.S. pro­tec­tion­ist poli­cies. To be sure, U.S. Pres­i­dent Don­ald Trump’s men­ac­ing tweets about slap­ping 20% tar­iffs on im­ports of Ger­man cars have not helped mat­ters for Ger­many. But that is not the pri­mary cause of Ber­lin’s trou­bles. It is also tempt­ing to as­cribe the in­sta­bil­ity in the Ger­man econ­omy to the po­lit­i­cal strife in Ber­lin, where Chan­cel­lor An­gela Merkel’s every state­ment is be­ing ner­vously parsed for signs of weak­ness. The ties that bind Merkel’s Chris­tian Democrats and their Bavar­ian sis­ter party, the Chris­tian So­cial Union – a po­lit­i­cal al­liance that has lasted 69 years – are fray­ing. But the truth is that Die Welt has it right. Ger­many’s eco­nomic prob­lems are struc­tural, an in­evitable out­growth of the same as­pects that cat­a­pulted Ger­many from stag­na­tion to the Euro­pean econ­omy’s only hope af­ter the 2008 fi­nan­cial cri­sis.

Ger­many’s first eco­nomic “mir­a­cle,” the so-called Mir­a­cle on the Rhine, came af­ter World War II. West Ger­many’s rapid re­cov­ery from that war was stun­ning but, in the lit­eral sense, not quite mirac­u­lous – un­like a mir­a­cle, West Ger­many’s re­gen­er­a­tion was very ex­pli­ca­ble.

First, there was a pop­u­la­tion ex­plo­sion. West Ger­many, which on the eve of World War II looked like a de­mo­graphic night­mare, saw its pop­u­la­tion grow by 28% from 1950 to 1970, with an av­er­age to­tal fer­til­ity rate al­most dou­ble the cur­rent 1.5%. Sec­ond, the Nazis left Ger­many with a haunt­ing mo­ral in­her­i­tance but be­queathed to West Ger­many a tremen­dous eco­nomic head start. The Al­lies suc­ceeded at dam­ag­ing only about 20% of the Ger­man in­dus­trial plant by May 1945, and the Nazi gov­ern­ment’s mas­sive in­vest­ments in new in­dus­trial equip­ment and its fo­cus on in­dus­tries such as engi­neer­ing and ve­hi­cles made Ger­man pro­duc­tion of these goods world class. In other words, Ger­many wasn’t known as a man­u­fac­tur­ing pow­er­house be­fore the 1950s. And then there was the im­mense sup­port of the United States, which needed to re­build West Ger­many to hold the line against the Iron Cur­tain. Through the Mar­shall Plan alone, the U.S. contributed $1.45 bln (about $13.77 bln to­day) to West Ger­many’s re­con­struc­tion.

For al­most four decades, the West Ger­man econ­omy hummed along, un­til the Soviet Union un­ex­pect­edly col­lapsed in 1991. Most economists be­lieved that Ger­man re­uni­fi­ca­tion would crip­ple the West Ger­man econ­omy. In­deed, the early re­sults weren’t pretty. All told, Ger­many spent roughly 2 trln eu­ros ($2.3 trln) to pro­vide East Ger­mans with so­cial ben­e­fits, to re­build East Ger­man in­fra­struc­ture and to of­fer a 1:1 ex­change for East Ger­man cur­rency. The sit­u­a­tion was so grim that by 1999, an Econ­o­mist re­port con­cluded that Ger­many was con­signed to the role of “sick man of Europe” for the fore­see­able fu­ture. The coup de grace of the anal­y­sis was a com­par­i­son of the freshly uni­fied Ger­man state to the scle­rotic Ot­toman Em­pire on the eve of its col­lapse. At first, it seemed like the cor­rect anal­y­sis. In 2003, af­ter years of stag­nant growth, the Ger­man econ­omy shrank by 0.71%.

But then, Ger­many took off once more. The recipe for the sec­ond Ger­man eco­nomic mir­a­cle bore lit­tle re­sem­blance to the first. Ger­many’s fer­til­ity rate con­tin­ued to de­cline through­out the 1990s and 2000s. But Ger­many com­pen­sated for this by tak­ing ad­van­tage of cheap la­bor in East­ern Europe. By re­lo­cat­ing pro­duc­tion to the east and in­tro­duc­ing

Ger­man tech­nol­ogy and in­dus­trial pro­duc­tion meth­ods, costs plum­meted and pro­duc­tiv­ity soared. The es­tab­lish­ment of the com­mon cur­rency in 1999 helped make Ger­man goods more com­pet­i­tive through­out Europe and put an end to the volatile ef­fect Ger­man boom-and-bust cy­cles had on the deutsche mark. Good pol­icy also helped. Brought to eco­nomic cri­sis and sport­ing stub­bornly high un­em­ploy­ment rates rel­a­tive to the rest of Europe, es­pe­cially in the for­mer East Ger­many, the Ger­man gov­ern­ment had no choice but to en­act ma­jor la­bor mar­ket re­forms as well as large cuts to the aging coun­try’s long sacro­sanct wel­fare state.

The com­bi­na­tion of these de­vel­op­ments worked. The Ger­man econ­omy went from shrink­ing to grow­ing at al­most 4% an­nu­ally. But the seeds of the cur­rent cri­sis were laid in the very so­lu­tions that al­lowed re­uni­fied Ger­many to pros­per. Ger­many be­came ad­dicted to ex­ports to fuel its econ­omy. In 1991, Ger­many’s econ­omy de­pended on ex­ports for 27.3% of its gross do­mes­tic prod­uct. Ac­cord­ing to the World Bank, that fig­ure had climbed to 46.1% by 2016. For the East­ern Euro­pean coun­tries that have be­come part of the Ger­man sup­ply chain, this num­ber is as­tro­nom­i­cally larger.

Fur­ther­more, the la­bor re­forms that kick-started the Ger­man econ­omy and re­duced un­em­ploy­ment to record lows had an un­for­tu­nate byprod­uct: eco­nomic in­equal­ity. In many cases, the rich got richer while the poor sim­ply got less gen­er­ous gov­ern­ment ben­e­fits. Mone­tary eas­ing poli­cies en­acted af­ter the 2008 fi­nan­cial cri­sis ag­gra­vated the prob­lem, to the point that Ger­many now has the sec­ond­high­est wealth in­equal­ity rates among Or­gan­i­sa­tion for Eco­nomic Co­op­er­a­tion and Devel­op­ment coun­tries (only the United States out­does Ger­many in this re­gard).

These are the real prob­lems Ger­many faces. There are no more la­bor pro­duc­tiv­ity gains to be made – East­ern Euro­pean labour pro­duc­tiv­ity rates sur­passed that of Ger­man work­ers years ago. There are no more ba­bies to be had – fer­til­ity rates hit a 43-year high in 2016, but at 1.59 it is still far be­low the re­place­ment rate of 2.1, and its pop­u­la­tion is one of the old­est in Europe. There is no new, large mar­ket to sell to – China is try­ing to in­crease do­mes­tic de­mand, the U.S. has turned pro­tec­tion­ist, Europe is over­sat­u­rated, and the pur­chas­ing power of the av­er­age Rus­sian wouldn’t make much of a dif­fer­ence even if EU sanc­tions weren’t pre­vent­ing Rus­sian-Ger­man eco­nomic re­la­tions from deep­en­ing. And all of this is to say noth­ing of Ger­many’s an­ti­quated ed­u­ca­tion sys­tem, high cor­po­rate tax rates, 20th-cen­tury dig­i­tal broad­band con­nec­tiv­ity in­fra­struc­ture and hi­er­ar­chi­cal com­pany struc­tures that sti­fle in­no­va­tion. Even in the ar­eas where Ger­many is sup­posed to ex­cel, like cars, Ger­many’s best days seem be­hind it. Volk­swa­gen, Audi, Porsche, BMW and Daim­ler have now all been ac­cused of dis­tort­ing emis­sions and are re­call­ing hun­dreds of thou­sands of ve­hi­cles in what has be­come known as “Diesel­gate.” Last but not least, Ger­many’s bank­ing sys­tem is in sham­bles.

There is a sil­ver lin­ing to these clouds, how­ever. Ger­many is not in the throes of a cri­sis yet – it is stand­ing on the precipice. And when modern Ger­many (i.e., post-1871) reaches se­ri­ous mo­ments of cri­sis, petty po­lit­i­cal squab­bles are usu­ally put aside, and the Ger­man pop­u­la­tion re­sponds with a so­cial dis­ci­pline that few other na­tions in the world have ever matched. For ex­am­ple, Ger­many’s in­dus­trial plant sur­vived World War II in­tact, but the Ger­man rail sys­tem did not. On V-Day 1945, only 10% of Ger­man rail­ways were op­er­a­tional. Just 13 months later, West Ger­many had re­built 93% of its rail­road sys­tem, which in­cluded re­pairs on 800 bridges. Ger­many had ad­van­tages – not the least of which was U.S. eco­nomic aid – but what Ger­many was able to do with that aid was noth­ing short of re­mark­able. The same can be said of Ger­many’s rapid re­cov­ery from its in­te­gra­tion of East Ger­many and its sub­se­quent sick­ness of the late 1990s, a process that would have crip­pled less co­her­ent na­tions.

The miss­ing piece in all this is where Ger­many is go­ing to find pro­duc­tiv­ity gains. In the 1950s, it was the pop­u­la­tion ex­plo­sion, and in the 2000s, it was East­ern Europe. The only sav­ing grace of the Ger­man econ­omy right now is healthy do­mes­tic de­mand, but cur­rent lev­els of do­mes­tic de­mand can­not make up for the over-reliance Ger­many has de­vel­oped on ex­ports. Per­haps Merkel’s plan with refugees and mi­grants all along was to in­fuse Ger­many with a fresh batch of young peo­ple, her own ver­sion of the West Ger­man guest worker agree­ments of the 1950s, ‘60s and ‘70s. Per­haps her ide­al­ism was so fer­vent that she be­lieved any Syr­ian or So­mali or Afghan could be in­te­grated into a Ger­many that had left its past be­hind and em­braced the idea of a cos­mopoli­tan, mul­ti­cul­tural Europe. Japan is in many ways the mir­ror im­age of Ger­many, with a shrink­ing pop­u­la­tion and ex­port de­pen­dence of its own, but Japan pre­pared for its cur­rent predica­ments by sac­ri­fic­ing growth for al­most three decades. Ger­many took the money and ran – and now the bill is com­ing due.

The in­equity of Ger­many’s predica­ment is hard to es­cape. Ger­many is si­mul­ta­ne­ously the boogey­man and saviour of the Euro­pean project. Ger­man eco­nomic growth and Ger­many’s han­dling of the 2008 fi­nan­cial cri­sis made eu­ro­zone coun­tries ex­tremely un­com­fort­able – that is, un­til the prospect of Ger­man eco­nomic growth stalling be­came a re­al­is­tic pos­si­bil­ity. Ger­many’s con­sis­tently pal­try de­fense spend­ing – well be­low the agreed-upon 2% by NATO coun­tries – is a prob­lem for its NATO al­lies. But if Ger­many ac­tu­ally be­gan remil­i­ta­riz­ing, hys­te­ria about the im­mi­nent re­turn of Teu­tonic knights, Fred­er­ick the Great’s tall Prus­sian sol­diers and Nazi Panzer di­vi­sions would soon en­sue. Even now, as anti-Ger­man sen­ti­ment has in­creased across the Euro­pean Union, pro-EU of­fi­cials look to Ber­lin for the an­swers. So far, the best re­sponse they’ve got­ten ap­pears to be, “Ask Paris.”

And yet de­spite this dis­so­nance, the fear is not ex­actly un­rea­son­able. Ger­many’s predica­ment may be un­fair – but then, Ger­many has much to pay for. The hypocrisy of Ger­many’s en­forc­ing aus­ter­ity on Greece while it sat on large trade sur­pluses, or its lam­bast­ing the United States with­out any sense of ap­pre­ci­a­tion for the tax dol­lars U.S. cit­i­zens sent to re­build a once-mor­tal enemy seems lost on a Ger­man gov­ern­ment that, with the best in­ten­tions, be­lieved the lions had al­ready lain down with the lambs and the swords had al­ready been beaten into plow­shares. Now Ger­many, which as­cended to its po­si­tion on the backs of the euro and the U.S., must look to its own na­tional in­ter­ests, and try to de­fend them with­out im­pos­ing its will on its Euro­pean neigh­bors. If Ger­many can find a way to do that, per­haps there is room in his­tory for mir­a­cles af­ter all. Ei­ther way, the storm clouds are gath­er­ing, and the world waits to see if light­ning will strike a third time.

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