The economic powerhouse that is Germany seems a miracle,what can go wrong?

28th February 2012 by Shaun Richards

I would like today to look at the other outlier in the Euro zone. So rather than the travails and problems of Greece I will look at the economic success story that is the Federal Republic of Germany. If we consider both countries we see that their extraordinary economic divergence where in 2011 their economic growth rates were -7% and +3% respectively puts the lie to the claims of the architects of the Euro that there would be economic convergence.

How has Germany diverged from the rest of the Euro zone?

Back on the 29th of September I expressed the view that German reunification had after the initial struggles and problems given her economy a boost and made her very competitive. For example her workforce received a boost from an increase in population of 16 million and these workers were willing to be flexible and to change as these quotes from an economic paper by Rainer Eppelmann illustrate.

We in the East had to reorganize our lives. Just consider that today about 70 percent of East Germans pursue different professional careers than before 1989.

The flexibility of the wage agreements in the East is more distinct than in the west.

If we wish to measure the effect of this we can do so by using the tables for economic competitiveness calculated by the European Central Bank. It defines them as shown below and I have used the one which uses unit labour costs.

The purpose of harmonised competitiveness indicators (HCIs) is to provide consistent and comparable measures of euro area countries’ price and cost competitiveness that are also consistent with the real effective exchange rates (EERs) of the euro.

Our base level of 100 for every country is the beginning of the Euro in 1999. So a number below 100 indicates increased competitiveness and we see that the lowest number for the 3rd quarter of 2011 is Germany at 82.3. In fact there is only one other nation whose competitiveness has improved as in an attempt at an economic Anschluss Austria records 92.5.

This leads to an interesting consequence as you could conclude from the overall number that the Euro zone has improved its competitiveness overall as it has a reading of 95.5. However it is more realistic to say that Germany’s improvement with a little help from Austria has offset everyone else’s decline! 

If you wish to look for the worst performers over the period you may well get a surprise. It is in fact the new entrants Slovakia (180.9) and Estonia (142.9). The good news for Slovakia is that she has improved from a reading of 195 since she joined the Euro at the beginning of 2009 and Estonia must hope that she can do the same after her entry.

What about Greece?

The numbers here are genuinely chilling and should be recited in my opinion to the architects of the Euro. Back in 1995 when they start Greece (88.3) was more competitive than Germany (113.3). We know what happened next… But if we look more closely we see that the period where Greece really deteriorated from the beginning of 2002 (87.4 at the end of 2001) to the beginning of 2008 (114.5) is solidly on the Euro’s watch.

Employment and Unemployment trends are different in Germany

It is always difficult in economics to know which is the chicken and which is the egg but we see that her employment and unemployment performance is an outlier too. For example her economy employed 38.33 million people in December 2008 and employed 40.13 million in December 2011. This makes me think immediately of the United States where we have been given a lot of “good news” recently if you believe the hype but still has some 7 million or so fewer jobs than before the credit crunch. Which would you prefer?

If we switch to looking at unemployment and use unadjusted figures we see that for the month of January since 2007 the unemployment rate has gone 10.2%’ 8.7%,8.3%,8.6%,7.9% and now 7.3%. This is a much better performance than elsewhere and is plainly linked to the competitiveness figures above.

How has Germany managed this?

I think that there are three main factors which are as follows.

1. She has managed to drive down costs and thereby increase competitiveness and her workers have been willing to accept low wage rises. According to her statistics agency her index of wages and salaries on a base of 2008=100 is now 99.7.

2. Her economic system has allowed companies to thrive when in the UK they tend to founder and a different relationship with banks and the providers of capital seems to have allowed manufacturing to succeed on a bigger scale. It is not that other nations do not do this it is simply that Germany manages more of it.

3. She changed her labour laws in 2008 to restrict lay-offs and this seems to have allowed more skilled businesses to survive rather than the opposite. I think that this only worked in combination with the more paternalistic structure described in 2 above. And added to this German workforce has been willing to be very flexible in terms of working shorter hours for example. Up until the credit crunch there had been a considerable increase in the flexibility of the German labour force.

Can Germany even survive austerity?

I established a theme a while back that the two opposing camps of austerity and fiscal expansion were concentrating too much on these features which were less of an influence than they would have us believe. The consensus now has moved to austerity means lower growth and maybe recession/depression. However care is needed because Germany is in the process of applying austerity. There were 11.1 billion Euros of cuts in 2011 , rising to 17.1 billion Euros this year 2012, 25.7 billion Euros in 2013 and 32.4 billion Euros in 2014.

In response the Germany economy grew by 3% in 2011! Of course even Germany is likely to be affected by the slow down which seems apparent in 2012 but already we see that the picture is not as clear cut as many would claim. You see her fiscal or budget deficit fell from 4.3% of economic output in 2010 to just 1% in 2011. So far austerity has worked in Germany as if you combine it with economic growth it is a powerful weapon. The problem elsewhere has been caused by combining it with economic decline and even worse covering up the likely consequences with economic growth forecasts which are in effect fraudulent.

An exporting powerhouse

There are many ways of demonstrating this. If we look at the last three Decembers we see a trade surplus which has gone 12.5 billion Euros,12.6 billion,12.9 billion created a sequence which looks ,ahem, very Germanic! The chart on her statistics agencies website goes back to 2003 and every month is a surplus and the graph has as it x-axis base a surplus of 7 billion Euros a month.

What could go wrong?

At times like this it is easy to declare a “miracle” and look to copy it. However history tells us that such thoughts are in general prevalent at exactly the wrong moment. Looking at Germany reminds me of the concept of a “perfect storm” and this came mostly from her labour market. Here the gains from reunification were reinforced by the reforms of the early and middle parts of the last decade. These meant that the new employment regulations of the credit crunch were able to succeed and the combination led to where we are now.

Eevn better keeping employment up meant that Germany was able to recover quickly in terms of economic output and bring her fiscal deficit back to near balance by avoiding a surge in social security payments. Such economic strength means that her debt costs are low too as there is little perceived risk in lending to her and she can borrow for 30 years at an interest rate of 2.44%.

However there is a shark in the water. If we look at Germany’s national debt to GDP figures we see that it has risen over the period of the credit crunch by much more than you might think by looking at her fiscal deficit numbers and is now 81.8%. Tucked away in there is a small part of a big danger and yet again it is the banks. Germany’s banks lent on a large scale around the world and they are involved in all of the casualties such as the American mortgage market and the peripheral Euro zone nations.

It is always the banks is it not? Ironically the austerity hard (wo)man has perhaps the most to lose from a banking collapse as it would show that her economic edifice is by no means as strong as it might appear. Going forwards the question is can her exporters pay for the sins of her banks? To that question we do not know the answer yet. In a world of realpolitik you may already be seeing how Germany let an Italian be in control of the ECB and that her complaints may be a case of.

The lady doth protest too much, methinks

In short if this was a game of football we may not yet be even at half-time which is a great relief as an Englishmen  as what we want least of all is a penalty shoot-out……..

26 thoughts on “The economic powerhouse that is Germany seems a miracle,what can go wrong?”

  1. PieterC says:

    Hi Shaun, very interesting as always. Would you agree that, as well as the factors you mention, part of Germany’s export success is due to operating within the euro, effectively a devalued currency compared with a stand-alone Deutschmark? Some have speculated that this would be on a par with the Swiss franc and would presumably have a marked effect on Germany’s export performance.

    1. Anonymous says:

      Hi PieterC

      I agree that this is a factor. How much is the perennial problem when you know where you are but are making estimates for where we could/might be.

      In my opinion the Euro has operated as a soft-Dm andso Germany has benefited from a lower currency but perhaps not as much as one might assume. Mind you there is no way of knowing how much capital would like to pour into a safe-haven Dm and how high it could get pushed by it…

  2. Anonymous says:

    Hi Shaun
    Would not Germany be better insulated from her banking sector by the fact that she has run current account surpluses for a considerable period and did not have a property ‘boom’ domestically. I accept she may have imported other people’s ‘busts’ via her banks but at least does not have to cope with her own?

    1. Anonymous says:

      Hi Shire

      Agreed and it is a nice irony that such an exporter has imported banking problems is it not? What to do with the funds gained is an issue that both Japan and latterly China have struggled with.

      I used to be in contact with a Japanese economist (unfortunately she died last year) who was often on the FT website under the name of Lady E. She was convinced that the scale of the problems the German banks had in the US mortgage market had been underestimated and was a serious problem on its own.

  3. Anonymous says:

    A shortage of electricity in Germany caused by the nuclear power shut down will hinder energy intensive manufacturing.,1518,816669,00.html

    This is partly a story about a Krefeld steel plant the faced electricity costs tripling since 2000. As a result it is being closed with 400 job losses.

    1. Space Man says:

      I’m sure that Germanys eastern neighbours will be more than happy to sell them all the electricity that they want.

      1. Anonymous says:

        8 reactors went offline in 2011 as a result of the referendum and another 9 will be shut down within the next decade. So Germany needs to replace 17 reactors.

        Of Germany’s eastern neighbors, Poland does not have nuclear power and Austria banned it in a referendum. This leaves only the Czech republic with it’s electricity company CEZ. CEZ are a totally incompetent bunch of clowns who tolerate gross incompetence and corrupt senior employees. Their response to me was basically silencing the messenger and sweeping the issue under the carpet. This was the board’s action when challenged at their 2008 AGM in Prague.

        CEZ have 6 dubious Soviet built reactors and made a promise to the Czech greens in the ruling commission not to build any more nuclear reactors.

        Hence I conclude that CEZ cannot replace more than a small fraction of the German nuclear generating capacity. Taking electricity from further east will require substantial power grid investment and may face political hurdles.

        I’d suggest that EDF is the most likely candidate for exporting electricity into south western Germany.

        1. JW says:

           Hi ExpatInBG
          Absolutely correct. EdF is the only viable source externally. It already exports a lot , it has to because of the flat supply curve ( nuclear have to run base-load) its way of managing against its own internal demand is to export the rest.
          Poland could build more coal plant, but then so could Germany, but the ‘greens’ wouldn’t like that.
          Indeed the whole of Europe is facing severe supply problems soon with its brainless approach to useless ‘renewables’.
          Dependancy on Russia for gas is not a sensible solution.

          1. Anonymous says:

            I’ve previously posted about spiegel articles and the pending German coal shut down. Germany will face serious electricity shortages. Dithering Merkel is unlikely to take decisive action to address this looming problem.

            Electricity is best generated near heavy users – grid infrastructure over long distances is expensive and takes a long time to construct.

            Geographically speaking, German heavy industry tends to be concentrated in the west – Ruhr, Saarland, Baden Wurtemburg and Bavaria. CEZ’s Temelin site is close to Bavaria. Poland is a long distance from these West German districts and I doubt the grid could transmit the quantities of electricity needed.

            I suggest that 10 to 15 new large reactors are needed to replace the existing German reactors. Politically speaking the French and Belgian governments would allow them.

            But it’s an open question whether EDF & ElectraBel could get finance and also whether they’d take the commercial risk.

          2. Rods says:

            The only other country that is a major exporter of electricity in the region is the Ukraine.

            If they were used it would be better to transfer the electricity that sort of distance using a very high voltage DC connection as the losses are lower and this would also be required if the two grids aren’t synchronized. 

          3. Anonymous says:

            Ukraine’s excess electricity is small beer compared to German consumption.

            The transmission system is high cost and requires political cooperation between Germany, Poland and Ukraine. Gazprom might try to influence Ukrainian politics to hinder a competitor.

            Easier for the German industrialists to move their plants east for cheaper electricity and labour.

          4. JW says:

             Eon could partner Edf and Electrabel in new plant outside Germany specifically for export to Germany.
            This ‘game’ has been going on for some decades, German energy planners thought they had it licked with Yeltsin, but then along came Putin and Gazprom was made into a ‘national champion’ more than ever, and the Germans weakened RWE and EON with all this green nonsense. Now their energy policy looks worse than the UKs which is saying something!

          5. Anonymous says:

            As Shaun often points out – the economic policies of these politicians are untenable and badly thought through. Sadly the same politicians are pursuing untenable badly thought out energy policies.

          6. Anonymous says:

            Hi Rods

            You and Expat may gain some amusement from a  cartoon map of Europe  drawn by a Bulgarian artist called Yanko Tsvetkov. He did various versions and the German one had the following description of Russia and the Ukraine “Gas Vault”.

            Somewhat ominously some of the countries in between them were labelled “Gas Transit Land”

            We in the UK were “Enigma Code Breakers”…

    2. Anonymous says:

      Hi Expat and thanks for the link which of course echoes the Japanese experience to some extent.

      Here on a similar subject are the numbers on oil costs in Germany which I had got ready for the post but decided you have to stop somewhere. So energy prices are an issue right now.

      “In 2011, German importers had to pay an average of Euro 583 per tonne of crude oil imported to Germany. As reported by the Federal Statistical Office (Destatis), the previous all-time high reached in 2008 (Euro 506 per tonne) was markedly exceeded. In the course of 2011, the average values for crude oil imports were highest in May (Euro 626 per tonne) and lowest in January (Euro 505 per tonne). In 2010, the price of one tonne of imported crude oil had been an average Euro 435.”

  4. Drf says:

    “It is always difficult in economics to know which is the chicken and which is the egg…”  That must be one of the most honest statements ever made by an Economist! If it is difficult to know which is the chicken and which is the egg then in macro system terms cybernetically Economics is shot? There have been one or two other Economists recently admitting that macro-Economics does not really work, and that the supposed mathematics is modeled to fit what is believed at any particular time rather than as in Science and Engineering to discover reality. When we consider that politicians claim to practice the idiocy they impose upon us on the basis of what the Economists state is so and what will happen it is thus no wonder that we are now in such a mess?

    The truth is thus that we do not really know what will occur, because we cannot predict the future and we cannot predict human reactions and human nature.  That is what always seems to crash the theories, and leads to disasters like that which we enjoy now. It is a similar problem in the realm of Psychology with supposed actions and system resultants and theory. 

    “Going forwards the question is can her exporters pay for the sins of her banks?”  I don’t think it is just the sins of the banks that now have to be paid for; it is the combined sins of the banks and Euro politicians which are now coming home to roost, and they are likely to bring the whole edifice down with their present posturing and fiscal idiocy I fear. We live in extremely dangerous times, where the blind are leading the blind!

    1. Anonymous says:

      Hi Drf

      The sins of the politicians are beyond my scope for now! Well apart from the economic consequences of them…

      I think Germany may well have enough troubles from the sins of her banks.

    2. JW says:

      Hi Drf
      To use a Physics analogy, Economics is stuck in Newtonian era, it never got to Quantum. Its static not dynamic.

      1. Anonymous says:

        A physicist would probably tell you that it is in the dark ages

  5. JW says:

    Hi Shaun,

    Germany’s impressive trade figures are built on the back of ‘flexible’
    labour. So flexible in fact that they don’t share the bounty. If they
    were paid more and spent more some of the EZ problems would reduce. But
    this together with a weak currency has produced a ‘mercantile’ bonanza
    for a few. Yes local German banks work much more closely with industry
    than the ‘big’ banks in the anglo world, but as you say they have their
    fair share of ‘big’ banks doing the same casino banking. Having local
    banks of itself didn’t stop Germany having poor years previously.

    Germany is starting to see house price inflation take off after years of
    flat-lining. Even in Germany the LTRO money has to go somewhere… and
    the Germans do buy houses just not in Germany, as well as the Med they
    are big buyers in the USA.

    As has been pointed out in other articles Germany at a fraction the size
    of the US is responsible for trying to bail out the EZ an economy $1tn
    bigger than the US. It can’t be done and no-one is going to ride in to

    So yes good trade numbers but as you say its only 30 minutes into the
    first half and there are some big injuries around the corner with no
    substitutes on the bench.

    Off topic I posted late on your previous thread that Mr Cook is
    forecasting Brent at $60 in Q2, because of the unwinding of those
    Goldman/BP ‘dark contracts’. He sees backwardation forcing a plunge in
    price just before the US election.  

    1. Space Man says:

      “Germany’s impressive trade figures are built on the back of ‘flexible’ 
      labour. So flexible in fact that they don’t share the bounty.”
      What’s your alternative? Inflexible labour, and bad trade figures so that there’s no bounty to share at all, and no jobs? The workers in Germany know what they would prefer and thats what they have gone for. And it’s not like there is some massive elite in Germany taking all the money – in fact their industries make small profits compared with the amount of investment.

      The exchange rate has helped them, but Germany would still be doing well without it, because of the points that Shaun has pointed out above.

      1. JW says:

         Hi Space Man
        What is wrong with being flexible and being rewarded more for it? You infer the wealth is not going to an elite, then where is it going, Mars?

    2. Anonymous says:

      Hi JW

      The oil numbers remind me that so often we seem to be facing what seem bi-polar options these days dont we? Some of it is of course headline chasing but it is true that in reality we are at times veering between extremes such as inflation or disinflation (although exJapan there is a marked shortage of disinfaltion considering where we are).

      If Mr.Cook turns out to be correct eyes will turn again to speculation and should then turn to the central banks who have “splashed the cash”. Also my chartist friend will be pleased as his chart was looking for a $70 oil price.

  6. Mike says:

    I read a stupid headline a couple of weeks ago ”Japan on the brink” due to having run up 3 consecutive months of trade deficit! That, after 30 years of trade surplus!! How could UK MSM come up with this without embarassment!!
    The UK on the other hand last ran a trade surplass bearly within living memory of most city scribblers. And because for years we have spent more than we’ve earned, we’re now finally in this precarious situation, to the tune of £1 Trillion and still counting.
    USA can get away with it as printers of the $dollar, but UK is sunk and still sinking in debt racked up by trade imbalances and bankstering.
    Germany by comparison is a safe bet even with its bankstering and the EZ & EU millstones round her neck.
    As a time served Englishman I regret having to say this.

    1. Anonymous says:

      Hi Mike

      Japan has issues that I have recounted on here but with the surpluses she has built up it will be a while before a trade deficit is one of them. Whilst it was of note that she has  a trade deficit the writer of that headline may be eating his/her words if the Yen should continue to weaken in 2012.

      Current a/c surplus:Just after the MPC was formed I think 97-98 but the numbers are revised even as far back as then and the ONS website is foiling me right now on that subject.

  7. Rods says:

    Hi Shaun,

    Excellent blog as always.

    “What can go wrong?”

    Long term demographics are against them with an aging population, but high youth unemployment in other EU countries may well solve this.

    Green party and climate change policies including carbon taxes may force high energy metal bashing industries to relocate to cheaper countries.

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