The German miracle
What’s at stake: Four months ago the question on economics blogs was whether Germany was ever going to grow. It was accused of not living up to its responsibility to the European/global community due to its dedication to savings and addiction to exports. The announcement of a fiscal consolidation was considered extremely selfish and ultimately counterproductive. Now the world looks on with astonishment and wonders why Germany outperformed most of the developed world in the second quarter, growing at a 9% annual pace (the best since German Reunification). Economists have been debating intensely about the roots of the boom, with some arguing that the performance is little more than a dead-cat bounce, while others are pointing towards past structural reforms and still others suggest Germany is relying on beggar-thy-neighbour policies.
Cyclical responsiveness
Wolfgang Münchau writes that it’s important to keep some perspective and not draw false inferences from the Q2 GDP growth number. If you look at the period since the beginning of the financial crisis, Germany’s economic performance has been dismal. If you compare levels of gross domestic product between Germany and the US since the crisis, you find the US significantly outperformed Germany during that period. That situation may still be reversed if the US were to go into a double-dip recession. But the best judgment we can make now is that of Christine Lagarde, the French finance minister, in her recent interview in the Financial Times: Germany is recovering faster this year because it contracted faster last year, when GDP fell by 5 per cent. So far, this looks like classic dead-cat bounce.
Philippe Le Coeur compares the economic performance of France and Germany after the crisis, arguing that the differences in economic growth rates boil down to differences in cyclical responsiveness. Germany was hit much harder by the recession than France, and enjoys now a more dynamic recovery. Ryan Avent writes that a key difference between the US and Germany is that Germans remain upbeat while Americans grow ever more dour: the Munich-based Ifo institute said its business climate index had risen to the highest since June 2007, defying expectations of a modest correction.
Is-it only exports?
Harold James credits Germany's export orientation. The surprisingly strong and successful German recovery is almost entirely a consequence of export demand, in particular from vigorous growth of emerging markets. It is not a uniquely German phenomenon, in that the same pattern of a vigorous export recovery can be seen in other countries with a similar structure (notably Switzerland), but also some of the dynamic Central European economies (Slovakia or Poland) that see the German development as a model.
Scott Sumner indicates that a weakening euro cannot be ignored. Whereas the euro had traded in the range of 1.35 to 1.45 to the dollar in the first four months of 2010, the exchange rate has dropped to the 1.20 to 1.32 range since the beginning of May. Because Germany has an export-based economy, this contributed to a fast rise in output. Just the opposite happened in the US, where a recovery that looked on track in the first quarter of 2010, suddenly stalled in May and June. Some have argued that the winding down of fiscal stimulus caused the recovery to weaken in the US. But spending rose briskly in the second quarter; the problem was a widening of the trade deficit.
Beatrice Weder di Mauro pushes back against the importance of the euro’s fall. Some 40% of Germany’s trade is in Europe where (nominal) exchange rates play no role. Trade outside the euro area will be positively affected by the depreciation of the euro but this is never an immediate effect. The recovery of exports in spring coincides with the pressure on the euro but is caused by stronger foreign demand for German-type products. If you doubt this, look at Switzerland, which exports similar products and saw its exports jump in spring—at the same time as the exchange rate appreciated massively. The more important part of the story is actually not about net exports. The news that did not make the news is that the growth contribution of domestic demand in Germany was larger that of net exports. Domestic demand contributed 1.3% and net exports only 0.8% in the second quarter (quarter-on-quarter) to growth. In the first quarter the relative contribution of domestic demand was even stronger (1.6% domestic versus -1.1% foreign).
Economics 21 debunks conventional wisdom about German growth being mostly export-led. Although growth in net exports did boost GDP in the quarter, it accounted for only 36% of German second quarter GDP growth, less than the 50% contribution from private sector consumption and investment growth (excluding inventories). Were this simply about trade flows and demand for manufactured goods, the German economy would probably resemble that of Japan, where exports were up by more than 25% (annualized) in the second quarter, but the economy remained stagnant due to contractions in consumer spending and private sector investment.
Structural reforms ahead of the crisis
David Brooks argues that the Germans are doing better because during the past decade, they took care of their fundamentals and the Americans didn’t. As an editorial from the online think tank e21 reminds us, the Germans have recently reduced labour market regulation, increased wage flexibility and taken strong measures to balance budgets.
Carmen and Vincent Reinhart point to the lack of leverage in the German economy. Despite rapid increases in government debt since the crisis, Germany does not have a private or public debt overhang of the historic proportions confronting most other advanced economies. It follows that a long and painful deleveraging is not on the horizon. In this regard, Germany is the advanced economy counterpart to emerging markets in Asia and Latin America. Those economies also deleveraged during the tranquil booming years (as discussed in Reinhart and Rogoff, 2010). These emerging markets are not only recovering robustly – some are showing signs of overheating.
A victory for the austerity camp?
Alberto Alesina argues that the German figures should give pause to those who keep arguing for even more deficit spending in the US and that fiscal prudence would push Europe into a second depression. Germany’s recovery is based on some labour market reforms in the last couple of years and a long period of wage moderation. It is also not based on the dubious and at most temporary effect of discretionary public spending increases. It is based on a private sector recovery and increases in productivity. What would sustain growth in Germany and in the rest of Europe is not more public spending but more pro-market structural reforms. If they take place, then growth will be sustainable, unless the US runs into a new recession.
Ryan Avent argues that Germany is absolutely not an example of strong growth despite austerity. Germany's stimulus spending was smaller than America's, but it was quite large by developed nation standards. Have a look at this cross-country assessment of stimulus policies put together by the Brookings Institution. Meanwhile, Germany has committed itself to deficit cutting, but it is not cutting now. Germany is one of the few euro zone countries to increase its budget deficit from 2009 to 2010. And planned 2011 cuts are quite small relative to those in countries pursuing crash austerity programmes, which are also suffering very weak recoveries
Paul Krugman says that holding Germany up as proof that austerity is good is foolish since Germany’s austerity policies have not yet begun — up to this point they’ve actually been quite Keynesian. But it’s also worth having some perspective on actual German performance to date. Everything you’ve been hearing is about the latest uptick but the cumulated output loss since the beginning of the crisis has actually been higher in Germany than in the US. Here’s the German story: it’s an economy that didn’t have a housing bubble, so it wasn’t caught up directly in the bust. But it’s very export-oriented, with a focus on durable manufactured goods. Demand for these goods plunged in the early stages of the crisis — so that Germany, remarkably, had a bigger GDP decline than the bubble economies — but has bounced back since summer 2009. This has pulled Germany back up; exports to China have done especially well.
The kurzarbeit scheme for a steadier job market
Gavyn Davies write that there have been some tentative signs that consumer confidence has been rising a bit faster than in previous recoveries, but that it because of the much improved performance of the labour market, which is the heart of the story. Much of the German miracle discussion has focused only on the performance of GDP, exports or consumption, where little seems to have changed, and has largely over-looked the performance of the labour market, which has actually been rather remarkable. In the 1950s and 1960s, everyone talked about the German economic miracle. We certainly have not seen that repeated in the last few years, but we have seen a complete overhaul in labour market policy which is now bearing fruit, and which deserves to be more widely recognised.
Jack Ewing writes in Economix that the German labour market has been surprisingly bulletproof during the economic downturn with the unemployment rate now being lower than at the start of the crisis. One big reason Germany has kept a lid on unemployment, already well known, is the widespread use of so-called short work — “Kurzarbeit” in German. The scheme allows companies to cut workers’ hours, with the government making up some of the lost wages. During the first quarter of 2010, 22 percent of firms surveyed by the Ifo Institute, a Munich research organization, said they were using Kurzarbeit. Among manufacturers, 39 percent were taking advantage of it. One reason Kurzarbeit is so popular with companies is that it allows them to hang on to skilled workers. Tyler Cowen writes that Germany's kurzarbeit scheme is a major still uninternalized lesson of the recent crisis. In a highly specialized modern economy, it is much easier to prevent jobs from being destroyed than to create them again, at least assuming those are "good" jobs in the first place.
Commerzbank economist Eckart Tuchtfeld also points that there were some other factors at work that were also crucial to saving German jobs. The most important may be the increasing use in the last decade of so-called work-time accounts. Often as part of contracts with labour unions, companies allow workers to bank overtime hours during busy periods, and then take paid time off when business is slow.
Jurgen von Hagen says that Germany’s short-time work arrangements constituted a real devaluation inside the eurozone. It was okay for small countries to act like this, but not for large economies like Germany. He said the Finnish arrangement was different, as it was design for a small country when it was in recession, and the rest of the eurozone was not.
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