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German Economy – Reforms Paying Off
by Stefan Schneider, Chief International Economist, Deutsche Bank Research
While hard hit by the global recession, the German economy recovered strongly during 2009. With GDP growth of 3.7% in 2010 and 3.0% in 2011, respectively, Germany recorded not only the highest growth rates among the G7 countries, but was also one of the top performers among all industrialised economies. This stellar performance can be attributed to several factors. Firstly, Germany benefited from labour market reforms – in combination with wage restraint and increased flexibility in industrial relations – implemented during the last 10 years. Secondly, Germany pursued a policy of fiscal consolidation targeting the social security system in particular. But thirdly, and above all, the German corporate sector assumed an active role in the new wave of globalisation, which combined the innovative power of corporate Germany with the cost-saving potential of global value-creation chains. This helped German companies to take advantage of the increasing demand from emerging markets, while at the same time fending off increasing competition from those regions.
EMU debt crisis weighs on exports
Given that 40% of German exports go into EMU and about 60% into the EU, the consolidation measures implemented as a consequence of the European government debt crisis, however, have left their imprint. The negative impulses were initially transmitted via the confidence channel, as evidenced by the sharp drop in confidence surveys such as the Ifo index or the PMI in the second half of last year. But recently, the negative demand effects have become more apparent. Take, for example, the 11% year-on-year decline in orders from EMU countries in January/February. Sluggish external demand is not confined to the peripheral problem countries, which account for about only 10% of German exports and imports. In the whole of EMU ex-Germany the structural deficit – measuring the discretionary fiscal policy impulse – will shrink by 1.9% of GDP after falling 1.2% in 2011, while GDP in EMU ex-Germany will decline by 0.5% in 2012.
Implications of peripheral rebalancing for Germany
There is a general assumption that the required rebalancing of the peripheral countries’ current accounts, read ’elimination of the deficits’, which stood at a combined EUR 121bn in 2011 (Italy, Spain, Portugal and Greece), will be mirrored in a 1-to-1 shrinkage of the German current account surplus (EUR 148bn in 2011). However, this assumption is much too mechanistic. Our analysis shows that, while bilateral current account deficits are indeed narrowing mainly because of lower import demand in the problem countries, Germany has so far been able to partly compensate with higher exports elsewhere. We therefore expect the German current account surplus to shrink relatively modestly, from 5.7% of GDP in 2011 to 4.9% in 2012.
Given the limited direct trade exposure of Germany to the problem countries, requests that Germany should boost domestic demand in order to support the adjustment in the peripheral countries are not very convincing. In an analysis, Germany’s Bundesbank (the country’s central bank) showed that the impact of German domestic demand on the peripheral countries’ current accounts is very small.
Taking a more holistic, rather than a purely bilateral perspective also eases some of the concerns that in the EMU surplus countries – Germany, to be more specific – inflation has to increase substantially in order to help erode the deficit countries’ competitive disadvantage via internal appreciation in Germany. Here again, the intra-EMU unit labour cost differential vis-à-vis Germany accumulated since 2000 and giving a range between 25% and 35% exaggerates the actual loss in peripheral countries’ competitiveness, which is more appropriately measured by the change in the specific countries’ real effective exchange rates. These have risen by between 10% (Italy, Portugal) and some 20% (Greece, Ireland). This metric shows not only a smaller necessary adjustment, but also indicates that the adjustment will have to take place vis-à-vis all the important trading partners and not just with regard to Germany.