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German imbalances are harming Europe

German imbalances are harming Europe

Policy-makers should be as tough on surpluses as deficits 

by Simon Tilford

Wed 11 Mar 2015

The German authorities and media regularly point to data allegedly showing that rebalancing of the German economy is in progress. Newspaper articles froth about German consumers rediscovering shopping, and the government intones that the economy is now being driven by domestic demand. But the data tell a different story.

The country’s current account surplus hit a record 7.5% of GDP in 2014. Put another way, the gap between what the country produces and consumes is wider than ever. At over €200bn this was easily the biggest surplus in the world,  larger even than China’s.

Germany is in breach of the EU’s excessive imbalances procedure (which requires member states to restrict current account surpluses to no more than 6% of GDP, and deficits to 4%). German policy-makers are proud of the country’s export success, but a much smaller surplus would be in Germany’s interests and those of its trade partners.

Europe is awash with talk of the need for structural reforms, but little attention is paid to the chronic imbalances in Germany’s economy, which comprise perhaps the biggest structural problem of all. This needs to change for Germany’s sake and for the sake of its trade partners.

It is not in Germany’s interest to run such a large surplus. It means that living standards and investment are lower in Germany than would otherwise be the case. Moreover, the country has lost almost a third of the money it has invested abroad over the last 15 years; it would have made much more sense to invest the money at home. At the same time, German imbalances represent a formidable obstacle to a sustainable economic recovery and escape from deflation in Europe.

How did Germany’s economy become more imbalanced when it was supposed to be growing robustly and unemployment has been low? The reason is that growth in domestic demand has been anaemic – averaging 0.4% a year in 2012-14 – while economic growth averaged 0.8%. The difference was accounted for by exports growing more rapidly than imports. Domestic demand did account for the lion’s share of 2014’s GDP growth of 1.6%, but just because domestic demand is contributing more to growth than the external sector does not mean that the economy is rebalancing.

Domestic demand accounts for the overwhelming proportion of GDP, so it can be the principle driver of GDP growth even when expanding very weakly. If net exports are positive – that is, exports are rising more rapidly than imports – the economy is still becoming more, not less, imbalanced. For the German economy to rebalance in any meaningful way, net exports will need to be negative for a prolonged period of time. This will require the German government and private sector to save less and invest more.

In any economy, the sum of the savings surpluses or savings deficits of government, the private sector and the foreign balance has to equal zero. If the private sector balance is in surplus, then the government or foreigners must be borrowing – they must be in deficit. If both the private sector and the government are saving, as is the case in Germany, then other countries must be borrowing those surplus savings. In other words, they must be living beyond their means, something German policy-makers and economists like to criticise.

Since it is a net saver, Germany has to ‘import’ demand from other countries which are running a current account deficit, and which are therefore borrowing money from Germany. Germany has substituted external demand, in the form of additional net exports, for deficient demand at home.

The German economy is not about to rebalance significantly. Real wage growth will accelerate in 2015 as a result of falling commodities prices, but will not put a significant dent in the country’s surplus. For this to happen the government will need to embark on a series of policy interventions.

A fiscal stimulus is the most obvious way of soaking up some of the country’s surplus savings, and Germany has plenty of fiscal space to provide one. A more progressive tax system would also help: Germany relies too much on consumption taxes, whereas corporate income, wealth and property are undertaxed.

Financial liberalisation to encourage greater home ownership could also help to address Germany’s highly unequal distribution of wealth, lowering households’ precautionary savings in the process. In addition, the German authorities could openly back aggressive monetary easing by the ECB, including its programme of quantitative easing. There is no sign of any inflationary pressure in Germany and the awareness that interest rates will remain very low for a prolonged period of time could deter German households from saving so much.

As the German government shows little inclination to take active steps to foster rebalancing, the European Commission should step up pressure on it to do so. The German government does not take the Commission’s tame warnings seriously. This is unacceptable.

German imbalances have a deleterious effect on Germany and its trade partners. German rebalancing would boost the euro area economy as a whole and lift inflation, making it easier for indebted euro area countries to service their debts, including those they owe to Germany. If Germany and its partners could organise such an outcome, everyone would gain.

Simon Tilford is deputy director at the Centre for European Reform. This is an extract from his paper 'German rebalancing', first published by CER.

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