A country on the make

Strolling the broad, prosperous streets of Munich, it is worth recalling the times in the past decade when Gordon Brown used to boast in his budgets about how the United Kingdom economy was leaving Germany for dead.

Now, following the most successful year for Europe’s biggest economy since the euphoria that followed reunification two decades ago, that looks like the sort of prediction English football fans make ahead of each World Cup: premature, based on little more than wishful thinking—and wrong.

“We will have a golden decade now,” said Hans-Werner Sinn, president of Munich’s Ifo Institute, one of the country’s leading think-tanks. Sinn wrote a book early in the past decade, when unemployment was high and pessimism rampant, called Can Germany Be Saved? His view was that it could be. Now he says it has been.

The phrase “crisis, what crisis” also springs to mind outside the Audi plant in Ingolstadt, where a happy band of German motorists have come to pick up their new cars, fresh off a production line churning out 2 500 vehicles a day, six days a week.

“2010 was our best ever year,” said Jurgen de Graeve, Audi’s head of communications.
“At the beginning of last year it was clear the market was about to turn up but we didn’t expect it to happen so fast.”

Current trading conditions for Audi, as for the rest of German industry, have been transformed since the long, hard winter of 2008-2009, when some factories slashed output by up to 90% as the financial crisis threatened a second Great Depression. Overdependent on its export sector, Germany suffered a 20% drop in manufacturing output in 2009.

But government wage subsidies meant companies could keep highly skilled workers employed part time rather than throwing them on the dole, enabling industry to respond quickly to the rise in global demand.

There is now confidence that the traumas of 2008-2009 will help the country reinvent itself after a troubled period in which the economy was hobbled first by the costs of reconstruction in the former East Germany, then by the uncompetitive rate at which Germany joined the single currency and finally by the collapse of the IT bubble in 2001.

It was then that the rumours of inexorable decline started to circulate. The list of defects was long: pampered workers; an overgenerous welfare state; a too cosy relationship between companies and their bankers; the lack of a venture capital industry; too high a reliance on family-run manufacturing businesses; a population that was getting older and starting to shrink.

Put together, the view was that for decades Germany had been living on past glories—the explosive growth of the Wirtschaftswunder, or economic miracle, in the 1950s and 1960s—and had allowed its economy to become sclerotic. Now there is belief the good times are coming back and that some of the weaknesses flagged in the 1990s and 2000s have turned out to be strengths.

Skewed nature of German growth a concern
But it will take more than a year of powerful growth to convince sceptics that a second Wirtschaftswunder is guaranteed. The integration of the old communist Länder is far from complete: money has moved from west to east, the people have moved in the opposite direction. Some Germans now say the old East Germany is the equivalent of a Potemkin village: the buildings have been given a make-over but the mass exodus of the young means there is no one living in them.

The skewed nature of Germany’s growth is also a concern. Unemployment is falling and in rich states such as Bavaria it is below 5%, but there are few signs yet of a classic export-led revival broadening into a rise in wages and consumption.

Heiner Flassbeck, once adviser to Oskar Lafontaine—briefly the left-wing finance minister to Gerhard Schröder—is one who says there
is no real comparison with the 1950s and 1960s, when the proceeds of growth were shared by companies and their employees.

In those days Germans worked hard and grew prosperous, earning higher wages as the factories they worked in became more efficient. In the past decade there has been another productivity spurt as companies have overcome the handicap of an overvalued exchange rate on entry into the single currency by making themselves hypercompetitive. This time, though, real wages have stagnated, consumption stayed weak.

“In the next 10 to 15 years there has to be an increase in wages to shift demand from the export sector to domestic demand,” Flassbeck said, echoing the calls from the International Monetary Fund and the Organisation for Economic Cooperation and Development for Germany to play its part in evening out the imbalances in the global economy between those countries that run massive trade surpluses and those with chronic deficits. As the two biggest exporters in the world, China and Germany are seen as sharing a problem: “Chermany”, it is said, needs to import more.

Flassbeck said that unless Germany does so at a European level the euro cannot survive because weaker countries will face permanent austerity.

Sinn believes falling unemployment will eventually lead to increases in wages, which in turn will boost consumer spending. But there is little sign of Germany’s policymakers hastening this process. They seem quite content with the combination of factors that help explain Germany’s comeback.

Germany not immune to speculation
The first is the country’s economic and political structure. Prosperity is far more widely spread across the country, with none of the excessive concentration of wealth in one region found in Britain. There is an emphasis on long-term growth and boom-busts in the housing market are unknown.

Germany was not immune from the speculative mania and one reason Angela Merkel is prepared to bail out the struggling economies of the eurozone is that German banks are up to their eyeballs in Greek, Spanish, Irish and Portuguese debts.

But there was still an industrial bedrock. Thomas Mayer, chief economist at Deutsche Bank, agreed. “Looking back, some economies were putting too many of their resources into sectors such as real estate. Perhaps they overdid it. Germany benefits from an old-fashioned structure. What looked old-fashioned was more durable. The UK has overdone it but it is not the only one. The Americans, the Irish and the Spanish all overdid it.”

So, while the City boomed and Wall Street became fixated by subprime mortgages and collateralised debt obligations, Germany concentrated on making stuff.

This was true of the prestige international names such as BMW and Siemens, but it was also true of the hundreds of thousands of lesser-known names that make up the Mittelstand. These are companies, often family-run and in many cases founded a century or more ago, which provide the hidden wiring for the global economy. Germany provides the kit that other companies need to make their products and the Mittelstand companies have become expert at dominating their corners of the market.

The second explanation for Germany’s renaissance is that the country finally embraced structural reform of its economy at least two decades after Margaret Thatcher and Ronald Reagan pioneered deregulation, privatisation and welfare reform in the UK and the United States.

What happened, according to supporters of this theory, is that unlike Britain and America, Germany coped well with the oil shocks of the 1970s and 1980s and saw no need to change anything in the 1980s. Towards the end of that decade, and more so after reunification, the economy became increasingly sclerotic but the warning signs were ignored by Helmut Kohl.

But by the early 2000s the evidence of slow growth and high levels of unemployment was too powerful to ignore, so Gerhard Schröder introduced the Agenda 2010 reforms that cut business taxes, slashed the top rate of income tax, made pensions less generous, cut unemployment pay and allowed the shops to stay open later.

A more dynamic country
“Schröder didn’t get the full credit for what he did,” Mayer said. “He attacked all the sacred cows and paid the price by losing the election to Merkel. Industry embarked on a ruthless cost-cutting programme, they exploited new production techniques and IT to make their operations leaner and more profitable. Some parts of manufacturing were moved overseas but not all of it. It is an amazing comeback. The country seems to be a lot more dynamic.”

Flassbeck has a different view. He blamed the timidity of the unions on the changes introduced by the former SDP-Green coalition. “There is no pressure for higher wages because of the fear of being fired. Schröder killed the unions. That’s a nice paradox.”

The third explanation is that German investors had their fingers burned in the financial crisis and are now keeping their money safely at home. That has provided the capital for an investment boom that will help keep German industry hyper-
competitive in the future. Sinn said this is a real change from the period 1995 to 2008, when Germany had one of the lowest investment rates in the West. “The crisis has meant the perception of risk has changed. Investors see that not all that glitters is gold.

“There was a period under the euro when lots of attractive investment opportunities seemed to be in other countries. Government bonds seemed to be absolutely secure so German banks invested there. The risk perception means that German savings now don’t go out of Germany.”

Finally, there’s China, where year after year of 9% to 10% growth has sucked in exports from Germany. In part this has been demand for German cars, with Audi now expecting to sell more cars in China this year than it does at home. But it is also the result of Germany’s global dominance in investment goods, the products countries need when building up a manufacturing capacity. Britain talks about breaking into the Chinese market: Germany has done so.

Are there lessons in this? Yes, said Martin Zeil, the deputy prime minister of Bavaria. “All the countries that have kept the nucleus of their industry are more successful.” Bavaria has invested carefully in the region’s science and technology base, identifying future growth sectors such as green technology and life sciences and building up clusters of excellence that act as a magnet for investment. It takes more than a clutch of world-class companies to provide a solid industrial base.

Yes, too, said Mayer at Deutsche Bank, who spent eight years in London watching the boom-bust come to grief. “You have to realise that Gordon Brown was wrong when he praised economic stability and high growth as the result of his policies. It was an illusion. A large part of the world was living on the drug of credit. The UK economy is so reliant on housing. It has a high social value. Everybody is obsessed with it. In Germany almost everybody rents.

“Britain was on a 10-year high and now it is doing cold turkey. You have to wean the economy off credit and rebalance towards production and traded goods. But it takes years and years and years. In Britain there is a tendency to take the easy way out, to just go for another gin and tonic.”

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