/ 28 September 2012

The miracle economy is a misnomer

Real income growth for German workers has been weak.
Real income growth for German workers has been weak.

The leading German banker did not mince his words. Answering questions about whether his government was prepared to dig deep to save the eurozone from destruction, he said Berlin would insist on stringent conditions in exchange for financial help: "You can't just hand over your chequebook and let somebody else spend your money."

That sentence speaks volumes about the way economics has changed the dynamics of eurozone politics. Germany is not just Europe's biggest economy. It has made itself more competitive during the past decade through the sort of hardline structural reforms it now wants to see in Greece, Italy, Spain and Portugal. The message from the eurozone's paymaster is simple: if we can do it, so can you.

Three separate factors explain why Germany carries such clout. First, there is the country's powerful economic base – a web of small, medium and large companies that have access to long-term finance, boast highly skilled workers and have spent decades investing in product development and after-sales service.

Second, Germany has taken steps since the creation of the single currency to make itself more competitive. Trade unions accepted low pay deals that resulted in real living standards rising much more slowly than in the United Kingdom, France or the United States. The Hartz reforms made the labour market more flexible, allowing German firms to undercut their foreign rivals.

Finally, the shift in global economic power from West to East has played to Germany's strengths. Countries such as China and India are looking to build up their manufacturing sectors. To do that they need the capital goods that are the speciality of the often family-run businesses of Germany's Mittelstand.

Miracle economy
But comparisons with the postwar Wirtschaftswunder, or miracle economy, do not stack up. The rapid expansion in the decades after World War II resulted in rising real incomes as the proceeds of growth went to both capital and labour. Over the past decade, it has been the factory owners who have reaped the rewards from supply-side reforms in terms of higher profits. Real income growth has been weak.

What is more, the economic climate, notwithstanding the emergence of China, India and Brazil as economic superpowers, is less benign than it was in the 1950s and 1960s. The eurozone's sovereign debt crisis has been rumbling on for almost three years, and Germany is not immune. The latest data showed that Germany's economy grew by 0.3% in the second quarter of 2012, but business surveys suggest a slowdown in the second half of the year.

Compared with the rest of the euro­zone, Germany's recent economic performance has looked good. But compared with the days of Kon­rad Adenauer, Ludwig Erhard or Willy Brandt, it has been unimpressive. For much of the past decade, German banks were as reckless as their American and British counterparts, shifting capital abroad to finance housing bubbles in Spain and Greece. Investment in domestic industry was weak until the sovereign debt crisis prompted a much more conservative approach to lending.

"It is a myth that the German economy has gained from euro membership," said Charles Dumas, of Lombard Street Research.

"Its growth has decelerated. Its growth of productivity has halved. Its citizens have accepted severe wage restraint without the former benefit of a rising currency, leading to negligible gains in consumer welfare. The undervaluation granted by their wage restraint has benefited producers artificially, and weakened the incentive to cut out waste, hence lower productivity growth."

Even so, Germany's economic clout means Chancellor Angela Merkel has an effective veto on the proposals canvassed for sorting out the problems of monetary union. None of these are cost-free. One option would be for Germany to sanction an increase in inflation, making it less painful for the poorer southern European economies to adjust. That is anathema, as is the notion of writing blank cheques in a repeat of the transfer payments to the east following reunification.

Breaking up the euro is also unthinkable, which means Merkel's only feasible option is to turn Germany's postwar foreign policy on its head. Instead of making Germany more European, henceforth the rest of Europe will be made more German. – © Guardian News & Media 2012