The German economic miracle – What could go wrong?

28th February 2012

How has Germany diverged from the rest of the Euro zone?

Back on the 29th of September I expressed the view that German reunification had after the initial struggles and problems given her economy a boost and made her very competitive. For example her workforce received a boost from an increase in population of 16 million and these workers were willing to be flexible and to change as these quotes from an economic paper by Rainer Eppelmann illustrate:

'We in the East had to reorganize our lives. Just consider that today about 70 percent of East Germans pursue different professional careers than before 1989.'

'The flexibility of the wage agreements in the East is more distinct than in the west.'

If we wish to measure the effect of this we can do so by using the tables for economic competitiveness calculated by the European Central Bank. It defines them as shown below and I have used the one which uses unit labour costs.

'The purpose of harmonised competitiveness indicators (HCIs) is to provide consistent and comparable measures of euro area countries’ price and cost competitiveness that are also consistent with the real effective exchange rates (EERs) of the euro.'

Our base level of 100 for every country is the beginning of the Euro in 1999. So a number below 100 indicates increased competitiveness and we see that the lowest number for the 3rd quarter of 2011 is Germany at 82.3. In fact there is only one other nation whose competitiveness has improved as in an attempt at an economic Anschluss Austria records 92.5.

This leads to an interesting consequence as you could conclude from the overall number that the Euro zone has improved its competitiveness overall as it has a reading of 95.5. However it is more realistic to say that Germany’s improvement with a little help from Austria has offset everyone else’s decline! 

If you wish to look for the worst performers over the period you may well get a surprise. It is in fact the new entrants Slovakia (180.9) and Estonia (142.9). The good news for Slovakia is that she has improved from a reading of 195 since she joined the Euro at the beginning of 2009 and Estonia must hope that she can do the same after her entry.

What about Greece?

The numbers here are genuinely chilling and should be recited in my opinion to the architects of the Euro. Back in 1995 when they start Greece (88.3) was more competitive than Germany (113.3). We know what happened next… But if we look more closely we see that the period where Greece really deteriorated from the beginning of 2002 (87.4 at the end of 2001) to the beginning of 2008 (114.5) is solidly on the Euro’s watch.

Employment and Unemployment trends are different in Germany

It is always difficult in economics to know which is the chicken and which is the egg but we see that her employment and unemployment performance is an outlier too. For example her economy employed 38.33 million people in December 2008 and employed 40.13 million in December 2011. This makes me think immediately of the United States where we have been given a lot of “good news” recently if you believe the hype but still has some 7 million or so fewer jobs than before the credit crunch. Which would you prefer?

If we switch to looking at unemployment and use unadjusted figures we see that for the month of January since 2007 the unemployment rate has gone 10.2%’ 8.7%,8.3%,8.6%,7.9% and now 7.3%. This is a much better performance than elsewhere and is plainly linked to the competitiveness figures above.

How has Germany managed this?

I think that there are three main factors which are as follows.

1. She has managed to drive down costs and thereby increase competitiveness and her workers have been willing to accept low wage rises. According to her statistics agency her index of wages and salaries on a base of 2008=100 is now 99.7.

2. Her economic system has allowed companies to thrive when in the UK they tend to founder and a different relationship with banks and the providers of capital seems to have allowed manufacturing to succeed on a bigger scale. It is not that other nations do not do this it is simply that Germany manages more of it.

3. She changed her labour laws in 2008 to restrict lay-offs and this seems to have allowed more skilled businesses to survive rather than the opposite. I think that this only worked in combination with the more paternalistic structure described in 2 above. And added to this German workforce has been willing to be very flexible in terms of working shorter hours for example. Up until the credit crunch there had been a considerable increase in the flexibility of the German labour force.

Can Germany even survive austerity?

I established a theme a while back that the two opposing camps of austerity and fiscal expansion were concentrating too much on these features which were less of an influence than they would have us believe. The consensus now has moved to austerity means lower growth and maybe recession/depression. However care is needed because Germany is in the process of applying austerity. There were 11.1 billion Euros of cuts in 2011 , rising to 17.1 billion Euros this year 2012, 25.7 billion Euros in 2013 and 32.4 billion Euros in 2014.

In response the Germany economy grew by 3% in 2011! Of course even Germany is likely to be affected by the slow down which seems apparent in 2012 but already we see that the picture is not as clear cut as many would claim. You see her fiscal or budget deficit fell from 4.3% of economic output in 2010 to just 1% in 2011. So far austerity has worked in Germany as if you combine it with economic growth it is a powerful weapon. The problem elsewhere has been caused by combining it with economic decline and even worse covering up the likely consequences with economic growth forecasts which are in effect fraudulent.

Continue Reading…


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