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Under the bonnet, Germany is stalling

nbr14112014Published in The National Business Review (Auckland), 14 November 2014 (PDF)

As Chancellor Angela Merkel is visiting New Zealand today ahead of the G20 summit in Brisbane, we are bound to hear praise, compliments and flatteries for the German economy; the supposed “economic powerhouse of Europe.”

No doubt Chancellor Merkel herself will point out what a great success story her country has been under her leadership – and what the world might be learning from the Germans.

Unfortunately, if economic indicators and long-term trends are anything to go by, a eulogy for the German economy would be more appropriate. At least that is the quintessence of a new book under the pessimistic title The Germany Bubble: The last hurrah of a great economic nation (Die Deutschland-Blase: Das letzte Hurra einer großen Wirtschaftsnation).

Written by Olaf Gersemann, economics editor of conservative broadsheet Die Welt, it mercilessly reveals the weaknesses of Germany’s business model.

If Gersemann is right, the country’s best days are behind it. What lies ahead is a painful process characterised by population ageing and shrinking, economic stagnation and deteriorating public finances.

However, it is not just Germany’s future that looks frightening. Gersemann convincingly points out, contrary to popular belief, Germany’s past and present cannot be called a success story either.

The world may think of Germany as the stability anchor of the eurozone and the home of some highly successful companies, not least in car manufacturing. But these attributes mask some more unpleasant facts that run counter the narrative of the alleged German economic powerhouse.

To set the record straight, Gersemann delves deep into economic growth data. According to his calculations, out of 166 countries for which data are available over the past 20 years, only 10 have recorded worse average growth rates than Germany.

It may be hard to believe but at an average growth rate of just 1.29% per year, even Tonga (1.3%) grew faster than Germany.

There are only two ways countries can build their economies. They can either work more or they can work more effectively.

The first option could mean an increased work participation rate, longer working hours, fewer holidays or later retirement. The second option would require increases in productivity, defined as producing more output per unit of input. On both counts, Germany performs poorly.

Germany’s official unemployment rate of just over 5% may not look too bad at first glance. The real figure for underemployment is much higher, though. That is because people in retraining programmes and early retirees are excluded from the official statistics.

The real unemployment figure is not three million as statistics suggest but closer to four million. Even that figure may be too low as it excludes people working short-time. One thing is clear: There is no “jobs miracle” the German government loves to talk about but persistent underemployment.

Those Germans who are still working are working less, not more. The number of hours worked per person has been trending downward for decades and is now among the lowest in the world.

In 1960, the average German worked 2162 hours per year. Today it is only 1397 hours, which compares unfavourably to the US (1790), Spain (1686), Poland (1929) or Switzerland (1636).

The situation is even worse once work participation rates are taken into account. Gersemann calculates that per capita only 720 hours of paid work are done per year in Germany, compared to, say, 963 hours in Switzerland.

Being work-shy might work for the Germans if at least they were super-productive. As it turns out, that is not the case either. Productivity growth has been falling for decades.

Whereas West Germany recorded productivity growth of 4.1% per annum in the 1970s, in the 1980s it was only 2.1%, in the 1990s 2.2% and since the year 2000 only 1.2%. In fact, for the years 2005-13, productivity growth fell to a low of 0.9%.

Given the combination of poor productivity growth and declining working hours, it is therefore not surprising that Germany’s growth figures can only be called disappointing.

But there are other factors as well that negatively impinge on Germany’s economic performance. First and foremost, Germany has been suffering from a lack of investment, both public and private.

Since 2003, the government’s net capital formation has been negative in every single year. In other words, Germany is living off the substance of its infrastructure.

Bridges, roads, canals and rails are not replaced. The result: Half of all river locks are older than 80 years; the average age of railway points systems is an incredible 93 years. Businesses suffer, for example, when the Kiel Canal could not be used because neither of the two locks worked and ships had to take a 900km detour around Denmark instead of sailing through the 98km long freshwater canal in the state of Schleswig-Holstein.

Businesses are also disinvesting in Germany. From 2000-11, net fixed assets in manufacturing declined 7%. If this trend continues, Germany is headed for deindustrialisation. Quite clearly, German companies find it more attractive to build their factories elsewhere, rather than at home.

BMW, for example, has been systematically increasing its productive capacity in its US-based Spartanburg factory, which will soon be its largest plant.

Demographic change is the icing on the cake of Germany’s structural problems. Since the 1970s, fertility rates have been well below the so-called replacement age. This has already pushed up the median age to 45.3 years but the situation will deteriorate further.

Not only will Germany lose about a quarter of its population by 2100 but it will also see a rapid increase in pensioners. This process has already begun. In 2008, there were only 337 pensioners for every 1000 persons of working age. By 2040 this figure will have already reached 525 pensioners.

All factors combined will mean, in just a few years, trend growth could well become negative for Germany – and even “boom” years would rarely see growth rates above 1%.

So why, despite all these severe problems, does Germany still look like a haven of stability? As Gersemann argues, Germany has perversely benefitted from the troubles of its neighbours.

By keeping its wages low within the fixed exchange rate framework of the Eurozone, it has effectively devalued internally. This created a highly competitive export-driven economy.

At the same time, Germany benefitted from the euro crisis in the form of ultra-low interest rates, which saved both the government and German companies billions of euros. However, these effects are temporary and one cannot build lasting economic success on them.

To make matters worse, creeping denigration of economic growth is a target of economic policy. It is rather bizarre but even conservative politicians such as Finance Minister Wolfgang Schäuble publicly ponder whether growth in developed countries should not be systematically curtailed – as if Germany suffered from too much, not too little growth.

Former federal economics and labour minister Wolfgang Clement was right when he called Gersemann’s book a wake-up call against complacency. He added he agreed with the author “that many things in Germany have to change just so that some things can remain the way they are.”

When Chancellor Merkel visits New Zealand or speaks at the G20, she will of course try to portray a very different image of her country. Unfortunately, the self-righteous self-image of Germany bears little resemblance with the cold, hard facts of its economy.

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