What is the secret to Germany’s economic success?

The consensus view is that Germany is firing on all cylinders, making its economic model something worthy of emulation for large economies. Sweden is often touted as a similar example for small open economies. The reality, however, is that for every exporter, there must be an importer; So, to the degree that German economic success is built on exports, it is also built on global imbalances.

First, let’s focus in on the positives. For the overall economy, Germany saw its highest rate of economic growth in two decades, with an annual 3.6% GDP growth in 2010. In the private sector, German households have the second lowest debt levels in the G7. And in the public realm, German fiscal deficits are the lowest in the G7 and are now poised to drop under the Maastricht 3% hurdle. Business confidence is at a record post-unification high as a result, with the Ifo Institute’s Business Climate Index now at 110.3. This has translated into employment gains, bringing the German unemployment rate to 7.4%, its lowest level since reunification.

The charts from the Economist below highlight these data points:

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The bottom line: the fundamentals of the German economy are relatively good and support continued long-term growth.

Nevertheless, I am sceptical of the pace of German recovery for two reasons. First, Germany is fully integrated with the rest of Europe where many economies are struggling with debt issues, weakening demand for German exports. Germany is increasingly exporting to the growing emerging markets. However, its prime export market is within the euro zone. So, when the global downturn hit, German GDP was savaged by its export dependency. GDP fell by 5% in 2009. So, Real GDP in Germany is still lower than when the downturn began, whereas in the U.S. it is higher than when the downturn began. Working from a lower base certainly makes it easier to report higher GDP growth. See Economic recovery and the perverse math of GDP reporting for why.

Second, domestic demand remains weak in Germany. While German retail sales increased 1.2% in 2010, German retail sales were down for the fourth month in five in December, the latest month for which figures are available. That this weak 1.2% increase in 2010 is the highest reading since 2005 and cause for optimism tells you that domestic demand growth is a sticky wicket for the German economy. Demographic factors almost certainly come into play here. Claus says Germany is too old but this is because fertility rates in Germany are one of the lowest in Europe. And without immigration, retail sales growth will be slower. Is this a bad thing? If all we cared about was per capita income or per capita growth, the answer is no. However, Claus’ post on an aging Germany points to an increasing burden from Germany’s social programs for pensioners. And German national debt of over 77% of GDP reflects this burden.

These headwinds point to moderating growth. And if the European periphery spirals down, it will drag Germany down with it via trade and financial linkages. Germany needs to develop internal demand, especially if it is going to pay for its social programs. Nearly 5 million people in Spain are out of work. Unemployment is low in Germany, which could offer hope for the Spanish jobless. Germany has the lure of high wages and Spanish workers have the benefit of being highly education and skilled. Outmigration from Spain to Germany could be a win-win for both nations and a reinforcement of the advantages of European integration.

Overall, we should credit Germany for building a recovery based not just on exports, but on capital investment and saving. One reason that Germany is a manufacturing and export powerhouse is because it has invested in those businesses. Certainly, wage restraint over the past decade by German labour unions has kept German companies in the mix. But, at heart, the German export story is about investment in human and physical capital. And that is definitely worthy of emulation.

Below is a video highlighting this success.

9 Comments
  1. Positroll says

    A few comments:

    – weather wise, December 2010 was the worst December in Germany in 40 years: It was freezing cold. Snow started falling early and remained in the streets, stopping construction works and keeping people indoors, except for a few trips to the Weihnachtsmarkt. Any conlcusions based on December numbers are therefore highly suspect (on the contrary: that GDP – growth at 0,4% in Q4 was only slightly smaller than predicted (0,5%) is a minor miracle under these circumstances, boding very well for 2011 imO). January also won’t be of much use, since many new taxes / fees etc came into effect on Jan 1, disturbing the picture. So I’d wait at least for the February numbers before starting to cast doom over the German consumer (esp. as many pay rises are going to be negotiated in the coming months).

    – Germany’s trade surplus is currently expanding due to increased exports to the develloping economies, esp. China and India. Imports from other EU countries are rising faster than exports to EU countries:
    “Germany has been criticised by eurozone partners for not buying more goods from them but a breakdown of the numbers showed imports rose faster than exports for both the eurozone and broader 27-member European Union in 2010. German exports to eurozone partners, which numbered 15 last year, grew by 12.7 per cent while imports were up by 16.7 per cent. For the full EU, German exports gained 14 per cent, but imports rose by 17.5 per cent” http://www.smh.com.au/business/world-business/german-exports-set-record-pace-20110210-1anbs.html

    – I remember reading (but no cite at hand) that German imports from Spain in 2010 increased by 25% from 2009

    – domestic demand is strongly increasing based on INVESTMENTS into the German industry. Once the inflated Anglo – American model had broke down and the german economy started to come back, German banks (and other) started to reinvest in Germany. The restraints of lack of capital that held back Germany in the 2000s (as capital moved to other “hot spots”) are over – Germany itself is now a hot spot.
    That’s at least the thesis of Prof Sinn of the Ifo-Institutes in this presentation of 14 dec 2010 (”Europa in der Krise” in German, http://mediathek.cesifo-group.de/player/macros/_v_q_1000_de_640_480/_s_ifo/_x_s-764870657/ifo/index.html?locale=en
    ( He also argues that the losses of German bank on peripheral loans (-20-30% haircut on a big amount of loans) were covered by TWICE AS BIG GAINS on German bunds (+10% on a huge amount of loans).
    Now, I don’t know how many Bunds the banks sold back when the chart was made and since then the German Bunds came back down again due to fears that Germany would be saddled with GIPS-debt. But that would reverse the moment Germany decides not to bail out the GIPS-countries. If true, this means no real risk for the German banks: either they are saved via bailout, or they make up for their losses by selling the then surging German Bunds. Win – win for the banks. Might be a rough awakening for some GIPS countries if they consider a German bailout a sure thing and overstretch their hand by not giving in to some German demands…) ).

    – Germany and Spain are doing intensive talks on possibilities to get unemployed Spaniards to Germany, including language courses, easier recognition of diplomas etc:
    http://www.bbc.co.uk/news/world-europe-12359897
    http://www.spiegel.de/international/germany/0,1518,741201,00.html

    – With the economy taking up speed in 2006, birth rates incresed in Germany. All the doom and gloom of the “Krise” made it plummet agin in 2008-2009. But 2010 saw one of the strongest increases in the German birthrate in a long time. So with the economy booming (and the politicians finally increasing options re: childcare for working mothers a la France), I’m not convinced that the current demographic downtrend is a sure thing.

    Ups, wrote a lot more than planned …

    1. Edward Harrison says

      Positroll,

      Thanks for your thoughts.Notice that retail sales growth was down four months in five. So I would say that December is as good a number as any to make a comparison. Clearly, retail sales are not really that robust given that run. The point is that year-over-year comparisons were the best in five years but only 1.2% higher. That speaks to anaemic domestic demand growth – due in large part to the demographics of the issue. The situation is identical in Italy and Japan for example.

      I am encouraged for Germany that more and more exports are going to the emerging markets. I mentioned that in the post. And I agree that the concept that German banks are investing at home is great. The Landesbanks were especially reckless over the past years and that probably has to do with the seductive allure of outsized returns and a lax regulatory environment.

      As I said above, the German export story is about investment instead of speculation- and that is definitely worthy of emulation. The American model of relying on services, especially the financial sector still holds sway. Witness comments from Tim Geithner:
      https://pro.creditwritedowns.com/2011/02/geithner-dont-shrink-financial-services.html

      I find the German model more robust, but the demographic issue is still a problem.

      1. Positroll says

        “The Landesbanks were especially reckless over the past years and that probably has to do with the seductive allure of outsized returns and a lax regulatory environment.”
        Personally I mostly fault the EU Comission’s obsession with “free markets” and competition. The Landesbanken were working fine as they were set up at the outset: publicly guarranteed banks doing utterly boring stuff in their home regions, not making big profits but keeping investment into the “real economy” going.
        But then came the Commission and complained that this guarrantee would violate competition rules – after all, private banks would surely never receive a bailout from the taxpayer. Yeah, right … never …
        So the Landesbanken suddenly were forced to compete with the private banks without the guarrantee – paying higher interest to the Bundesbank etc, and therefore needing higher ROI themselves.
        Result: the Landesbanken had to go out and look for higher profit ventures – getting into risky (later aka toxic) US, Spanish and Irish papers and withdrawing funding from the German economy. Due to lax oversight (the structures for oversight were still adapted to the old model of low risk, low profit), the risks were ignored, and when the poop hit the fan, the taxpayer had to pay.

        And now, to add insult to injury, the Commission (and the Basel III folks) want to require the German states to pony up even more cash NOW to improve the Landesbank balance sheets. Why? Well, if they don’t, then there would be a risk that the states would have to bail them out LATER. Come again ??? We have to pay now in order to avoid the risk that we might have to pay later? What kind of argument is that ?? Hey, says the Commission, we want a level playing field, free competition, baby! – Didn’t they learn anything from the crisis ???

        If I were Angela Merkel, one of my prime requirements for any Euro – bailout mechanism would be a explicit clause allowing all memberstates to run a public banking system, competition be damned.
        Just look at the US banks: despite all their free competition, fees are skyhigh, usury is rampant and the consumer is getting screwed (I say that as someone who bought Wells Fargo shares in March 2009, so call me a hypocrite if you want; at least I bought Siemens, too). Ok, enough ranting for today … ;-)

    2. Positroll says

      CNN just posted a piece by Sinn where he covers a small part of the talk I linked to (this time in English): http://edition.cnn.com/2011/OPINION/02/17/sinn.germany.trade/

  2. Positroll says

    A few comments:

    – weather wise, December 2010 was the worst December in Germany in 40 years: It was freezing cold. Snow started falling early and remained in the streets, stopping construction works and keeping people indoors, except for a few trips to the Weihnachtsmarkt. Any conlcusions based on December numbers are therefore highly suspect (on the contrary: that GDP – growth at 0,4% in Q4 was only slightly smaller than predicted (0,5%) is a minor miracle under these circumstances, boding very well for 2011 imO). January also won’t be of much use, since many new taxes / fees etc came into effect on Jan 1, disturbing the picture. So I’d wait at least for the February numbers before starting to cast doom over the German consumer (esp. as many pay rises are going to be negotiated in the coming months).

    – Germany’s trade surplus is currently expanding due to increased exports to the develloping economies, esp. China and India. Imports from other EU countries are rising faster than exports to EU countries:
    “Germany has been criticised by eurozone partners for not buying more goods from them but a breakdown of the numbers showed imports rose faster than exports for both the eurozone and broader 27-member European Union in 2010. German exports to eurozone partners, which numbered 15 last year, grew by 12.7 per cent while imports were up by 16.7 per cent. For the full EU, German exports gained 14 per cent, but imports rose by 17.5 per cent” http://www.smh.com.au/business/world-business/german-exports-set-record-pace-20110210-1anbs.html

    – I remember reading (but no cite at hand) that German imports from Spain in 2010 increased by 25% from 2009

    – domestic demand is strongly increasing based on INVESTMENTS into the German industry. Once the inflated Anglo – American model had broke down and the german economy started to come back, German banks (and other) started to reinvest in Germany. The restraints of lack of capital that held back Germany in the 2000s (as capital moved to other “hot spots”) are over – Germany itself is now a hot spot.
    That’s at least the thesis of Prof Sinn of the Ifo-Institutes in this presentation of 14 dec 2010 (”Europa in der Krise” in German, http://mediathek.cesifo-group.de/player/macros/_v_q_1000_de_640_480/_s_ifo/_x_s-764870657/ifo/index.html?locale=en
    ( He also argues that the losses of German bank on peripheral loans (-20-30% haircut on a big amount of loans) were covered by TWICE AS BIG GAINS on German bunds (+10% on a huge amount of loans).
    Now, I don’t know how many Bunds the banks sold back when the chart was made and since then the German Bunds came back down again due to fears that Germany would be saddled with GIPS-debt. But that would reverse the moment Germany decides not to bail out the GIPS-countries. If true, this means no real risk for the German banks: either they are saved via bailout, or they make up for their losses by selling the then surging German Bunds. Win – win for the banks. Might be a rough awakening for some GIPS countries if they consider a German bailout a sure thing and overstretch their hand by not giving in to some German demands…) ).

    – Germany and Spain are doing intensive talks on possibilities to get unemployed Spaniards to Germany, including language courses, easier recognition of diplomas etc:
    http://www.bbc.co.uk/news/world-europe-12359897
    http://www.spiegel.de/international/germany/0,1518,741201,00.html

    – With the economy taking up speed in 2006, birth rates incresed in Germany. All the doom and gloom of the “Krise” made it plummet agin in 2008-2009. But 2010 saw one of the strongest increases in the German birthrate in a long time. So with the economy booming (and the politicians finally increasing options re: childcare for working mothers a la France), I’m not convinced that the current demographic downtrend is a sure thing.

    Ups, wrote a lot more than planned …

    1. Edward Harrison says

      Positroll,

      Thanks for your thoughts.Notice that retail sales growth was down four months in five. So I would say that December is as good a number as any to make a comparison. Clearly, retail sales are not really that robust given that run. The point is that year-over-year comparisons were the best in five years but only 1.2% higher. That speaks to anaemic domestic demand growth – due in large part to the demographics of the issue. The situation is identical in Italy and Japan for example.

      I am encouraged for Germany that more and more exports are going to the emerging markets. I mentioned that in the post. And I agree that the concept that German banks are investing at home is great. The Landesbanks were especially reckless over the past years and that probably has to do with the seductive allure of outsized returns and a lax regulatory environment.

      As I said above, the German export story is about investment instead of speculation- and that is definitely worthy of emulation. The American model of relying on services, especially the financial sector still holds sway. Witness comments from Tim Geithner:
      https://pro.creditwritedowns.com/2011/02/geithner-dont-shrink-financial-services.html

      I find the German model more robust, but the demographic issue is still a problem.

      1. Positroll says

        “The Landesbanks were especially reckless over the past years and that probably has to do with the seductive allure of outsized returns and a lax regulatory environment.”
        Personally I mostly fault the EU Comission’s obsession with “free markets” and competition. The Landesbanken were working fine as they were set up at the outset: publicly guarranteed banks doing utterly boring stuff in their home regions, not making big profits but keeping investment into the “real economy” going.
        But then came the Commission and complained that this guarrantee would violate competition rules – after all, private banks would surely never receive a bailout from the taxpayer. Yeah, right … never …
        So the Landesbanken suddenly were forced to compete with the private banks without the guarrantee – paying higher interest to the Bundesbank etc, and therefore needing higher ROI themselves.
        Result: the Landesbanken had to go out and look for higher profit ventures – getting into risky (later aka toxic) US, Spanish and Irish papers and withdrawing funding from the German economy. Due to lax oversight (the structures for oversight were still adapted to the old model of low risk, low profit), the risks were ignored, and when the poop hit the fan, the taxpayer had to pay.

        And now, to add insult to injury, the Commission (and the Basel III folks) want to require the German states to pony up even more cash NOW to improve the Landesbank balance sheets. Why? Well, if they don’t, then there would be a risk that the states would have to bail them out LATER. Come again ??? We have to pay now in order to avoid the risk that we might have to pay later? What kind of argument is that ?? Hey, says the Commission, we want a level playing field, free competition, baby! – Didn’t they learn anything from the crisis ???

        If I were Angela Merkel, one of my prime requirements for any Euro – bailout mechanism would be a explicit clause allowing all memberstates to run a public banking system, competition be damned.
        Just look at the US banks: despite all their free competition, fees are skyhigh, usury is rampant and the consumer is getting screwed (I say that as someone who bought Wells Fargo shares in March 2009, so call me a hypocrite if you want; at least I bought Siemens, too). Ok, enough ranting for today … ;-)

    2. Positroll says

      CNN just posted a piece by Sinn where he covers a small part of the talk I linked to (this time in English): http://edition.cnn.com/2011/OPINION/02/17/sinn.germany.trade/

  3. Positroll says

    P.S. While I’m sure that Mr. Harrison is well informed about the German economy, those readers who are not might want to read this piece:
    http://www.prospect.org/cs/articles?article=germanys_economic_engine

  4. Positroll says

    P.S. While I’m sure that Mr. Harrison is well informed about the German economy, those readers who are not might want to read this piece:
    http://www.prospect.org/cs/articles?article=germanys_economic_engine

  5. Daniel says

    “Nearly 5 million people in Spain are out of work. Unemployment is low in Germany, which could offer hope for the Spanish jobless. Germany has the lure of high wages and Spanish workers have the benefit of being highly education and skilled. Outmigration from Spain to Germany could be a win-win for both nations and a reinforcement of the advantages of European integration.”

    I have no numbers, just anecdotes, but I wouldn’t be surprised if this is already happening. In 2003-2005 when the german economy stagnated (or so), a lot of people (ok, I’m talking about students looking for a job/perspectives) left germany and went to Ireland and Spain. Ireland had high wages and low taxes, spain had great weather, low taxes and jobs for architects. I don’t have a comparism because I didn’t notice spanish people in germany before the recession, but I’d say that there are actually a lot of young spanish people here in germany (this is a completely subjective impression). It would make sense when you consider that youth unemployment in spain is at 40+% levels…

    1. Edward Harrison says

      Hi Daniel, I think you’re right, it is happening. And as Positroll says, the German an Spanish governments are trying to help it along. That’s exactly the right thing too. I say, keep it coming.

      By the way, I don’t think I was forceful enough in talking down the U.S. ‘speculative’ model. Yes, the soft underbelly of the German growth is the weak domestic situation. Nevertheless, I still like the German industrial economic model on the whole a lot more than the British or American.

  6. Daniel says

    “Nearly 5 million people in Spain are out of work. Unemployment is low in Germany, which could offer hope for the Spanish jobless. Germany has the lure of high wages and Spanish workers have the benefit of being highly education and skilled. Outmigration from Spain to Germany could be a win-win for both nations and a reinforcement of the advantages of European integration.”

    I have no numbers, just anecdotes, but I wouldn’t be surprised if this is already happening. In 2003-2005 when the german economy stagnated (or so), a lot of people (ok, I’m talking about students looking for a job/perspectives) left germany and went to Ireland and Spain. Ireland had high wages and low taxes, spain had great weather, low taxes and jobs for architects. I don’t have a comparism because I didn’t notice spanish people in germany before the recession, but I’d say that there are actually a lot of young spanish people here in germany (this is a completely subjective impression). It would make sense when you consider that youth unemployment in spain is at 40+% levels…

    1. Edward Harrison says

      Hi Daniel, I think you’re right, it is happening. And as Positroll says, the German an Spanish governments are trying to help it along. That’s exactly the right thing too. I say, keep it coming.

      By the way, I don’t think I was forceful enough in talking down the U.S. ‘speculative’ model. Yes, the soft underbelly of the German growth is the weak domestic situation. Nevertheless, I still like the German industrial economic model on the whole a lot more than the British or American.

  7. DavidLazarusUK says

    Germany might on the surface being doing well, but its banks are a mess. They have huge exposure in all the PIIGS. Germany needs to carry on its current policies to enable the banks to trade their way bank to health. It is no different to what the Fed is doing to the big US money centre banks or the Bank of England is doing with it’s banks.

    As for its low birth rate, in the long run that is what is needed everywhere. Constant economic growth is unsustainable in a world with finite resources. Someone has to suffer if it continues. Germany does have it’s huge savings to get its ageing population through its demographic time bomb.

    It’s industry is obviously doing well because it has constantly moved to the top of the quality end of every industrial sector, so does not have to compete with China directly.

    As for expanding Germany’s domestic demand that might be next to impossible. I would flip the proposal and ask what should other countries be doing? What should happening is that other countries increase their savings to the same level as the Germans. That would dampen inflation as people switch from consumption to savings. Higher interest rates would help that. It would also squeeze out the last life out of the asset bubbles.

    Germans are practically engrained to bargain hunt and save. Look at German supermarkets. The top two are Aldi and Lidl. Yet these brands are the lowest cost supermarkets in the UK. So any increase in domestic demand will have to come from the government, though that is unlikely. They were pretty fast to make cuts even though they barely need it. If Germany is going afford its social programs it might actually increase taxes to pay for it. Though it might demand tougher sanctions on those countries that harbour German tax evaders. Hence its tough rhetoric against Ireland low tax rates.

    If Chinas bubble does burst then German exports will be hit. Though that might hit domestically it is probably problems in the PIIGS that will be the biggest worry for Germany.

    As for mass migration from Spain to Germany or anywhere else all that does is rapidly age Spain’s demographics. Look at the baltic states and Ireland for examples. You cannot compare Europe to the US or China, when it comes to population migration. In many ways it is the differences that makes it special. I do not think that any of their regions want to become the European version Gary Indiana, which is simply rotting as the population migrate to the jobs.

    Also within Europe it would require ever greater integration financially and I doubt that would get the support of the UK Conservatives.

  8. Anonymous says

    Germany might on the surface being doing well, but its banks are a mess. They have huge exposure in all the PIIGS. Germany needs to carry on its current policies to enable the banks to trade their way bank to health. It is no different to what the Fed is doing to the big US money centre banks or the Bank of England is doing with it’s banks.

    As for its low birth rate, in the long run that is what is needed everywhere. Constant economic growth is unsustainable in a world with finite resources. Someone has to suffer if it continues. Germany does have it’s huge savings to get its ageing population through its demographic time bomb.

    It’s industry is obviously doing well because it has constantly moved to the top of the quality end of every industrial sector, so does not have to compete with China directly.

    As for expanding Germany’s domestic demand that might be next to impossible. I would flip the proposal and ask what should other countries be doing? What should happening is that other countries increase their savings to the same level as the Germans. That would dampen inflation as people switch from consumption to savings. Higher interest rates would help that. It would also squeeze out the last life out of the asset bubbles.

    Germans are practically engrained to bargain hunt and save. Look at German supermarkets. The top two are Aldi and Lidl. Yet these brands are the lowest cost supermarkets in the UK. So any increase in domestic demand will have to come from the government, though that is unlikely. They were pretty fast to make cuts even though they barely need it. If Germany is going afford its social programs it might actually increase taxes to pay for it. Though it might demand tougher sanctions on those countries that harbour German tax evaders. Hence its tough rhetoric against Ireland low tax rates.

    If Chinas bubble does burst then German exports will be hit. Though that might hit domestically it is probably problems in the PIIGS that will be the biggest worry for Germany.

    As for mass migration from Spain to Germany or anywhere else all that does is rapidly age Spain’s demographics. Look at the baltic states and Ireland for examples. You cannot compare Europe to the US or China, when it comes to population migration. In many ways it is the differences that makes it special. I do not think that any of their regions want to become the European version Gary Indiana, which is simply rotting as the population migrate to the jobs.

    Also within Europe it would require ever greater integration financially and I doubt that would get the support of the UK Conservatives.

  9. Daniel says

    Zahl der offenen Stellen steigt auf eine Million

    http://www.spiegel.de/wirtschaft/soziales/0,1518,745965,00.html

  10. Daniel says

    Zahl der offenen Stellen steigt auf eine Million

    http://www.spiegel.de/wirtschaft/soziales/0,1518,745965,00.html

Comments are closed.

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