Wolfgang Munchau: Germany’s need for growth (FT)

There was a time, not too long ago, when the US president and the German chancellor agreed that the German economy should act as a “locomotive” to stimulate global demand.

There is no chance that George W. Bush and Angela Merkel could have held such a discussion at their recent summit in Washington. Global economic demand management has been out of fashion for a while. The notion of a locomotive arose out of the 1978 summit of the Bonn Group of Seven leading industrial nations. Helmut Schmidt, the German chancellor at the time, was a reluctant convert to the idea. He worried that it might overburden Germany’s economic capacity.

From the point of view of the world economy at large, Mr Schmidt was probably right, especially considering that only a year later the second oil crisis triggered a global recession. Yet it is debatable whether the policy, which led to boom and bust, was best for Germany itself.

Nowadays, it would be trivial to say that Germany no longer acts as a global economic locomotive. A less trivial point is that Germany barely fulfils such a role even inside the eurozone.

There are two reasons for this. First, Germany’s political class is more inward-looking than the generation of politicians who governed in the 1970s. Second, its current economic establishment is more contemptuous of macroeconomic demand management than that of any other western nation. This extreme position is largely ideological. It may also have been influenced by the “locomotive days” of the late 1970s.

Since Germany accounts for one-third of the eurozone’s gross domestic product, it should come as no surprise that the recent German recovery coincides with that in other parts of the eurozone. Italy, in particular, is heavily dependent on Germany for its export growth. It is therefore no accident that the Italian economy has recently picked up in tandem with Germany.

But the present recovery is hardly solid. Germany continues to underperform the eurozone average. During the first quarter of 2006, German GDP grew by only 0.4 per cent, after zero growth during the fourth quarter of 2005. These data flatly contradict exuberant German confidence indicators and business surveys. There has been a persistent gap between business sentiment, which has been improving, and consumer sentiment, which has remained depressed.

The reason for this gap lies in Germany’s national economic strategy, which consists of two planks, both of which aggravate Germany’s potential role as an economic locomotive: budgetary consolidation and a beggar-thy-neighbour real devaluation inside the eurozone as Germany improves its competitiveness through wage moderation.

One could make a case for budgetary consolidation during a cyclical upswing, but a systemic policy of real devaluation is destructive from the perspective of the eurozone as a whole. According to the European Commission’s spring forecast, Germany’s real unit labour costs will decline by 1.6 per cent this year and by a further 2 per cent next year, having already declined during 2004 and 2005.

As the economy goes through a cyclical upswing, one would have expected the period of wage moderation to come to an end. But the opposite is the case. Real wages not only continue to decline, but do so at an increasing rate. No wonder domestic consumption is so weak. If people expect to earn less money in future, they hold back on consumption today. German consumers act in a far more rational manner than they are usually given credit for.

This trend is reinforced by the present grand coalition’s economic policies. It has a clearly mapped-out strategy of tax increases – witness the commitment to raise value-added tax from 17 to 20 per cent. But it has no strategy for growth and employment – except to rely on this year’s football World Cup in Germany as a potential stimulus. I would put the chances of a further appreciation of the euro against the dollar higher than the probability of Germany winning the World Cup. The exchange rate has a far greater potential for damage than a short-lived football boom could ever compensate for.

The eurozone economy is facing a simultaneous rise in interest rates and the exchange rate. Monetary policy will continue to get tighter for the next two years. Jean-Claude Trichet, president of the European Central Bank, said last week that the eurozone was already growing at its potential rate – around 2 per cent per annum. As far as the ECB is concerned, this is as good as it gets. If it were to get any better, the ECB can be safely relied upon to restore “order”.

Germany has lost its role as a European and global locomotive not out of necessity, but out of choice. If this recovery turns out to be relatively short-lived, perhaps the country’s political establishment will find the courage to formulate an intelligent strategy for sustained growth in the future, just as happened in the late 1970s. Of course, it is perfectly legitimate to question the G7’s policies at that time. Mr Schmidt’s locomotive may not have quite reached the desired destination. But Ms Merkel’s train has not even left the station.