FT.com / Columnists / Wolfgang Munchau - Do not get too excited by Germany’s recovery

FT.com / Columnists / Wolfgang Munchau - Do not get too excited by Germany’s recovery

Do not get too excited by Germany’s recovery
By Wolfgang Munchau

Published: June 10 2007 18:40 | Last updated: June 10 2007 18:40

Germany’s economic recovery has turned out to be more robust than I had expected. But is it for real?

After economic growth of 2.8 per cent in 2006, Germany is looking forward to another year of growth of about 3 per cent. What started off as an export-led recovery has turned into a more broadly based boom. Most astonishingly of all, German consumers have been spotted spending some money.

Foreign investors have rediscovered Germany and are now investing in German equities, property and German private equity funds. The perception of Germany’s renaissance has been greatly helped by the impressive political leadership from Angela Merkel, the chancellor. On balance, I would expect the performance of Ms Merkel to prove more sustainable than the performance of the economy. While the economy is clearly not as weak as it appeared a few years ago, it is not nearly as good as it appears today.

My scepticism is based on the following five observations:

First, Germany’s economic growth is due to improvements in relative competitiveness, a strategy that is not sustainable in the long run, certainly not for a large country. Germany raised its competitiveness through a real devaluation in the form of wage moderation. Persistently high unemployment and low growth have weakened the negotiating positions of the trade unions, but this is not going to last forever. As conditions in the labour market normalise, wage growth will return to more normal levels and the scope for further improvements in competitiveness will be reduced.

Also, in the very long run, one should expect emerging industrial countries to challenge Germany in sectors such as electrical and mechanical engineering, at which Germany currently excels. India might emerge as a formidable challenger, given its similar industrial strengths.

Second, German gross domestic product growth is not matched by productivity growth – output per hour worked. The recovery is fundamentally a story of employment growth. There is nothing wrong with that. But productivity growth also matters in the long run. It is too early to pass judgment on Germany’s most recent productivity performance – especially as data are pro-cyclical, prone to revisions and often wrong.

The latest German productivity statistics show a large and persistent gap with the US and that seems to be borne out by other evidence too. The economists Alberto Alesina and Guido Tabellini, writing in Vox, the new opinion portal run by the Centre for Economic Policy Research, cite new evidence about the true income gap between European countries, including Germany, and the US. This gap is markedly more pronounced than the already formidable gap in officially recorded per capita GDP. The research suggests that one should not get too excited about Germany’s current economic performance.

Third, Germany’s export success is partially accounted for by growth in some of its largest export markets, including Russia and the Middle East, which are enjoying an energy price induced boom. This is unlikely to be the case forever. When growth in these markets normalises, Germany’s export performance will return to a more sustainable level.

Fourth, all of Germany’s mainstream political parties remain committed to the preservation of the antiquated state and mutual banking sector, a system that relegates the private sector to a niche existence in the domestic banking market. Germany is still notoriously poor at financial innovation, and while the country is less prone to subprime-mortgage-style crises, the lack of financial innovation is going to drag on long-term growth.

Finally, one of the most important factors for long-term growth is the quality of a country’s education system. German schools and universities used to be among the best in the world, but have been slipping in the global and European league tables. The problems are chronic under-investment, lack of reform and an excessive emphasis on vocational training over general education.

Germany is still likely to remain a better than average performer in the eurozone for quite some time. Italy’s economic crisis goes from bad to worse, as the centre-left government stumbles from one crisis to the next, and delays much-needed reforms. Spain’s economic honeymoon is about to end as the property market deflates. The French economy has been facing a deep structural crisis for years, and this will probably get worse under Nicolas Sarkozy, the new French president, whose economic policy agenda boils down to a combination of deficit spending and protectionism, mitigated only by the odd labour market reform.

Of the large economies in the eurozone, Germany is likely to remain the most attractive for some time. But does this really justify the present degree of optimism? When normality returns, we will see German economic growth return to about 1.5 per cent, close to my estimate of Germany’s trend growth. This is good relative to what we thought five years ago, but not compared to what it could be.

Copyright The Financial Times Limited 2007