Now We Know Why Germany Inc. Won't Invest

Germany's famously high savings rate owes to its unique pension fund structure, reckon analysts at Bank of America Inc.

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Germany's high savings rate. A damaged euro zone banking system. Elevated sovereign-debt ratios in southern Europe. 

All these factors have been blamed for Europe's economic slump. 

But perhaps the first — Germany's high saving impulse, particularly at the corporate level — is the most difficult to fathom.

After all, unlike the rest of the euro zone, German businesses haven't faced a significant tightening of credit standards from domestic financial institutions, while decent growth and profit prospects should, in theory, boost capital expenditure. What's more, a high savings rate was evident in corporate Germany even before the crisis of 2007-8, suggesting there may be more structural factors at work. 

By failing to hike investment spending domestically, Berlin has triggered deflation and depressed aggregate demand in the single-currency bloc, its critics contend.

So why don't they?

Bank of America Corp. might have just solved the mystery.

German businesses' compulsion to save — and, by extension their lack of willingness to invest — reflects their large pension liabilities, a challenge that traditional financial models have hitherto failed to capture, the Bank of America economists led by Evelyn Herrmann write in a report published on Tuesday.

They reckon corporate pension commitments, in addition to demographic pressures, have derailed the investment zeal of businesses in the euro area's largest economy, leading to a rise in their savings rate, which they express as their 'net lending'; a proxy for retained profits.

"We find evidence that German occupational pension liabilities held directly on the corporate balance sheet in the form of book reserves have been a significant determinant in rising corporate net lending since at least the early 2000s," the analysts write.

"Demographic aging matters, too: an older employee base coincides with higher corporate savings. In other words, pension constraints and demographics may have capped capex for a while now. This suggests to us that capex prospects remain underwhelming, despite decent growth and profits and good financial conditions."

The retained profits, or net lending, of Germany non-financial corporates amount to roughly 8 percent of the sector's output, defined as gross valued-added, in marked contrast to their borrowing binge in the late 1990s. The analysts reckon this shifting preference for financial savings over capital expenditure coincided with an increase in corporates' direct pension-fund obligations, and with the ageing of the population. 

They explain how a large number of German occupational pension schemes are actually held on company's balance sheets, and are known as book reserves.   

"The basic idea behind book reserves is that a company promises its employee a defined benefit pension after retirement, and builds reserves for this without specifically attributing assets. Their unfunded nature mean pension claims are paid out of cash-flow. This can have implications for corporate savings and capex behaviour," the analysts write. They add: "Pension reserves remain the biggest among outstanding cover across pension structures."

Having correlated corporate savings against operating profits, book reserves, and the age profile of workers in a regression model, they find savings are a function of pension reserves and ageing.

If they are right, the policy implications are significant. Population aging will only intensify, keeping the lid on German companies spending for years to come. 

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