Commentary: Is Germany Fast Turning into Another Japan?
By John Rossant
In Germany, these days, the talk is about Japan--and it's not about the newest Toyotas, the latest Sony gadget, or the weakness of the yen. The question on German lips is whether Europe's mightiest economy could follow Japan down the road of chronic deflation and economic hopelessness. On Oct. 15, Der Spiegel, one of the country's most influential magazines, asked whether Germany was "catching the Japanese disease." Says David Abramson, chief European strategist at BCA Research, a Montreal investment research outfit: "The similarities between Germany and Japan are very disturbing." If Germany is the next Japan, then Europe's most important growth engine will be a drag on the region for years to come. That will leave only the U.S. as the world's source of growth.
In fact, Germany is not Japan redux. But the similarities are many--and spooky enough--to warrant a close look. Start with the banking system. Japan's banks recklessly lent hundreds of billions to overleveraged developers and contractors. The result: a bad-loan crisis unlike anything the world has seen. Now investors are getting worried about Germany's banks: Bad loans are multiplying, and fears are increasing that as big media and telecom borrowers go under, a major bank may follow suit. Insurers such as Munich Re are facing record portfolio losses, too.
Then there's the corporate sector. Japan's strapped banks stopped lending to new borrowers years ago, driving bankruptcies to record levels and stifling the creation of new companies. Likewise, new-loan growth in Germany is barely 1%, and German bankruptcies are spiking, too. The corporate sickness is reflected in stock indices. The Nikkei is down to 1983 levels, while the Dax has collapsed 63% from its March, 2000, high--much worse than the Dow's performance over the same period.
Germany and Japan even share dismal growth records. In the past decade, Japan's economy grew an average of just over 1% a year. Germany has done better, but growth still has not even averaged 2%. Deflation is hammering prices across Japan, while Germany is already getting a whiff of deflation in property prices in its biggest cities.
Oh, and one more thing: Germany and Japan have two of the most rigid labor markets in the world. Although both countries boast highly productive workforces, that's not enough to offset the huge cost companies incur in laying off or buying out surplus workers. The will to slash and burn is wanting, too, thanks to the deep need for consensus in both societies.
Scary stuff. Japan risks slipping into irrelevance: Does the same fate await Germany? It's certainly not encouraging that Germans voted for the status quo on Sept. 22 when they reelected Gerhard Schröder's red-green coalition after three years of economic bad news. The Free Democrats, the only political grouping offering a real program of pro-growth economic reforms, got roundly trounced. Now, to finance a deficit that will top 3.7% of gross domestic product this year--a flagrant breach of the euro zone's Growth & Stability Pact--Schröder is responding the only way he knows how: by raising taxes. A similar tax hike in Japan killed off a nascent recovery five years ago.
And yet, a doomsday scenario for Germany is not inevitable. Deflation is affecting every sector of Japan's economy: For now, price drops in Germany are focused on the property sector. As many as 15% of all Japan's bank loans are unrecoverable: In Germany, bad loans, though increasing, are only a percentage point or two of banks' portfolios.
External pressures on Germany from other European countries and from Brussels are also mounting. In Japan, meanwhile, though the tradition of gaiatsu, or foreign pressure, is a long one, Tokyo does not have to contend with anything like the European Union or the European Central Bank when it contemplates its next economic move. European Commission President Romano Prodi, for example, is publicly urging policymakers to take the deflation threat seriously. And EU regulators have prevailed on Berlin to remove privileges enjoyed by the Landesbanken, the state-controlled banks that offer unfair competition to private financial institutions.
The fact that Germans are examining themselves through a Japanese prism is another encouraging sign. "The real lesson about Japan for Germany is that it shows you can be a shining success story and then lose it quickly," says Charles Wyplosz, head of Geneva's International Center for Money & Banking Studies. The warning couldn't be clearer.
Rossant covers European politics and economics from Paris.