The Wake-up Call Germany Must Heed
German Finance Minister Wolfgang Schaeuble said in April he was tired of hearing how his country should increase government spending to boost growth. Now Germany has reported its biggest fall in industrial production since January, 2009, perhaps he'll reconsider.
Schaeuble and Bundesbank President Jens Weidmann have long irritated commentators and policymakers in the Anglophone world and Europe's spendthrift south, by insisting on fiscal conservatism and tight-fistedness. Their resentment was a little like what class delinquents might feel toward an A-student who refuses to smoke pot. Yet the Germans have never submitted to the peer pressure. Their economy didn't suffer a catastrophe in 2008-2009, after the collapse of Lehman Brothers, and has looked healthier than most in Europe through the financial crisis.
Since the recovery began in 2009, the German economy briefly entered recession twice, in late 2012 and early 2013, but these seemed to be just hiccups. You don't hear Germans complaining of deterioration in their living standards the way the French or Italians do. Germany's unemployment rate dropped to 4.9 percent in August, 2014, from 5.3 percent a year earlier -- half the 10 percent rate in France. Retail sales have been steady and in August increased by 2.5 percent, the most since June, 2011. Employee compensation has been growing slowly, but in line with inflation.
Government finances and trade have looked strong, too. This year, Germany showed a first-half budget surplus for the first time since 1991, with an increased Bundesbank profit contributing to the achievement. And July's trade surplus was a record 23.4 billion euros ($31.4 billion at the July exchange rate).
These numbers would make anyone feel like an A-student. Germany doesn't believe it has an obligation help its neighbors by spending more to boost imports and raise its inflation rate. Europe may be united and Germany may share a currency with other nations, but the primary responsibility of politicians remains, in Germany as elsewhere, to their own nation state.
Now, however, it's time to do away with the smugness. The factors threatening to drive Germany into another recession are not going away anytime soon and need to be countered.
The economic sanctions the European Union has imposed on Russia are one such factor. Germany is one of Russia's biggest trading partners and investors, so the measures have had an impact and they'll be hard to cancel before there's a significant change in Ukraine. Given that country's terrible economic trajectory and Russian President Vladimir Putin's unwillingness to permit relief, such a change may not come for many months. At the same time, Germany's neighbors and major EU trading partners, such as France and Italy, are economically stagnant. The governments of those countries are making a lot of noise about growth-boosting reforms, yet the swift structural change needed to make a difference isn't taking place.
In Germany itself, chronic underinvestment is beginning to take its toll. The most troubling number in the August industrial production report was an 8.8 percent drop in the output of capital goods, such as machinery. This year's late school holidays, an important reason production was higher than usual in July and lower in August, can only explain part of the contraction. In general, investment in Germany has dropped to 17 percent of gross domestic product last year from 22.3 percent in 2000, and the downward trend continues. Germany cannot ride its accumulated economic potential forever: Germany's deteriorating roads and telecommunications infrastructure are visible to anyone living here.
There are ways to stimulate private investment, such as lowering taxes and increasing domestic competition, but these will not have an immediate effect. "If the German government is not willing to invest, why should German businesses do so?" Jacob Funk Kirkegaard of the Peterson Institute for International Economics wrote in a May paper.
The government has the money to lead by example: the first-half budget surplus amounted to 1.1 percent GDP. According to Kierkegaard, plowing an additional 1 percent of GDP into public investment would be the minimum requirement to start "making up for previous neglect." After all, in 1999-2011 the German government only invested, on average, 1.66 percent of GDP per year, compared with 2.47 percent in the U.S. and 5.36 percent in South Korea.
There's nothing better Germany can do with the money. In these circumstances, investing in infrastructure is a perfectly conservative way to reduce losses and improve the economy, and nothing that a true A-student should object to.
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