European Economy

Germany Needs Some of Its Own Medicine

What Merkel preached abroad, she largely avoided at home.

German leadership in Europe should start at home.

Photographer: Sean Gallup/Getty Images

This autumn, a newly elected European government will need to prove its reformist credentials to convince partners to press ahead with its plans for reforming the euro zone.

While most will see this assertion as applying to France, it could equally refer to Germany. Angela Merkel, who is on course to win a fourth term as Chancellor, has been much better at asking that other euro zone countries become more competitive than at transforming Germany's economy. If Berlin is to take the currency union into the next phase of the process of integration, its leadership must start at home.

Germany has one of the euro zone's most productive economies, but since Merkel first became chancellor in 2005, improvements have been far from impressive. Germany's output per hour worked has risen by 7.3 percent in the decade to 2016, according to OECD data, less than the EU or the euro zone average.

During the sovereign debt crisis, the German leader rightly insisted that countries in difficulty should overhaul their economies as a precondition to receive financial aid. The countries that did, such as Spain and Portugal, are enjoying a much faster recovery than those that didn't, for example Greece. The alternative -- cash in return for nothing -- would not only have been politically impossible to sustain; it would have transformed Europe's southern tier into a permanently depressed economic area, reliant on fiscal transfers for years to come.

Germany and the PIGS

Capital spending (% of general government spending), 2016

Source: OECD (2017)

The trouble is that what Merkel preached abroad, she largely avoided at home. The euro zone rightly insisted that Greece should open up its oligopolies, but Berlin has done preciously little to liberalize its service sector. The retirement age in Portugal and Ireland is higher than in Germany, and the last Merkel government even lowered it for some categories of workers. The share of capital spending over total spending by the German government has fallen behind Greece and Ireland, according to OECD data, and is only narrowly ahead of Spain.

Of course, as the euro zone's economic powerhouse and a bastion of fiscal responsibility, Germany can afford to retire earlier and let its government consume more and invest less. Berlin enjoys a budget surplus and can borrow for up to seven years at negative rates. Its sovereign debt stood at a mere 66.9 percent of gross domestic product in the first quarter of this year, and is firmly on a downward path. 

However, success in the past is no guarantee for primacy in the future. Germany's population is aging fast: Pension outlays relative to GDP will rise by more than 2 percentage points by 2050, with health and long-term care costs adding a further 1.3 to 2.1 percentage points, according to data from the Ministry of Finance. The penetration of fast broadband lags well behind the rest of the EU, raising questions over whether the German economy, and particularly its service sector, is well-equipped to meet the challenges of the digital revolution.

Most importantly, leadership in Europe begets responsibility. Berlin would like to set up a European Monetary Fund which would oversee assistance to countries in crisis. This fund would take over from the Commission the responsibility of monitoring national budgets in exchange for providing earlier and possibly more generous financial assistance.

It is not clear how this idea will fare against more ambitious plans for a euro-zone budget which will be brought forward by France's President Emmanuel Macron. Ultimately, as the euro zone's largest and economically most powerful country, Germany will have the final say over whatever route the currency union takes. However, Germany's moral authority in Europe would only be increased if it modernized at the pace it asks other countries to do. That would be truly to rule by example, rather than by fear. 

A reformed Germany would also have benefits for the stability of the euro zone. Greater public spending in infrastructure would somewhat reduce Berlin's towering external surplus, helping to boost demand in some of its weaker neighboring states. Opening up the service sector to competition would have a similar effect, by encouraging foreign and domestic companies to invest more, rather than hoarding cash.

At a crucial juncture for the future of the euro zone, the interests of Germany and its partners have rarely looked more aligned. The courage to act at home is what is needed abroad, too.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Ferdinando Giugliano at fgiugliano@bloomberg.net

    To contact the editor responsible for this story:
    Therese Raphael at traphael4@bloomberg.net

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