Burgess COMMENTARY

Peter Burgess

English Mail to friend PrintJAN 30, 2017 6 What’s the Matter With Germany? inShare 24

ROME – Italy may be the “sick man of Europe” today, but it is not the only country in need of medicine. On the contrary, even the mighty Germany seems to be coming down with something.

Italy is, to be sure, in dire straits. Over the last two decades, annual GDP growth has averaged just 0.46%, and government debt has risen steadily, totaling more than 130% of GDP today. Unemployment has remained persistently high, investment is plummeting, and the banking sector is deeply troubled.

Equally concerning, the number of women of child-bearing age has fallen by nearly two million since the fall of the Berlin Wall in 1989. And the share of active workers with a university education remains at levels barely comparable with other advanced economies.

Given all of this, it should come as no shock that Italy and crisis-plagued Greece are the eurozone’s weakest performers in terms of per capita GDP growth over the last three years. What is surprising is that Germany is the third-weakest performer. Germany is fiscally sound, with a large accumulation of surplus savings. It is also highly competitive in unit-labor-cost terms, enjoys its highest-ever labor participation rates, and benefits from a steady inflow of skilled labor from other parts of Europe.

But the fact is that Germany’s average annual per capita GDP growth of 0.51% since 2014 puts it far behind other core eurozone countries – namely, Austria, Belgium, Finland, and the Netherlands. Even France, where per capita growth barely exceeds that of Italy, slightly outperforms Germany.

How is it possible that economies as different as Germany and Italy have such similar per capita growth performance? To some extent, the explanation might seem obvious. Germany is much closer to potential growth than Italy and even the United States, which struggled more than Germany to escape the Great Recession. But the more recent recovery in other advanced countries should, if anything, have boosted potential growth in export-driven Germany.

Likewise, migration could affect per capita GDP growth. Germany has received 2.7 million new residents, net of outflows, over the last five years, nearly a million of whom are refugees. The latter provide an obvious Keynesian boost, but don’t add much to potential output.

Yet the migrant flows into Germany are not exactly anomalous. The country had experienced similarly strong net inflows at other times in the last three decades, without such adverse effects on per capita GDP growth. On the contrary, in many cases, migrants into Germany, particularly the young and skilled among them, have contributed to potential output.

The real culprit behind Germany’s low per capita GDP growth must be sought elsewhere. According to the Bank for International Settlements, German banks’ claims on other eurozone countries – including Austria, France, Ireland, Italy, the Netherlands, Portugal, and Spain – have fallen by over $200 billion, in aggregate, since the peak of the debt crisis in mid-2012. Claims on Italy are down to pre-euro levels, and claims on Spain are nearing that benchmark. Germany has even been disinvesting from core eurozone economies.

German banks’ quiet move toward disintegration contrasts sharply with the behavior of banks based in France, Italy, Spain, and the Netherlands, all of which have resumed European financial integration by stabilizing and often increasing their exposure in other countries. These divergent trends, rather than generic capital flight, explain part of the growing imbalances in the Target 2 eurozone payment system.

Why are German banks the only ones backtracking on integration? One possible reason is that domestic financial authorities, skeptical about the euro’s future, have instructed banks to cut their exposure to the rest of the eurozone. Another is that German banks are experiencing a slow-burn malaise that European regulators have yet to recognize fully. Their cost-base is, after all, the highest in the advanced world, yet their profitability is among the lowest, despite their negligible burden of bad loans.

Nonetheless, such skittishness is puzzling. Around half of the German banking system is publicly owned, and thus enjoys an implicit government guarantee. In fact, German banks received €239 billion ($253 billion) in state aid between 2009 and 2015.

In any case, German banks’ withdrawal from Europe cannot possibly be good for confidence, investment, or a dynamic service sector. And, indeed, investment in Germany last year was more than five percentage points below its 1999 levels as a share of GDP, even though gross national savings have climbed to the highest levels since the International Monetary Fund data series began in 1980. German officials usually explain away this huge drop by citing the parsimony of an aging society. But demographic challenges – which are tomorrow’s constraints on potential output – should inspire reforms in entitlements and education, not suppression of today’s demand. And that is where the real issue lies: no EU country, with the possible exception of France, has implemented so few reforms over the last decade as Germany.

That lack of reform is starting to show. Wary banks and low investment must have played a role since 2012 in what looks like Germany’s slowest stretch of growth in total factor productivity in three decades. Relying largely on exports – that is, other countries’ demand – may have distracted the German government from some of its own domestic responsibilities. But it is in the interest of all of Europe – and Italy, in particular – that the continent’s largest economy become even stronger. Fake news or real views

To be sure, the productivity slowdown is far from unique to Germany. But unless Germany addresses the roots of that slowdown at home, it risks taking a huge hit, in the event that its currency is sharply revalued, in the form of lower exports and damage to its already-weak banking sector, resulting from deflation and negative long-term interest rates. Italy’s illness is far more acute than Germany’s, but both are potentially serious. Both are in need of immediate treatment.

FEDERICO FUBINI Federico Fubini is a financial columnist and the author of Noi siamo la rivoluzione (We are the revolution).

COMMENTS

Comment Peter Burgess FEB 5, 2017 I always get nervous when the main measure of economic performance is GDP growth. Add in concern over the state of the banking system and the analysis is almost certain to be wrong. In my view, at its core the German economy is incredibly strong without much GDP growth. Germany is a mature economy which does not need GDP growth to be prosperous. Germany has an aging population which can be happy without needing the consumption growth essential for a younger society. Germany does not need significant production growth and is not constrained lack of output growth. It is insane for economists and analysts to focus on GDP growth 50 years after most everyone had debunked it as a meaningful measure! Peter Burgess http://truevaluemetrics.org READ MORE Reply

Comment Chris Parry-Davies FEB 5, 2017 What makes Germany's economic performance even more damming/concerning is that this AFTER the massive, never mentioned currency benefits it gets from the Euro. As this averages out the performance of all the Eurozone countries, Germany gains hugely from having a significantly undervalued currency (which has in turn been the real underpinnings of its exporting strength) while the less advanced economies, particularly in southern Europe are locked into what... READ LESS Reply

Comment David Morgan JAN 31, 2017 The influx of a million refuges are a burden on Germany and not an asset to the workforce as you will find that a lot of them are unskilled, as Syria was never known for its industrial base.

Comment M M JAN 31, 2017 The cost to the German economy alone, has exceeded €50 billion over the last 2 years, this figure could be much higher. If one add the cost to the other EU economies, such Greece, Italy, etc....no wonder why people across the globe are rising against the establishment.... Reply

Comment Paul Daley JAN 30, 2017 The Bundesbank does seem to take a dimmer view of what lies ahead than most. Weak banks will contribute to that. But prudence doesn't necessarily equate with weakness. After all, the Bundesbank may be right, particularly about the euro.

Comment Rosolino Scarlata FEB 5, 2017 The only Eurozone entity that should leave the EMU is just Germany. Given its dominant size, its economic strength, the political attitude (it is genetically impossible for Germany being a “Leading power” but instead just a “dominant” one) and even its socio-cultural mood (schadenfreude-based) the Bundesrepublik Deutschland is definitively incompatible with a peer union like Eurozone should be. If the Bundesbank, let alone the commercial German banks, feels so... READ LESS Reply

Comment M M JAN 30, 2017 As a start one must never compare one country with another, most definitely one must not compare Italy to Germany. The problems with the German banks are known and have been known for a very long time, if the author of this article had read my and other peoples comments here on PS about the state of the affairs of the German banking system, he would have noted that they are all undercapitalised and many of them have even recently failed their stress tests. What Merkel &Co have been doing... READ LESS