Many observers are concerned about Germany’s high trade surplus. In 2014, it hit about 7.5 per cent of GDP, or nearly €220 billion. Currently, at a time when higher growth is needed more than ever, German exports are regarded as a deflationary threat, especially for the eurozone. In the following, I will argue that such concerns are exaggerated. Germany should indeed raise public investment, but for its own sake and not in order to ‘save the world’, which it cannot do.
Rebalancing in the eurozone
Germany’s trade surplus with the eurozone has declined strongly in the past few years, while it has risen markedly outside the Economic and Monetary Union (EMU). Last year, Germany’s trade surplus with the eurozone was a comparatively low 2.2 per cent of GDP, after having been nearly five per cent in 2007. Importantly, of the €53 billion decrease in Germany’s trade surplus, €43 billion stemmed from rising German imports (and not from declining German exports).
This represents a cumulative growth effect of 0.6 per cent for the rest of the eurozone, which is not really so bad. In other words, the rebalancing process in the eurozone has already made substantial progress, thanks to stronger domestic demand in Germany. Germany’s trade surplus is no longer
particularly a eurozone issue. But what is it then? Some observers create the impression that it equates to a global imbalance – i.e. trade surpluses to many countries. It is true that the German trade
surplus to non-eurozone countries has risen strongly in recent years. In 2014, it was 5.2 per cent of GDP, a record high since the mid 1970s.
However, of the roughly five per cent, three percentage points alone stemmed from the United States and the United Kingdom, with approximately equal shares. Instead of being a widespread global phenomenon, Germany’s excess exports outside the eurozone were largely to just two countries. This simply reflects preferences for specific goods, such as cars and high-tech goods, rather than a worrisome development. Furthermore, both the US and the UK performed well in terms of growth. Obviously, the German trade surplus was not much of an obstacle.
To reduce trade imbalances, some observers have suggested a couple of measures that German policymakers should consider. Among them are higher investment activity in public infrastructure, raising wages and increasing private domestic investment spending through tax cuts. These policies may in fact be beneficial for the German economy itself, however, they are not a panacea for reducing (eurozone) trade imbalances.
Higher public investment activity
Germany should do more to increase public investment. In the past 10 years or so, the German public capital stock has shrunk in net terms. Funding costs are at record lows and, in some cases, even
negative. However, this should be done for Germany’s sake. Those arguing that public investment should be expanded for the sake of other countries to reduce trade imbalances are misguided.
Higher public investment does not automatically lead to significantly higher GDP growth in the rest of the eurozone and shrinking trade imbalances. This is suggested by historical evidence. One classic example of an expansionary (and asymmetric) fiscal stimulus by German policymakers is the reunification period (1991-1994). Public investment in the enlarged Germany almost doubled
compared to volumes in West Germany in the second half of the 1980s. But the positive impact on the rest of the eurozone was limited at best, and shortlived.
France and Italy only managed to grow by roughly one per cent on average in 1991/92. One year later,
they were in recession, as was Germany. The Bundesbank hiked interest rates to fight accelerating
inflation and central banks in other European countries were also forced to tighten their monetary policies in order to keep their currencies in the European Monetary System. At about one per cent of GDP, Germany’s trade surplus to the eurozone also did not change much between 1991 and 1994.
Of course, this time, it is different. The European Central Bank has been implementing quantitive easing, causing the euro exchange rate to decline. However, this historical episode says a lot about the relative power of policy tools. While German public investment activity was not dominant in impacting other eurozone countries, monetary policy and exchange rates actually were.
Raising German wages
Higher wages in Germany would have a positive impact on rebalancing in the eurozone. Moreover, German companies are becoming less competitive, while their peers abroad are catching up. However, these two factors are not powerful enough to trigger a massive turnaround in trade balances. If you take into account the latest collective bargaining rounds in Germany, one ends up with a nationwide wage rise of 2.5 to three per cent this year. The introduction of the minimum wage of €8.50 per hour may add nearly one percentage point on top of that. Thanks to lower oil prices, consumer prices will be more or less flat this year. Hence, real effective wages are probably increasing by three per cent to four per cent per annum. Only immediately after the reunification boom did wages rise more quickly, at nearly five per cent. Given that wages are continuing to outpace productivity gains, unit labour
costs will rise further, by at least 1.5 per cent this year. From 2010 to 2014, German unit labour costs were already up 8.5 per cent. This compares to increases of seven per cent in Italy and five per cent in France, and a six per cent decline in Spain. While this may sound great for rebalancing, two counterarguments should be borne in mind. First, trade between Germany and other EMU countries does not consist primarily of consumer goods, but of intermediate and capital goods. Typically, about
70 per cent or more of all German imports from the eurozone belong to these two latter categories. It is true that the share of imported consumer goods may rise over the next year or two, thanks to higher consumer expenditures in Germany. However, the international division of labour in the eurozone is different to what many – implicitly – assume. A massive rebalancing will only occur if the appetite
of German companies for intermediate and capital goods rises.
Second, the (moderate) loss in competitiveness of German companies may help in rebalancing the eurozone, but it is by no means a foregone conclusion. It is also possible that the slack will not be picked up by other EMU countries, but by competitors in the US or Asia. Finally, the rebalancing equation consists of more than just labour costs. Other variables, such as product quality and innovation, also play an important role. According to our estimates, there is pent-up demand of about €100 billion (or more than three per cent of GDP) in German capex spending. Tax cuts may lead to an unloading of this pent-up demand and an increase in companies’ appetites for intermediate and capital goods from abroad. However, there is no guarantee. In the end, companies will decide, not policymakers. We think that there is a good chance that capex spending will accelerate in the next
two years, even without tax cuts. One major reason is our expectation that German companies have become used to geopolitical uncertainties, in contrast to 2014.
As a result, Germany will increasingly act as a growth locomotive for the eurozone and trigger further rebalancing.
The full publication can be downloaded under http://www.g7g20.com/eBooks/G7-Germany-The-Schloss-Elmau-Summit-2015.pdf
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Der Beitrag Defending Germany’s trade surplus erschien zuerst auf onemarkets Blog (HypoVereinsbank - UniCredit Bank AG).