Is Germany Jeopardizing the Global Recovery?

Moody's

  • Germany's growing current account surplus may be weakening the global recovery.
  • Despite relatively strong economic conditions, German domestic demand remains soft.
  • Strong export growth testifies to Germany's competitiveness.
  • A large investment gap reduces the country's long-run growth potential.

In a report published last week, the U.S. Treasury sharply criticized Germany for its export-facing economic policies. The report urged the Berlin government to focus on revitalizing domestic demand, which has barely moved in the last few quarters despite the country's favourable fiscal situation. Germany ran a budget surplus in 2012, and this year the deficit should account for just 0.2% of GDP.

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The U.S. report contends that Germany's focus on exports adds to worldwide economic imbalances, especially within the euro zone. Last year the country's current account surplus equaled almost 7% of GDP, which has added to the deflationary bias in the single-currency region.

German officials rejected the U.S. criticism, saying Washington should look to its own problems. These include the financial market disruptions caused by default fears each time the U.S. nears its statutory debt ceiling, and what Germans believe is excessive money creation by the Federal Reserve. The Germans argued that their country's strength in exports testifies to the country’s competitiveness. Germany's economy and its labour market underwent major structural reforms in the early 2000s, which pinched domestic household consumption at the time but helped sustain the country through the difficult conditions after 2008.

German goods support investment

The Germans noted that the country's exports consist predominantly of investment goods. Countries where these goods are purchased might show current account deficits in the medium term, but will boost their investment levels long term, producing faster economic expansion in the future.

Germany's focus on exports has been criticized before. The International Monetary Fund has also urged the German government to do more to stimulate domestic demand. Even without stronger domestic demand, however, Germany's current account surplus has fallen versus that in the rest of the euro zone. Even as Germany continued to run a global current account surplus near 6% of GDP, its surplus against other euro zone countries fell by half from 2007 to 2012.

In Germany's view, imbalances among the euro zone’s peripheral economies stemmed from fiscal recklessness during the decade of strong expansion prior to the financial crisis. The situation has been slowly improving, and these countries are becoming more competitive outside the euro area.

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Nonetheless, there are downsides to Germany's reliance on exports outside of the euro area. The euro zone’s aggregate current account was close to balance in 2010, but turned to surplus in 2012. That surplus has grown this year as peripheral countries lowered their deficits significantly, while Germany and other northern countries continued to increase their surpluses.

Exports from northern euro zone countries are benefiting from a relatively weak euro tied to the slow recovery of the single-currency region. It would have been better had balance been achieved more uniformly across the euro zone, with the north and south sharing the burden of adjustment more equally. That would have stimulated growth across the region and ultimately given more support to the broader global economy.

German prosperity at risk

Germany's Institute of Economic Research recently cautioned that prosperity may be at risk within Germany. The institute contends that insufficient private and public domestic investment has created a large investment gap between Germany and the rest of the euro zone, amounting to around 3% of German GDP annually since 1999. Closing this gap in the medium term would increase potential output growth—the highest estimated rate of GDP growth that can be sustained in the long run—by 0.6 percentage point by 2017. Under current circumstances, however, the institute estimates this potential annual growth at only 1%. The German government should therefore do more to foster private investment and widen the scope of public investment.

But it is not clear how effective relaxing fiscal policy would be in boosting domestic demand, even if the government were willing to do so. German consumers and businesses are frugal and tend to increase savings and cut consumption in times of uncertainty. So despite the more favourable situation in the German domestic market than in most other European countries, activity has remained subdued.

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Germany's national unemployment rate is only slightly above the natural rate, which Moody’s Analytics estimates to be 6.7%. A recent rise in the number of job vacancies is a good sign for the labour market, despite an increase in the number of unemployed. Wages have grown steadily, and despite a slowdown in the first half they are expected to end 2013 up around 2.5% for the year.

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Despite that, household consumption and manufacturing are sluggish. Although monthly changes are volatile, both retail sales and industrial production have been rather downbeat, especially in light of relaxed lending. Access to credit has eased since German banks relaxed lending standards to enterprises of all sizes for loans of all maturities, yet lending to nonfinancial corporations has continued to fall because of lower demand. A fiscal stimulus would have to be strong to persuade German households and businesses to spend more. Moreover, such a move would likely aggravate southern euro zone countries, where strict austerity policies have raised taxes and cut wages.

Although the U.S. Treasury’s accusations are not new and not completely unfounded, the force of the criticism and its timing came as a surprise. Relations between the two allies were already strained by recent spying revelations, and the criticism was part of an otherwise unremarkable report concerned with exchange rate manipulation.


Anna Zabrodzka is an Economist at Moody's Analytics.


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