- Germany's economic growth has trailed the pace set by the U.K. and U.S.
- Fixed investment has dragged on the German economy.
- The services sector needs better regulation to make a real impact.
- The government should exploit its healthy fiscal situation.
- A smaller German current account surplus would reduce upward pressure on the euro.
Germany's recovery slowed in the autumn, with economic output expanding just 0.3% in the three months to September, after growing 0.7% in the previous stanza. Growth was most likely driven by robust domestic consumption and strong exports, while fixed investment remains subdued. Germany's reliance on external demand has come under criticism by the international community. Still, consumer and business confidence has improved significantly from the beginning of this year. Moody’s Analytics expects the German economy to expand 0.5% in 2013.
Although Germany’s growth is pulling the euro zone out of recession, the country’s economic policies, in particular its focus on external demand, have been criticised. The country’s large current account as a share of GDP—consistently above 6% for more than five years—has drawn especially sharp comments from the international community. However, the issue here is not strong exports but weak overall growth relative to the current account surplus. Compared with that of the U.K. and the U.S., Germany's economic growth has clearly been lagging.
Domestic demand is robust
Still, it cannot be said that German domestic demand is particularly weak. In the second quarter, domestic demand added 0.5 percentage point to GDP growth, while net trade added only 0.2 percentage point. A closer look at the components of domestic demand—household consumption, government spending and investment—show the first two continuing to expand robustly, growing quarter on quarter and year on year since at least the beginning of 2012, even if the expansions have not been especially fast.
The drag is fixed investment, which has been steadily contracting in year-ago terms since the beginning of 2012 and is expected to post a decline for all of 2013.
There is room for improvement and the government could step in, especially given that the investment gap—fixed investment as a share of German GDP compared with the euro zone average—has been accumulating for over a decade and threatens the country's long-term growth.
Services sector needs reforms
Germany’s services sector trails that of its European peers, mainly because of cumbersome legislation. Entrepreneurship is hindered by a bureaucratic permitting and licensing system, which has kept the share of services in the total economy stagnating since the mid-1990s. Services employment has increased substantially, driven by low-skilled, low-paid contract jobs with limited prospects for full-time permanent employment. Productivity in services has thus not improved much since the early 2000s.
Easier access to the services sector for startup companies and better job security could boost private investment within the sector, but even so the government would not be able to influence wages, which are set through collective bargaining between employers and trade unions. The new government coalition could guarantee a nationwide minimum wage, but this seems unlikely.
The government could also step up public investment in infrastructure, education, and research and development. Government investment amounted to only 1.65% of GDP in 2011, according to Eurostat’s most recent data, far below the 2.5% average for the EU and 2.2% in the U.K. An increase in public investment is particularly important now as Germany replaces its nuclear and fossil-fuel power plants with renewable energy sources. The government plans to increase the share of renewable energy in its electricity consumption from 23% last year to 35% in 2020 and to 80% in 2050. But progress is slow, especially considering the ambitious targets.
Space to maneuver
Germany does have some fiscal space, defined as the amount its debt-to-GDP ratio could climb without creating serious fiscal problems. Moody’s Analytics estimates Germany's space at 158.5 percentage points, well ahead of the 125 considered a prudent minimum. Germany benefits from low government borrowing costs since its bonds are viewed as a safe-haven investment. However, as global central banks begin to unwind their monetary stimulus programmes, yields on German government bonds will start to rise. The government should thus take advantage of its favorable situation now to boost domestic demand.
But the courses of action are limited. Although the government’s budget situation is positive, with a deficit amounting to less than 0.1% of GDP and a budget expected to be broadly balanced next year, the public debt is elevated. The debt-to-GDP ratio is expected to fall to 79.5% this year from more than 80%, but this is still well above the 60% maximum prescribed by the European Union.
Germany and global growth
The European Commission has begun to investigate Germany's large current account surplus. According to European Union rules, no member country's current account surplus should equal more than 6% of its GDP for three consecutive years. If the EC concludes by the spring that Germany’s surplus is excessive, the commission can require the German government to make policy changes.
Yet from Germany’s perspective, ensuring strong exports benefits the country since the economy is already growing and the government does not need to flex its muscles to ensure expansion. Still, Germany has undoubtedly benefited from being part of the monetary union. The euro's creation kept Germany from experiencing unwanted currency appreciation, which in turn allowed the country to accumulate such a large current account surplus for so long.
Germany’s large current account imbalance would have been corrected by the strong appreciation of the deutschmark, but with the euro this is not possible; instead, an “internal appreciation” is necessary—wages and prices have to rise faster because of stronger economic growth.
While the large current account deficits in the euro zone’s peripheral economies have been corrected, the northern member states continue to run large surpluses. The euro zone’s aggregate current account was close to balance in 2010, but turned to surplus in 2012 and continues to increase, exerting upward pressure on the single currency. The euro has been strong despite the region's sluggish recovery, and likelihood of contraction for the full year.
Helping the neighbors
Although a rise in German demand would not support troubled euro zone members directly, a smaller current account surplus would reduce upward pressure on the euro, easing access to global markets for exporters in countries such as Spain and Italy.
Right now, Germany’s approach seems rather self-serving. Although Germany did quite a bit to support its troubled neighbor economies during the downturn, it could do more to enhance growth in the region now that recovery is on the way.
Anna Zabrodzka is an Economist at Moody's Analytics.
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