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News : EU Economy Last Updated: Jun 24, 2010 - 8:02:33 AM

Germany and sustainable domestic demand
By Michael Hennigan, Founder and Editor of Finfacts
Jun 23, 2010 - 5:44:00 AM

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The issue of Germany and sustainable domestic demand has been a common topic in the context of the sovereign debt crisis in the Eurozone and a paper published on Tuesday looks at options for policymakers.

Also on Tuesday it was reported that the recently announced four-year German austerity program valued at €80bn will not be impacted by news that the federal finance ministry is set for a €20bn windfall this year due to higher-than-expected corporate tax receipts and proceeds from a recent auction of spectrum for fourth-generation mobile phone services.

US economist Tyler Cowen commented on his blog: "The Germans see themselves as having made the necessary wage adjustments, in advance, and in a manner that Keynesian economics is skeptical of. The Germans also see themselves as having produced and maintained true credibility about future fiscal policy (how many other countriescan claim that?) by a constitutional amendment, a lot of tough talk, and arelatively robust real economy. German bonds are a safe haven investment, even though Germany's numbers, such as the debt-GDP ratio, are not overwhelmingly wonderful. That's a testament to German public sector management.

Did I mention that -- after unification -- the Germans tried (against their will, they had to) more than a decade of massive fiscal stimulus, and subsidization of consumption, starting with well underfull employment, and yet withmediocre results? That wasn'tlong ago.

And yet somehow it is a mystery, or a strange annal in some long book of Dogmengeschichte, that the Germans are not more interested in Keynesian economics."

Despite massive public spending since 1991, GDP per capita in the former East Germany is about 70% of the level in the former Federal Republic. Convergence within Germany or in the Eurozone, is a long process.

In Europe, without checking the facts, commentators and economists can wrongly assume that the Germans are Europe's biggest savers and have no memory of the fact that as recently as 2003, Prof. Hans-Werner Sinn of the Ifo institute, had a book published: Ist Deutschland noch zu retten? (Can Germany Be Saved?) - - Its blurb read: “Taxes keep rising, the pension and health insurance systems are ailing. More and more companies are going bankrupt or are leaving the country. Unemployment has reached alarming levels. Germany is outperformed by its neighbours. It’s growth rates are in the cellar, and it can’t keep up with Austria, the Netherlands, Britain or France. Germany has become the sick man of Europe. “

The sick man of Europe!

Recently, Prof. Sinn made the point that in 2008, only 40% of German savings were invested domestically and while German banks lacked prudence with some of their lending, Germany had not erected a fortress with one-way autobahn routes.

Deutsche Bank Research says in a paper that during the last upswing, exports proved to be Germany’s strongest growth engine. In the course of the economic crisis, however, calls were heard that Germany should not focus solely on exports as more domestic demand would help stabilise growth. Private demand is concentrated primarily on services.

Economist Philipp Ehmer says that since the start of the decade Germany has registered a current account surplus every year. Moderation in wage negotiations has made German industry increasingly competitive and led to a current account surplus of nearly 8% of GDP in boom year 2007 - - the highest surplus in 30 years. Germany is considered to be among the countries with the greatest trade openness and boasts the second highest merchandise exports in the world.

A look at the other 15 Eurozone countries shows that only the Netherlands and the much smaller Luxembourg registered a larger current account surplus in relation to GDP during the last economic upswing (2004-2007). Compared with the large Eurozone economies, the share of exports in GDP is disproportionately high (roughly 50%) in Germany; in France, Italy and Spain the figure is only 30%. By contrast, domestic demand in Germany is relatively weak: its share in GDP came to 96% in 2009, while the figure was approx. 103% in the large Eurozone economies.

Ehmer says that while many policy instruments to boost private demand show fast effects, there are currently no funds available to finance direct stimulation measures.

Open to trade = dependent on trade?

Between 2004 and 2007, exports accounted for nearly two-thirds of total economic growth in Germany. But a current account surplus in one country automatically means a deficit in another. Substantial current account imbalances have developed in some parts of the euro area. These are closely linked to the debt problems in southern Europe. The austerity measures now necessary in European export destinations harbour sales risks for Germany's exporters. According to DBR estimates, government debt in the industrial countries stands at an average 100% of GDP in 2010 and looks set to rise to over 130% by 2020. The global recession in 2009 also showed that excessive reliance on trade can be harmful: within EMU, Germany was one of the hardest-hit economies in terms of GDP.

The paper says while there are services for which exports play an important part (e.g. wholesale trade, IT services), it concentrates on domestically oriented services and, among these, above all on industries that absorb a large part of private consumption expenditure.

The economist says that as nearly 90% of all goods purchased by consumers are sold via retail trade outlets, this sector absorbs the lion’s share of household spending (€408bn). Within the services sector (excluding retail trade), housing/home expenditure is the largest single cost factor for households, accounting for €270bn or 40% of household spending on services. The next largest spending blocks are for the hotels & restaurants sector and domestic tourism (12%) as well as insurance and finance (11%). While less than 10% of total spending currently goes to health and long-term care services as well as to education and telecommunications, these items belong to the most dynamically growing spending blocks with annual growth rates of 4-5% since the year 2000. On average, household spending on services only grew by 2% during this time, i.e. in line with GDP growth.

Ehmer says one of the reasons why some Anglo-Saxon and Asian economies, for instance, boast larger services sectors than Germany is that, in these countries, more people are employed in less productive, low-skilled jobs. Due to Germany’s extensive social-security network there are fewer incentives to take up such jobs. This limits the employment potential in the low-wage segment and hence potential domestic growth. Also, there is little willingness in Germany to pay people for doing simple jobs like packing shopping bags in the supermarket. If such jobs were created, this would lead to higher product prices as companies would pass on higher wage costs to customers to the extent that this is tolerated by the price elasticities in the markets

In its Economic Survey, the OECD recommends - - among other things - - that Germany seek to improve education opportunities. According to the survey, globalisation will lead to stronger demand for highly skilled labour in a knowledge-based economy. The economist says while this is a suitable measure -- and thus a sensible demand - - to safeguard the German economy's competitiveness, it will hardly contribute to a stronger orientation towards the domestic market. First and foremost, this would help exporting industry, as many knowledge-based industries which would benefit from a better qualified workforce are engaged - - directly or indirectly - - in export business. Within the industrial sector there is a clear correlation, for example, between export intensity and knowledge intensity. And even the most export-intensive and successful industries in the world markets (with an export ratio in excess of 40%) were unable to increase employment figures between 2000 and 2008, like German industry as a whole. Quite the opposite was the case: roughly 10% of the workforce, or 330,000 jobs, were cut. Hence it is difficult to create additional jobs, and increase purchasing power as a result, by improving the policy framework in industry.

One way Germany could boost employment in labour-intensive services sectors would be to abolish its Zivildienst, community service to be carried out in lieu of compulsory military service. Young men doing community service are crowding out private-sector companies thanks to unmatchably low, government-subsidised wages.

However, such a move would increase the cost of services!

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