Abacus: "The German Problem"

The Economist recently ran a cover story titled “Why Germany’s current-account surplus is bad for the world economy,” which began by highlighting the major ideological differences in free trade between our current Executive branch and the Prime Minister of Germany. With the two Leaders set to meet up in the G20 summit soon after the story was printed, Germany was seen as one of the major defenders of free flowing global trade against Trump’s push for isolationism.

However, the underlying story that The Economist wanted to highlight from this encounter was the German Current Account Surplus, which is huge. The article’s main push was that Germany’s hogging of their surplus made them “an awkward defender of free trade.” I did some extra research into what is called “The German Problem”.

Free trade is seen by most economists as a way to make the Global economic pie bigger, which implies that the slices for every country also increase in size. I.e., the more countries that take place in free trade (based on economic concepts like comparative advantage), the better off everyone is. Germany is all for this, but the problem is that their trading surplus has gotten way too large. Germany’s current account surplus sits at over 17 Billion Euros, which recently eclipsed 7% of their total GDP. This is big, it’s the second largest current account surplus in the world behind China.

The crux of the German problem: The country saves too much and spends too little. Their fiscally conservative account, based on their recent economic bust and boom, has created an ideology of excessive savings which has put a drag on their own economy, the Eurozone’s economy, and has put strain on the global free trading system.

In the late 90s, Germany was on their way to economic ruin. (The Economist also wrote and good article that relates to this paragraph: see here). Their unemployment was at record highs, their trade surplus had turned into an unusual deficit, and the major export industry was shrinking rapidly. Eventually, due to reasons beyond this article, the economy began to come out of this trough and the export industry started to come back. However, what was transpiring in Eastern Europe during Germany’s bust-and-boom was excessive wage increases. Germany responding to this by making a pact between the nation, the unions, and the employers to restrain wage growth. This has had positive effects, most notably is that it has kept unemployment really low, and the German economy has been operating very close to full-employment since the accord.

However, this pact also significantly reduced the household share of GDP. And then almost automatically, the national savings rate among German household increased as well. The big effect that we are talking about follows from A) German households consuming less, and B) German production increasing (Germany’s employment-population ratio has increased nearly 5% since the late 90s.) One can then infer: Same (or increased) production + Less consumption = More goods and services than will be consumed domestically. Germany has become one of the largest net creditors in the world, and this has caused the rest of the Eurozone and Global trading market to absorb the rest of Germany’s excess production.

Firstly, this affects Germany because their public and private domestic spending is low and not sufficient. Germany’s economy is strong in the sense that it benefits from “low interest rates, a weak euro and the ongoing debt-financed consumption and investment boom in some countries.” But the problem is that the country needs more productive (domestic) investment. It has markedly low productivity growth, a steadily worsening education system, poor infrastructure, and a shrinking workforce. This can be attributed to the high savings rates in the private sector, but the Government isn’t doing much to help: “Germany’s structural budget balance has gone from a deficit of over 3% of GDP in 2010 to a small surplus.”

The effect on the world is that it puts unreasonable strain on the global trading system. In essence, this is because the rest of the world (and particularly the Eurozone) must adjust their own trading balances to accommodate the extra German production. Countries like Spain, Italy, and Greece have begun to experience such high capital inflows that, “to offset such surpluses and sustain enough aggregate demand to keep people in work,” they must run equally as disturbing account deficits. Or, as The Economist put it in their article: “the rest of the world must borrow and spend with equal abandon.” Such high absorbing from certain countries ultimately shifts former German unemployment elsewhere, and can result in a lot of misallocated investment.

Germany is a big creditor to the rest of the world who run consistent deficits. The thing about debt and borrowing at the national level is that it usually isn’t a bad thing. Because large countries are considered so credible, they can often borrow money really cheap, and this can spawn huge economic expansions. This point relates in two ways: 1) Part of Germany’s slow economic growth can be attributed to their refusal to run deficits in certain places.

But more importantly: 2) The above debt explanation only is valid when countries pay back their debts. When countries borrow money and then spend it beyond their means, it creates an inevitable downward economic spiral. Furthermore, persistent deficits, which can easily be caused by adapting to Germany’s unsustainable production, can lead to this type of economic spiral.

For example: Greece. This nation’s very poor economic situation is widely known and comes up very often in the mainstream media. Greece’s downward spiral can be attributed to many other things (the creation of the Euro didn’t help), but soaring booms in capital inflows definitely influenced Greece to spend beyond their means. Plus, Greece’s continued borrowing and spending to A) run a perpetual deficit, and B) sustain high enough aggregate demand to handle The German Problem were two major catalysts that eventually led to default and the following economic crises.

So what’s the solution? To deal with their strain on the Global trading system, maybe we should moderate exports? By ending wage restraint agreements, we can drive up German wages and raise the price of exports to correct the oversized surplus. But, as economist Gustav Horn writes in Social Europe, the inelastic export demand for German exports would only increase yields in the short run anyways, and what would really solve this detrimental problem is to raise demands for imports.

I think it’s clear to conclude that the heart of The German Problem is the inability to break Germany’s strict mindset on debt. Free the nation from their inability to consume at a high enough level, and implore the Government to end their apparent need to be a net creditor, and you will see productive investment increase in both the public and private sectors. This change in monetary ideology can have far reaching effects in the global macroeconomic sectors.