Every now and then, I read an article or a commentary in which the author complains about or praises Germany’s alledged competitiveness. For authors and readers, this claim probably seems obvious. After all German cars and machinery are worldwide without comparison (not sure that is true, though) and it runs a huge current account surplus. Combine that with the cliché about oh-so efficient Germans and the story must sound plausible. But is any of that true? How do we know whether a country is “competitive”? And what does that mean anyway?
Before we start our exploration, let’s review why people think Germany is competitive:
- it has very successful firms,
- it has a high current account surplus,
- its wage growth has been relatively low during the last 20 years,
- and random observations on Germans in general “show” their compeitiveness.
The concept of comparative advantage is incompatible with the first argument, so let’s leave that. The fourth is story-telling to fit a predefined image of what Germans “are like”. No need to comment there. So let’s focus on the second and take Norway as a first and extreme example. I will come back to the third later.
Norway’s production of natural resources led to a current account surplus of almost 20% of GDP in 2008 (China’s is around 9%, Germany’s highest was 7.6 % in 2007). Does this mean, Norway is “competitive”? Well sure, its natural resources make output per capita among the top 5 of the world. That sounds “competitive”. But what if Norwegians were not as thrifty and thoughtful about the future as they are? Wouldn’t they rather spend the petro-money they earn, making their current account surplus, well, zero?
Having some very compeititive industries in a country, or some highly productive sector, is not sufficient for having a current account surplus. It is saving and investment that move last, if you will.
What about saving and investment then? Let’s say that Norway’s economy is very “competitive” in the sense that it attracts a lot of investment in physical and human capital. If the propensity to save (government-mandated, or private) in Norway is still much higher, we should observe a current account surplus. And that is what we in fact observe. My knowledge of the Norwegian economy is limited, but I guess that is a fair approximation. A country like the US on the other hand is also “competitive” in a way that it attracts a lot of investment, but the saving is low, resulting in a deficit.
Which brings me to Germany. Sure, there are some very productive sectors in the economy, but if saving and investment move last, what do these two tell us? Well, this:
This figure shows that the current account surplus of Germany between 2002 and 2009 was driven by two forces: rapidly increasing saving, and plummeting investment. Let me add a figure to show these two forces, saving and investment, by sector.
Since the early 1990s net domestic investment (on the right) was in almost constant decline, masked somewhat by the dot-com bubble. The state invested almost nothing (net), the households less and less, and also firms’ investment declined. Especially firms’ investment does not point towards a competitive economy. What about saving? It is remarkable that again firms were at the core of the rise in saving. This saving by firms is non-distributed profits – either to invest it abroad or to pay down debt.
One more indication is lending in Germany:
Lending to domestic non-banks stagnated for almost 10 years. There might be other reasons such as the change in how firms finance their investments, and the pattern is almost too striking to be true (it seems there are straight lines in economics after all, Nick), but it doesn’t point to any plausible definition of the word “competitive”, does it?
The most plausible story is this: German firms had for historical, regulatory and monetary policy reasons relatively low cost of finance. The Euro and the transformation, liberalization and integration of financial markets in Europe ended this period, leaving German firms with a relatively high and costly capital stock. So they paid down part of their debt (see saving of firms above) and slowed down on investing domestically. Wages, still not fully adjusted to the reunification shock, came under further pressure. Considering these effects, Germany entered the Euro overvalued and therefore saw wage increases way below the European average.
This wage adjustment took long because even though Germany’s labor unions are moderate and economically sensible, nominal rigidity is strongest at zero. And why did Germany have very low inflation for such a long time? It was facing a monetary policy that was too tight for its economy. This was not the ECB’s fault, the inflation pressures from the European periphery needed to be contained. Still, whoever claims that Germany has greatly benefitted from the Euro up to now has to come up with a different story to explain these facts and I doubt there is one.
So what is “competitiveness” then? Here is a plausible way to define it: wages are at market clearing levels. Then all resources of an economy are used to their full potential. Of course, labor market institutions, education and research policies, taxes and social policies, or even industrial policies could further add to making the economy more productive, but this is not the same as competitive.
Because many commentators don’t realize that Germany was actually uncompetitive and therefore had a high current account surplus, they suggest that Germany should not become even more competitive. If my argument is correct, that is nonsense. Germany’s progress in becoming competitive (in the above sense of that word) will lead to a falling current account surplus. And we see first signs of exactly that happening.
So please, commentators of the world, stop this competitiveness-cum-current-account gibbrish. First, we need to define what competitiveness really means and then ask whether a proper definition of that term applies to Germany. I have given you my answer. And if you are having aggregate demand (AD) problems, start focusing on what you (or better: your central bank) could do about them instead of blaming a country that has struggled through 15 years of stagnation and adjustment to become comeptitive at all.
HT: Henry Kaspar for figures and helpful links