from Follow the Money

Why is consumer demand so weak in Germany?

September 15, 2005

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David Wessel writes in today's Wall Street Journal: "Germany, alas, is showing few signs of a Japanese style rebound.  It is, essentially, relying on lower wages to make exports more competitive because it hasn't boosted consumer spending or business investment."

That sentence might well work better if read "Germany has had trouble boosting consumer spending because it has needed to lower wages to make its exports more competitive (and also to make German product more competitive in Germany)."    The cause and the effect are not clear.  Has low consumer demand kept wage growth subdued?  Or has German consumer demand been subdued because German wage growth has been (very) subdued?

I am a bit more cautious than most about projecting a massive boom if Germany implements efficiency enhancing reforms.  The link between reform and growth is not obvious in the short-run.  The dislocations associated with efficiency enhancing reforms (efficiency enhancing reform is economese for making it easier to fire people among other things ... ) can dampen consumer spending, as workers worry that they may lose their job and start to save more.   Long-term efficiency improvements do not always translate into higher consumer spending in the short-run.  One potential explanation for why consumer demand has been so weak in Germany (see the OECD data) is the fact that Germany has started to reform.  Unit labor costs in Germany are falling.   That may be part of the reason why German household savings rose from 9.7% to 10.7% between 2000 and 2003.

The connection between reform and higher long-term growth is also not a sure thing.  Work by Ricardo Hausmann, Dani Rodrik and Lant Pritchett suggests there is no guarantee that "more reform = more growth."  To quote a key conclusion of one of their recent papers: "most instances of economic reform do not produce growth accelerations."   That conclusion is most obvious looking at Latin America, but it does suggest to me that a higher degree of humility is called for.  Most commentators that I know would not have predicted that China's (largely unreformed and NPL ridden) state-owned banks could finance a growth explosion ...

I do think Germany needs to do more to prepare for a world where the US no longer supports global demand growth, and to make sure the German government's future commitments are commensurate with its resources.

But American commentary - in my view - might be strengthened if it emphasized two things:

a) Investment in Germany is now lower about 2% of GDP lower than investment in the US.  But I would guess that higher investment in housing accounts for most of the difference ...  and I am not sure all the capital now being invested in the US housing stock is the best use of available resources.  Investment in tradable production is probably higher in Germany.  The composition of investment may matter as much as the level.  Higher investment in Germany's export sector may not help with global rebalancing; what is needed is a surge in investment in Germany's non-tradable sector.

b) The flexible US labor market has not generated all that impressive employment growth recently.  The US has had trouble generating sustained real wage growth, at least for the average worker.  Economists are a bit of an exception --  Jessica Vacellaro pointed out in the Journal on Tuesday, earnings for economic teachers in the US have risen far faster than earnings for most other workers since 1997.  Strong domestic demand growth in the US has not coming from rising labor income, particularly for those not in the top 20% of the income distribution, so much as falling household savings.  And falling household savings has been intimately linked to housing appreciation.  

What distinguishes Germany is that it -- unlike many other European economies -- has not experienced a sustained increase in housing prices.  That probably goes further than anything else to explain why German domestic demand growth has lagged not demand growth not just in the US, but also demand growth in Spain,  France and even Italy (see table 2 of the April WEO statistical appendix).

In other words, global rebalancing would be a lot easier with a German housing bubble. 

I tend to think that there is a good chance growth in Germany will pick up over the next few years -  no matter who wins the election.  The long hard slog needed to cut German labor costs may be close to over.  At some point, German export success - success that has come in the face of a rising euro -- is likely to spillover and start to generate domestic demand growth.   I agree with Martin Wolf here, as elsewhere:

Divergences in productivity performance and wage behaviour have generated huge cost divergences. Germany's real effective exchange rate has depreciated by about a sixth against Italy's since 1999. In turn, the volume of Germany's exports of goods and services has risen by a stunning 47 per cent between the first quarter of 1999, when the euro was launched, and the end of last year. Allegedly uncompetitive Germany is the world's largest exporter. .... When Germany's domestic demand starts to pick up again, its economy is likely to do well.

The risk, of course, is that a slowing global economy - and a slowing US economy - will drag German export growth down before Germany domestic demand growth picks up,

Of course getting demand growth growing in Germany will be a lot easier if the ECB keeps rates low, and lays the foundation for an eventual rise in Germany housing prices.  The obvious downside: the low rates needed to support domestic demand in Germany may not be quite what say Spain - with surging housing prices and strong domestic demand growth - needs. ....

Update: check out the graph comparing Chinese and German export growth in Martin Wolf's latest analysis.  Sort of interesting.  Germany's growth looks to have stalled just a bit recently, for a while, it was almost keeping pace with China -- even with a rising euro.

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