Now that Germany’s current-account surplus has reached a record €270 billion ($285 billion), or close to 8.7% of GDP, the ongoing debate about its economic model has intensified. Eurozone politicians and Donald Trump’s administration in the United States are each blaming the other for the economic imbalance; and all are blaming the euro.
Trump’s administration, for its part, has attacked Germany for exporting too much, and accused it of manipulating the euro. In fact, Germany’s trade surplus has little to do with the euro; which has become a convenient scapegoat – a stand-in for other policy mistakes.
Many Germans view the latest wave of criticism as a sign that others are merely envious of their country’s success, and they have angrily refuted arguments that Germany has tried to gain an unfair competitive advantage. Germany, they point out, does not engage in price dumping or direct export promotion, and its leaders do not target the euro.
On the contrary, prior to adopting the common currency, Germany had for decades pursued a strong-Deutsche Mark policy, because it wanted to encourage domestic exporters to maintain competitiveness through innovation, rather than reliance on the exchange rate. This was the central feature of Germany’s economic model after World War II, and the main reason its long Wirtschaftswunder (“economic miracle”) could be sustained.
The criticism of Germany’s trade surplus suffers from three fallacies. For starters, many of the critics seem to believe that Germany’s trade balance can be systematically manipulated with the exchange rate. But, owing to the integration of global value chains, industrial exports now comprise many imported inputs, which means that the effect of exchange-rate movements on domestic prices and the trade balance has decreased substantially over time.
In fact, Germany’s bilateral trade surplus with the US has barely changed, despite substantial swings in the euro-dollar exchange rate – which was as high as €1:$1.60 in 2011, and as low as €1:$1.04 more recently. Germany owes its export success not to currency manipulation, but to its strong market position and the pricing power of its highly specialized manufacturing champions.
A second fallacy is the belief that politicians and central banks can actually set exchange rates. In most advanced economies, the exchange rate cannot simply be decreed; rather, it is endogenously determined by the underlying real economy and the state of the financial system. Currency markets are too deep for direct intervention to be worth the risk, as the Swiss National Bank discovered a few years ago when it tried to stem the franc’s appreciation. The US Treasury abandoned currency-market interventions in the 1990s; and the European Central Bank has tried to intervene only once, very briefly in 2000.
Accusations that the US Federal Reserve and the ECB have pursued unconventional policy measures to weaken their respective currencies miss the fact that exchange-rate movements have only a limited, short-lived effect on domestic inflation, exports, and growth. Both central banks are guided by their mandates, not by an implicit or explicit exchange-rate objective.
A third fallacy – which one often encounters on the German side of the debate – is the belief that a country’s current-account balance reflects the competitiveness of its exports. In reality, a country’s external balance is determined by its preferences and its intertemporal saving and investment decisions. Fundamentals such as Germany’s demographics alone probably account only for 3 percentage points – or one-third – of its current-account surplus.
As these three fallacies show, the debate over Germany’s external surplus should not be about the euro exchange rate or German exports. The euro is not too weak, and German exports are not too high. Rather, the problem is that Germany’s imports are too low, owing to its huge investment gap.
Germany has one of the lowest public-investment rates in the industrialized world. Its municipalities, which are responsible for half of all public investment, currently have unrealized investment projects worth €136 billion, or 4.5% of GDP; Germany’s school buildings alone need another €35 billion for repairs. Meanwhile, private investment Germany’s aging capital stock has been weakened by many German companies’ desire to invest abroad.
The gap is the result of policy failures – namely protectionist policies in the non-tradable services sector. The International Monetary Fund, the European Commission, and the OECD have long tried to convince Germany to deregulate services, curtail vested interests, and improve competition. But, as it stands, wages, productivity, and investment remain high in the German export sector, and low in the non-tradable services sector.
The international debate about Germany’s current account should thus focus on measures to liberalize the country’s services and remove other barriers to investment. To that end, Germany should improve its digital and transportation infrastructure; strengthen market mechanisms to encourage more renewable-energy development; address its shortage of skilled labor; change its tax system to strengthen incentives to invest; and reform its regulations to reduce uncertainty.
Germany is an increasingly important political and economic power in Europe and on the world stage. But, until now, the debate about Germany’s current-account surplus has been counterproductive. Criticism of Germany’s export prowess, and accusations of currency manipulation, are just as wrong-headed as Germany’s own defense of its excessive surplus. Ultimately, Germany can serve everyone’s best interests – including its own – by reducing its surplus, and thus the harmful economic imbalances that lie just beneath the surface.