This article was first published on FT.com on 18th November 2013.
Germany is under attack from the US government, the International Monetary Fund and the European Commission for its huge current account surplus. The criticism is right, but for the wrong reasons. The surplus is excessive, but the accusation that it hurts Europe is nonsense. Worse, it distracts German policy makers from tackling the true cause of the national surplus and the country’s economic Achilles heel: its huge private investment gap.
The common response in Germany has been anger at what is perceived as a criticism of its successful export model. The danger is that the policy debate in Germany is turning inwards, and what is good for Europe is increasingly seen as bad for Germany. This manifests itself in criticism of the European Central Bank’s decision to cut interest rates, which some see as against Germany’s best interests.
The flaw in the criticism is the implicit claim that trade is a zero-sum game. In fact, Germany’s exports of machinery, tools and chemicals surged after the 2008-09 crisis, and were a crucial part of the global recovery rather than an impediment to adjustment in Europe’s periphery. Criticism of the surplus distracts from the fact that it is a symptom of growing structural weaknesses in the country. Despite success in reducing unemployment, German growth since 1999 has been anaemic, real wages have been stagnant, labour productivity has been subpar, many jobs created are temporary and the net wealth of the government has declined sharply.
The common cause is a huge investment gap. The share of investment in gross domestic product is one of the lowest among industrialised countries. It has been declining rapidly, from an average of 23 per cent in the 1990s to less than 17 per cent today. A DIW Berlin study calculates that Germany has an investment gap of 3 per cent annually, or €80bn, which has reduced potential growth from 1.6 per cent to 1 per cent. Most of this gap is in private investment.
The cause of this paradox is a mixture of bad luck and bad policy. Germany’s highly competitive export sectors invest increasingly abroad and less at home. This makes sense for companies seeking to gain foreign market access and diversify risk, but it is becoming a serious predicament for the national economy.
Low private investment also reflects poor domestic economic policy. First, an uncertain regulatory environment plays a role, for instance, in the low investment in the country’s transition to renewable energy, which requires €30bn-€40bn of additional investment annually. German insurance companies are flush with cash and desperately in search of yield but regulatory uncertainty makes them reluctant to engage in this sector, or even forbids them outright from doing so.
Second, the tax system could be made more favourable to investment, for instance by giving breaks to companies and abolishing wasteful subsidies. A third crucial area is the labour market, in which companies are complaining about a lack of skills such as engineering and programming. A better and more flexible education system in the long run, and a more open migration policy in the short run, could help.
Finally, there has been a sharp decline in entrepreneurship, in part as financial incentives have been curtailed, even though such activity is crucial for innovation, investment and ultimately for generating jobs and growth.
Yet none of these issues is high on the agenda of the negotiations to form a coalition government, which have focused on redistribution. This alone will not address the private investment gap. What is needed is a careful balance between demand-side policies and supply-side policies, which strengthen labour productivity through greater capital investment and competition.
The biggest economic challenge for the new government is reducing the private investment gap. It is tempting to turn a blind eye, since the economic benefits may not fully materialise for years– but such action is crucial for competitiveness, growth and prosperity. It would also cut the current account surplus by increasing imports, and help Europe to grow its way out of the crisis. The consequences of a failure could be dire. Germany has managed to transform itself into Europe’s most resilient economy within a decade, yet the tables could turn as quickly.