Tuesday, April 01, 2003
Germany and Japan - too close for comfort
Posted by David Smith at 04:29 PM
Category: David Smith' s magazine articles

For many businessmen I speak to, the big worry is Germany. Germany’s problems seem to go from bad to worse, and its woes are dragging down European economic growth, to the point where the region as a whole appears dangerously stagnant.

Forecasters now predict zero growth this year for Germany, below even the government’s downbeat forecast of a mere 1 per cent expansion. It is probable, as this is being written, that the economy has slipped back into technical recession. German businesses are gloomier about prospects than at any time since the last full recession in 1993.

Nor is there much schadenfreude in Britain about Germany’s difficulties. The problems for the German economy, and in particular very weak domestic demand there, means that the competitive pressures on UK exporters are, if anything intensified.

Like Japan, the other miracle economy of the post-war period, Germany has fallen on hard times that would have seemed inconceivable a few years ago. And, given that Japan has had more than a decade of stagnation, which shows no sign of coming to an end, that is a worrying thought. The parallels between Japan and Germany, indeed, are disturbingly close. Here are a few of them:

1. Both economies are suffering long, post-boom, economic hangovers, In Japan’s case it was the “bubble economy” boom of sky-high stock markets and property prices. In the case of Germany, the tearing-down of the Berlin wall in 1989, followed by formal unification in 1990s produced an immediate boom, particularly in construction, followed by recession, in 1993.

2. Both have suffered weak growth for years. Japan’s “lost decade” of the 1990s saw the economy slipping in and out of recession, with only weak growth in between. In the case of Germany, growth has been well below the previous trend since that 1993 recession. Economists believe that “trend” growth in the two economies is now just 1 per cent a year, compared with 2.5 per cent or more in Britain.

3. Both have serious demographic problems. Japan has the oldest population in the world, while Germany is facing the biggest decline in population, certainly in Europe. Germany’s ageing population interacts worryingly with its generous state pensions system, implying a rising fiscal burden in the future.

4. Both are consensus-based societies. Germany’s non-confrontational system was once held up as a model by British commentators, including Will Hutton in The State We’re In a few years ago. But that model has proved to be a serious barrier to the kind of economic reform Germany needs to regain competitiveness. Meanwhile Britain’s tradition of confrontation in industrial relations has evolved. Like Japan, where consensus is needed for change, Germany does not vote for the kind of political leader likely to bring it about. At the last federal election Edmund Stoiber, Gerhard Schroder’s conservative opponent, proposed only modest reforms.

5. Both have serious banking problems. Again, the close relationships between banks and industrial and commercial companies, and the absence of hostile takeovers, were seen to be great post-war advantages for Japan and Germany. Now the legacy of those relationships is seen in vulnerable banking systems. A recent International Monetary Fund report pointed out that the return on equity of Deutsche Bank is just 0.42 per cent, with other German banks scraping in at just over 1 per cent Comparable figures for leading UK banks range from just over 10 per cent to over 20 per cent.

6. Deflation is a reality in the case of Japan, where consumer prices have been falling for three years (and share and property prices for a decade). It is also in prospect in Germany. Economists had expected the German economy to skate clear of deflation but the euro’s recent appreciation has brought it clearly into view, for later this year or next year.

7. Both had their greatest strength in manufacturing. The German and Japanese educational system seemed to be particularly attuned to producing skilled industrial workers and managers. But Germany, like Japan, has been less good at producing entrepreneurs in the service sector and in new technologies. Arguably, given the failure of the Neuer Markt, Germany’s Nasdaq, it suffered worse problems with new technology than other economies.

8. Both are seriously uncompetitive. Germany has the highest labour costs in the world, Japan some of the highest living costs. Just as Japanese firms have sought cheaper locations elsewhere in Asia, German companies are taking similar action in Eastern Europe. The existence of cheap locations on Germany’s borders, coupled with the near-term prospect of EU accession, is accentuating the “hollowing out” of the Germany economy.

One should not pretend, despite these similarities, that the difficulties Germany and Japan face are identical, or indeed that identical solutions are appropriate to their problems. I have barely mentioned unification, which many see as Germany’s biggest problem. Nearly a decade and a half after the Berlin wall came down, the former East Germany remains a high-unemployment, low-performing economy, requiring fiscal transfers from west to east of as much as 5 per cent of GDP.

There is also an interesting debate to be had over monetary and fiscal policy. Japan, free from any external constraints, has had a series of fiscal packages, which are now regarded with weary resignation by consumers and businesses, and increased its budget deficit to 7 per cent of gross domestic product.

Germany, of course, cannot do this, being constrained by the euro Stability and Growth Pact (SGP) to keep its deficit to 3 per cent of GDP or below. While many would argue that further fiscal relaxation is the right thing for Germany, maybe Japan’s experience shows it serious limitations.

Similarly, the Bank of Japan has cut interest rates to zero in an effort to stimulate the economy, while Germany has had to endure somewhat higher interest rates (willingly, it should be said) because the European Central Bank sets monetary policy for the whole of the euro area. The Bank of Japan’s lack of success suggests, again, that easier monetary policy would be no panacea for Germany.

Instead, Germany desperately needs labour market flexibility and creation of a new entrepreneurial culture in place of the old corporatism. Its Mittelstand of small and medium-sized firms, once the envy of Britain, is creaking. Without thoroughgoing reforms, Germany will continue to creak. Reform is in the air. The question is whether it is thoroughgoing enough.

From Business Voice, April 2003