Sunday, June 04, 2006
Germany revives, but Britain is still well ahead
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

Germany, for the next few weeks at least, will be under the world’s spotlight. On Friday Gordon Brown went for a sneak preview, and a meeting with Angela Merkel, the German chancellor.

Last time I was in Berlin, a few weeks ago, they were already discounting World Cup memorabilia to entice reluctant German shoppers to spend.


So one question is whether the tournament will mark a turning point for Europe’s biggest economy, and add to recent signs of revival.

A bigger question, arising from this, is whether the German economic model of slow, export-led growth will turn out to be bettter or worse in the long-run than the recent British experience of a more rapid, but arguably less sustainable, consumer-led expansion. Will the German tortoise, in other words, end up doing better than the British hare?

When you use the words “German economy” and “revival” in the same sentence, you have to define your terms carefully. The Organisation for Economic Co-operation and Development(OECD), in its economic survey of the country, published last week, predicted 1.75% growth this year, up from 1.1% in 2005. It also noted that this year’s growth is “above potential”.

That says a lot about what Germany has become. Britain’s potential growth rate - the trend rate of expansion - is 2.5% or 2.75% a year. Germany’s is about 1.5%, its growth revival means a pick-up from the pathetic to the merely lacklustre.

That is also true on other measures. Unemployment fell last month by an impressive 93,000 but still stands at 4.6m, or 11% of the workforce. Retail sales were very strong in April but only after big falls in the two previous months.

The OECD’s cautious assessment is that the recovery is slowly gaining ground and that the German economy’s long and painful adjustment, which dates back to 1993, is gradually coming to an end. That looks about right. The giant may still be lumbering but it is lumbering in the right direction.

A World Cup would not be the same without a bit of Anglo-German rivalry. What about the current state of economic rivalry? When George Osborne, the shadow chancellor, began quoting comparisons showing that Britain was as highly taxed as Germany, I did point out to him that for many people in Britain, despite everything, the Federal Republic still had an economy to be admired and looked up to.

Can that still be true? The four traditional measures of economic success are growth, inflation, unemployment and the balance of payments. A successful economy maintains a good rate of growth, low inflation and near full-employment, while keeping the balance of payments in broad balance.

On this basis, Britain has clearly won the battle when it comes to growth, the economy expanding by an average of 2.9% a year since 1994, almost twice Germany’s rate of 1.5%.

Germany, under the watchful eye of the Bundesbank, used to be the one to beat when it came to price stability but it is testimony to the successful operation of monetary policy in Britain in recent years that this is no longer the case. You can barely put a cigarette paper between Germany’s average inflation rate since 1994, 1.6%, and Britain’s 1.7%.

You can, however, put plenty of distance between Britain and Germany on unemployment, with the Federal Republic on 11% and Britain, despite a now-rising trend, under half that at 5.2% on a comparable basis. Germany, of course, has had to take on the burden of the eastern lander, where a fifth of the working population is unemployed a decade and a half after unification. Even in the west, however, the jobless rate is more than 8%.

The really interesting question, however, is on trade. Germany is a champion, the biggest exporter in the world, despite the rise of low-cost China. Germany accounts for 10% of world exports of goods, outsells America - the world’s biggest economy - and exports half as much again as China.

While Germany is in top place among goods’ exporters, Britain is in eighth place, with export earnings just over a third of the Federal Republic’s. Britain, it should be said, does better in service-sector exports, and is second to America (Germany is in third place). Even so, taking goods and services together, Germany exports twice as much as Britain.

Germany and Britain also diverge strongly on the balance of payments. Germany, perhaps surprisingly, ran a current account deficit for most of the 1990s, only returning to surplus in 2001. Since then, however, the surplus has grown, was $114 billion (£60 billion) last year, and is predicted by the OECD, and just about everybody else, to grow sharply over the next couple of years.

Britain, in sharp contrast, was close to balance on the current account when Labour was elected in 1997, but has been in chronic deficit in recent years, the red ink totalling £32 billion last year.

So should we be emulating Germany? Britain’s current account deficit is not a healthy sign but neither is Germany’s huge surplus. You can have too much of a good thing. The surplus reflects Germany’s export success, which is good, but it also reflects the weakness of domestic demand stretching over a number of years.

The two things, according to the OECD, are linked. German export competitiveness has been achieved through holding down the growth in wages, a process made easier by very high unemployment. Germany may be the export champion of the world but its households feel financially squeezed and downtrodden. They’re not celebrating.

There is a happy medium to be struck and you could argue that neither Britain nor Germany has achieved it. But Germany has a long way to go before recovering past dynamism, and on economic reform Angela Merkel, the country’s chancellor, appears unwilling to make the journey. For all Germany’s export success, and Britain’s shortcomings, I’d rather have our problems than theirs.

PS This will be an important week for interest rates. The European Central Bank is set to raise rates from 2.5% on Thursday, the debate being over whether it chooses a quarter or half-point in response to recent evidence of higher inflation.

Here, the eight-member Bank of England monetary policy committee (there’s still a vacancy), is likely to split again on rates, though it has lost its sole rate-cutter in Steve Nickell. This time, in spite of volatile markets, the split will be between those who want to keep rates on hold and those who want to hike.

That is also the way the “shadow” monetary policy committee (SMPC), which meets under the auspices of the Institute of Economic Affairs, divides in its latest vote. Of the nine SMPC members, seven vote to hold, while two opt for an immediate hike.

The two hikers, Tim Congdon and Anne Sibert, cite continued rapid growth in the money supply and the strength of the global economy. Of the seven on hold, two, Roger Bootle and Peter Warburton, think a cut may eventually be needed. One, Peter Spencer, maintains a position of neutrality.

But John Greenwood, Ruth Lea, Kent Matthews and David B. Smith all think the next move should be up, delay being justified mainly by the continued fragility of financial markets. They all think the economy is growing fine and are worried about the pace of money and credit growth. Add them to the two hikers and that means the bias on the SMPC is for higher interest rates. That also appears to be the case on the actual MPC.

We’ll see. There is tentative evidence that this year’s housign boomlet is fading, and retailers could be struggling after the World Cup spending boost subsides. I don’t see a case any more for lower rates - unless global stock markets really collapsed - but I don’t yet see a need to hike either.

From The Sunday Times, June 4 2006


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Posted by: Anthony Thomas Flynn at June 6, 2006 08:04 PM

The reason Germany has had better export success is because of the rise in the pound since 1996. This priced our exports out. Indeed since then, despite the boom manufacturing output is about the same as it was then, which rather proves it. The curse of North Sea oil.
Talking of which since the rise in the oil price over the last 2 years
the value of our oil output must have more than doubled. This should have given a massive boost to GNP. Why has this not been shown in the figures?

Posted by: David price at June 6, 2006 10:28 PM

What matters over the long term are growth and employment - the balance of payments doesn't matter at all, as long as it can be financed, since Britain has a floating exchange rate. If the markets ever believe that our current account position is unsustainable, our currency will fall and the position should improve (subject to certain conditions). Germany, of course, doesn't have this option since it foolishly embraced the Euro (or Teuero, as some people call it over there).

Germany has a better position on trade because its manufacturing sector is bloated, for a number of reasons, making up something like 35% of its economy compared to half that in Britain, the US or France (figures from memory). Manufacturing goods are much more tradeable than services, on average. Its education system produces a large number of high-school graduates perfect for manufacturing companies, and it has an admired system of technical education, in which I briefly participated as a teenager some years ago. Its university education is arguably much weaker than Britain's however, taking a much longer time to award its degrees and allowing people to drag out their student years almost indefinitely. During the Bretton Woods period, its exchange rate was low, which biased the economy in favour of producing tradeable goods, and the legacy of the companies and skills-base formed in that period survives. And the commitment of the Buba to price stability, and with it relatively stable interest rates, meant that manufacturing business in particular could plan better. In addition, there are numerous short-term factors such as the insatiable demand of industrialising third-world countries such as China for German capital goods.

Posted by: PJ at June 8, 2006 05:12 PM
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