Ifo Viewpoint No. 107: Germany’s Wrong Business Model

Hans-Werner Sinn
Munich, 1 July 2009

German merchandise exports plummeted by 29 percent in the year to April 2009, the largest drop since statistics started to be kept in 1950. The biggest fall to date had occurred during the first half of 1993, with around 16 percent. After the 42 percent slump in foreign orders in manufacturing in January and February, the collapse was not unexpected, but frightening nonetheless. Germany is being buffeted particularly savagely by the shockwaves of the US financial crisis. In 2009 Germany’s economy will shrink by more than 6 percent, more than all other western European countries except for Ireland.

Germany’s export dependency has turned it unwittingly into the world’s shock absorber. While the US reduced its annualized merchandise imports by 361 billion dollars more than its exports in the first quarter from a year before, and China increased its annualized trade surplus by 71 billion dollars, Germany’s annualized trade surplus deteriorated by 168 billion dollars. This is in effect equivalent to Germany providing the world with a gigantic economic stimulus package of this magnitud.

Germany is not exactly receiving accolades on this account. Quite the contrary, the charges that its fiscal policy is doing too little to battle the global slump continue unabated. However, no other major country is being pummeled so hard from abroad as Germany. When it comes to writing off structured instruments Germany is also up to the ears, thanks to its enormous capital exports. Massive liabilities are still lurking in the balance sheets of German banks and are pushing the country’s finance system to the brink of insolvency.

Granted, Germany follows a somewhat better economic model than Great Britain’s, where the real export economy has been largely relinquished and the financial business is in shambles too, but the Teutonic model is also showing cracks. That it made no sense to sell Porsches against Lehman Brothers certificates and then crow as the world’s top exporter must by now have dawned on even the more rose-tinted journalist.

For many years, Germany systematically obliterated its labor-intensive domestic sector with its even-out wage policy, which propelled it to world-champion status in unemployment among the low-skilled. Germany became a no-service economy. The personal service sector was decimated, and the labor-intensive sectors in manufacturing – from the textiles industries to precision engineering – were far too quickly surrendered to its international low-wage competitors. This structural shift was not wrong in principle. But what took place in Germany was a virtually unparalleled mass exodus out of the import-competing and domestic sectors. Both capital and talent fled these sectors out of fear of a misguided social policy that attempted to ward off international low-wage competition by brandishing a high-wage domestic strategy.

Part of the capital fled abroad. This explains the high German capital and merchandise export surpluses. Instead of putting the machines produced in Germany to work in the country, they were exported and created jobs abroad that would then be missed in Germany. Germans are world-champion savers, but invest only little. Recently the country’s macroeconomic savings rate amounted to 13.1 percent of the national income, yet its investment rate was a piffling 5.4 percent. As in previous years, it probably ranked lowest once again among the OECD countries. The surplus of savings over investment, which amounted to a sizable 166 billion euros in 2008 or 7.7 percent of national income, flowed abroad and provided foreigners with the financial means to acquire those German-made machines.

Another part of the capital flowed into the export industries, where it made the export value added balloon out of all proportion, in particular in the final stages of production (the so-called “bazaar effect”). As a result, Germany experienced a pathological export boom. While the growth in value added in the export sector was in itself a fine thing, it was not enough to compensate for the loss in value added in the domestic and import-competing sectors – with which it had been bought in the first place. The capital took all the high-skilled workers in the export industries and left part of the unskilled ones, including their potential value added, to the care of the welfare state. Small wonder then that Germany, despite its passable performance in the last boom from 1995 to 2009, still came in bottom of the list in economic growth. While even the old EU nations on average grew by 27.1 percent over the period, Germany only managed a bleak 14.3 percent, topping only Italy, which came in last with 11.9 percent.

The groundwork for shifting to a better business model was laid by the so-called Agenda 2010 of the previous German government. These reforns brought about a miracle in the labor market and are contributing towards furthering the domestic sector and setting Germany’s distorted economic structures gradually aright. Even now it is helping to cope with the crisis. But there is danger in indolence. The recent sectoral minimum-wage laws are akin to a stealthy counterrevolution that threatens to solidify the old model again and prolong Germany’s inertia.

Hans-Werner Sinn
Professor for Economics and Public Finance
President of the Ifo Institute

Published as "Falsches Geschäftsmodell“, WirtschaftsWoche, No. 26, 22 June 2009, p. 38, additionally printed in Wall Street Journal (USA).