The German economy

Press echo, The Economist, 14 Jul 2007, no 8537, p 81-82

A gloomster’s lament

THERE is something rather annoying about the German economy. It is the object of endless lectures about taxes and wages that are too high, welfare and pension benefits that are too generous, east German states that have become subsidy junkies and a labour market that is irredeemably sclerotic. Yet it always bounces back. Just now exports and profits are at record highs, unemployment is falling fast and annual GDP growth has picked up to almost 3%. It is, in short, a place that seems to work in practice but not in theory.

Liberals like Hans-Werner Sinn, who runs the CESifo institute at the University of Munich, are unconvinced. For two decades he has been one of the loudest voices preaching the urgency of structural reform (another is Horst Siebert at Kiel University, who argued a similar case two years ago in “The German Economy: Beyond the Social Market”, published by Princeton University Press). Mr Sinn's new work is a thoroughly updated English-language version of a German book that has gone through no fewer than 11 editions. Not for nothing is Angst a German word.

It is hard to argue with most of the author's conclusions. Even with its present revival, German GDP growth remains low by historical standards. There is little chance of further supply-side reforms under Angela Merkel's consensus-driven grand coalition. The coddled, low-productivity east is an expensive drag on the innovative, high-productivity west. And much of the rise in profits and exports reflects a ferocious one-off squeeze on real wages that has allowed German companies to steal a march on less efficient competitors in France and Italy, but this is not a process that is indefinitely sustainable without far more liberalisation.

The case for more reform, especially to the labour market and welfare state, is unanswerable. But Mr Sinn is sometimes too gloomy about the country's prospects. Not only does he overlook some of the genuine structural changes made in the past few years; but he also largely dismisses the lessons from Scandinavian countries that have managed to combine high taxes and generous welfare with rapid growth and high employment.

The book also betrays another German obsession: with the health of manufacturing industry. In fact, the continuing high share of manufacturing in German GDP, long a source of competitive strength, might now be a weakness. The forces of globalisation are driving even high-end manufacturing to lower-cost competitors in eastern Europe, China and India. As Britain found in the 1980s, most efforts to keep manufacturing jobs fail.

What is striking about Germany to an outsider is not its dynamism, export prowess or even the famous Mittelstand of small and medium-sized enterprises, impressive as these are. It is the absence of well-developed service industries. Part of the wrenching change the country now needs is to switch from low value-added manufacturing towards higher value-added services. And that needs a cultural as much as an economic shift, away from a macho world view that looks down on serving people. The transition could be painful but it must come.