Germany’s Growth Model under Attack?

Björn Bremer

European University Institute

Björn Bremer is a PhD Candidate at the European University Institute (EUI) in Florence and a doctoral researcher in the ERC-funded research project POLCON. Mr. Bremer studies the political economy of advanced economies and his main research interests are the politics of macroeconomic policies and the political consequences of economic crises. In his PhD, he examines the fiscal policies that social democratic parties adopted in response to the Great Recession.
Mr. Bremer holds a BA in Philosophy, Politics, and Economics (PPE) from the University of Oxford and an MA in International Relations and International Economics from the School of Advanced International Studies (SAIS) at Johns Hopkins University. He previously worked at the Center for Transatlantic Relations in Washington, DC, and was involved in two research projects at the German Institute for Economic Research (DIW) in Berlin. He was also a visiting lecturer in Political Economy at the University of Lucerne and a visiting researcher at the WZB Berlin Social Science Centre as well as the London School of Economics and Political Science (LSE).

He is a 2018-2019 participant in AICGS’ project “A German-American Dialogue of the Next Generation: Global Responsibility, Joint Engagement,” sponsored by the Transatlantik-Programm der Bundesrepublik Deutschland aus Mitteln des European Recovery Program (ERP) des Bundesministeriums für Wirtschaft und Energie (BMWi).

On his last visit to Berlin in the beginning of May, French president Emmanuel Macron said that “the German growth model has perhaps run its course.” He argued that the economic reforms that Germany made in the early 2000s allowed the country to benefit from imbalances within the Eurozone, but that these imbalances have created problems for the rest of Europe, which are too large to ignore.

These criticisms are not new. For several years, Germany has been attacked for its large current account surpluses, but it resisted rebalancing its growth model in the wake of the European sovereign debt crisis. The German government expected the Southern European countries like Greece, Portugal, and Italy to implement scarring austerity policies and structural reforms, and remained unwilling to write-off debt, boost domestic demand, and rebalance its current account. Germany thus shifted the entire pain of resolving the crisis onto the periphery.

In light of recent evidence, however, Macron’s comments may still be right. Toward the end of 2018, growth in Germany slowed and the growth forecasts are  dire. Germany had a small rebound in the first quarter of 2019, but amid continued economic uncertainty Germany’s economic model may still have run out of steam. The IMF forecasts growth in Germany for 2019 to be lower than in all other advanced economies except Italy (see Figure 1).

Figure 1: Forecasted GPD growth of advanced economies in 2019; Source: IMF World Economic Outlook, April 2019

There are many reasons for this slow down. As Germany has become dependent on exports to China, a possible American-Chinese trade war is threatening Germany’s prosperity, as is Trump’s threat to introduce tariffs on imported cars. Brexit and the political upheavals in continental Europe further create economic uncertainty, but in the long-run, the German economy is even more at risk. The famous Deutschland AG (or Germany Inc.) is stuttering, and its most important export sector—the automobile industry—is lagging behind the innovation frontier.

The end of export-led growth, however, may not hit the German economy as strongly as commonly expected. Its current account surplus remains high, but most of its economic growth in recent years has been due to domestic and household consumption, as shown in Figure 2. In the best case scenario, this could be a sign that Germany is quietly moving toward a more balanced growth model. It may follow Sweden’s trajectory in the 1990s. The Scandinavian country first relied on exports to generate growth after its domestic economic crisis, before it successfully combined domestic consumption and exports-led growth (see Figure 2).

Figure 2: Contributions of different components of aggregate demand to German and Swedish GDP growth at constant prices, 1991-2018; Source: Ameco Database, author’s calculations

Yet, it is uncertain whether Germany can make this shift. According to Lucio Baccaro and Jonas Pontusson, the country’s exports are more price sensitive than Sweden’s. Germany relies on wage moderation to retain the competitiveness of its exporting industry, which makes it difficult to follow the Swedish example: an increase in wages that would spur domestic consumption would directly reduce the competitiveness of Germany’s products abroad. In fact, as Figure 2 shows, the influence of net trade on Germany’s economic growth was already negative in the last three years as wages have slowly increased.

To overcome this problem, Germany faces the tricky task of reducing the price sensitivity of its exports. It needs to shift production toward goods and services into new areas, increasing innovation across a range of sectors. Policymakers can do much to help this process, though: the government should increase public investment in education as well as in research and development, attract high-skilled immigrants, and establish innovation clusters across the country. This would allow Germany to increase consumption while retaining its export strength, reducing the current account surplus, and improving the country’s growth prospects at the same time. Emmanuel Macron would certainly approve of such a plan.

The views expressed are those of the author(s) alone. They do not necessarily reflect the views of the American Institute for Contemporary German Studies.