A Euro Saved, A Euro Earned? Germany and Its Current Account Surplus

Merkelby Daniel Reinhardt

Once again, German current account (CA) surplus reaches the largest one on the globe, hitting the total of €220 billion for the previous year. Defined as the sum of a country’s balance of trade, net income from abroad and net current transfers, Germany’s CA excess is seen as a success by many German policy makers. They see it as a result of “Agenda 2010,” carried out in 2003 with an aim to make Germany more competitive. However, heavy criticism is coming from across the Atlantic, as a growing number of American economists and institutions see this development as harmful.

Germany, who was described by the U.S. Treasury Report as creating “a deflationary bias for the euro area, as well as for the world economy,” has been using beggar-thy-neighbor policies, according to Nobel Laureate Paul Krugman. Such policies have caused the ongoing economic depression in vast parts of Europe and led to Germany’s unbalanced CA. Because of such policies, “it’s time to kick Germany out of the eurozone,” Foreign Policy’s Patrick Chovanec suggests.

Many of these statements and their underlying arguments are problematic. Take an example from Krugman’s recent article “Being Bad Europeans”: he contends that since the euro has come into effect, the growth of Germany’s unit-labor costs has been too low to be in line with the European Central Bank’s inflation target (in contrast to that of France, Spain, or Italy). Unit-labor costs are the ratio of total labor costs to output quantity, therefore reflecting productivity. Thus, according to Krugman, Germany’s unit-labor costs have increased slower than in said countries, therefore the country has wrongfully increased its competitiveness at its neighbor’s expense.

This argument would make sense if all euro countries had identical unit-labor costs, in absolute terms, when the common currency had been introduced. However, by 1999 Germany had the highest level of absolute unit-labor costs in the euro zone, and current OECD statistics suggest that even today Germany has higher absolute unit-labor costs than the euro average, especially far beyond those of Greece, Portugal, or Spain. Moreover, the statistic also shows that since 2012 the growth of Germany’s unit-labor costs were above the euro average. The conclusion this leads to is that unit-labor costs per se are by far not sufficient to explain competitiveness and that in terms of productivity, Germany is not more competitive than the euro average. Rather, competitiveness is a function of unit-labor costs and innovation, and Germany is one of the most innovative economies in Europe according to 2013’s Innovation Union Competitiveness Report of the European Commission.

A closer look at trade figures also helps to gets some facts straight. Although it is true that Germany runs trade surpluses with many countries in the euro zone, it also runs deficits with some others, including The Netherlands, Ireland, Slovakia, Slovenia, and Malta. This proves that German bilateral trade surpluses with euro countries are not inevitable. Moreover, since 2007 Germany’s trade surplus with the euro zone, including bilateral surpluses with deficit countries such as Greece, Spain, Italy, or Portugal, has significantly shrunk, as figures in the UN Comtrade Database show.

Although Germany in total does run a trade surplus with the euro zone, the disproportional height of its CA surplus today is better explained by a number of other factors. One of them is its trade with non-European countries. On one hand, in contrast to most European states, Germany has successfully managed to enter the markets of many emerging economies, especially the BRICS countries. According to a study of the German Employer’s association (BDA), these have a high demand for investment goods, such as machinery or plant engineering, both of which Germany specializes in, as well as for German cars. Consequently, Germany runs high surpluses with many of these emerging countries.

Germany has the highest bilateral trade surplus with the U.S., which on the other hand, has a massively negative and unbalanced CA. The bilateral trade surplus of over €50 billion represents one fourth of Germany’s entire CA surplus, while at the same time accounting for only 15 percent of the U.S.’ entire CA deficit, according to trade figures of comtrade and the IMF. Therefore, it is hypocritical to only blame Germany for CA imbalances without acknowledging that the U.S. has simply lived beyond its means, as Columbia professor, Patrick Chovanec points out. It is worth saying that the German non-European exports are not only beneficial to Germany, but also to other euro zone countries, since Germany imports more than 40 percent of its non-European exports from other euro zone countries, according to the BDA study.

Contrary to Krugman’s argument that the country has gained an unfair advantage through its economic policy, German problem is a different one – high saving rates and low domestic investment rates that the country has been having for many years. Much of the money that Germans have been saving was either lent to euro zone countries, in order for them to finance their excess consumption, or invested abroad, causing high returns on foreign investment. Since recent foreign investments in Germany have been significantly lower than German investments abroad in recent years, Germany’s net investment income account, which measures the returns on the country’s investments abroad minus the returns of foreign investments in Germany, ran a surplus of $77 billion in 2013. This figure constitutes one third of Germany’s entire current account surplus.

One solution professor Chovanec proposes is Germany’s exit from the euro. According to him, allowing a reintroduced Deutsche Mark (DM) appreciate is an option worth considering. However, whether this will have any significant effect on Germany’s trade balance is only speculation, since he himself notes that “a stronger yen made barely a dent in Japan’s structural trade surplus.” Moreover, how this could change Germany’s saving and investment habits is also ambiguous, there is no apparent reason why a reintroduction of the DM would lower German saving rates or shift investments to Germany. Finally, provided that Germany does exhibit healthy trade relations with many countries in the euro zone, the argument for Germany’s exit from the euro zone becomes even weaker.

Improving domestic investment conditions is the inevitable economic policy Germany needs to implement. This includes eliminating bureaucratic and financial obstacles for startup companies, a point highlighted by the German startup monitor (DSM) in 2014, as well as increasing public investments in infrastructure and education. More private investments in Germany would not only decrease the net income account surplus, but are also likely to stimulate domestic demand and consumption, which in return could lead to higher imports and a consequential decrease in the trade balance.

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