Germany bashing takes G20 spotlight off China
with Tom Holland
China's announcement last week that it is to ditch its currency peg to the US dollar looks set successfully to deflect criticisms of Beijing's economic policies at this weekend's Group of 20 meeting in Toronto. Instead attention is likely to focus on Germany, which like China has drawn flack in the past for saving too much, consuming too little, and running a trade surplus so large that it risks destabilising an already unbalanced global economy.
But whereas many economists applaud China for its recent attempts to boost domestic consumption and address its external imbalances, Germany appears to be heading in the other direction. Instead of ramping up public spending in an effort to boost domestic demand and support growth rates, the government of Chancellor Angela Merkel recently announced an Euro80 billion (HK$763.56 billion) programme of spending cuts over the next four years intended to trim Germany's modest budget deficit.
To Berlin's legions of critics, this austerity drive is little short of suicidal idiocy. They argue that the promised spending cuts will suppress demand across the European Union, which will kill growth, erode tax revenues and worsen the euro zone's sovereign debt crisis. According to Charles Dumas, chairman of Lombard Street Research, Germany's fiscal policies 'virtually guarantee a fresh European recession, possibly a medium-term depression'.
German officials are standing firm, however. They maintain that the fiscal stimulus package Berlin implemented following the 2008 collapse of Lehman Brothers - Germany ran a budget deficit worth 3.3 per cent of gross domestic product last year - has worked and that industrial and consumer sentiment is recovering.
Extending the stimulus now would be counter-productive, they insist. Further government generosity will fuel consumers' expectations of new tax increases in the future, which will encourage higher precautionary saving and depress demand. What's more, continued deficits will risk spooking bond market investors, pushing up government borrowing costs and making stimulus spending increasingly expensive.
Critics might well argue that these two objections are contradictory. If consumers respond to deficits by saving more, the extra supply of funds should push bond yields down, not up. But German government officials are undeterred, insisting further counter-cyclical stimulus spending would be inefficient and ineffective.
Berlin also rejects accusations that Germany isn't pulling its weight in international efforts to correct global economic imbalances by addressing what many observers believe is the structural shortage of domestic consumer demand represented by the country's persistent current account surplus. Senior officials point out that just 10 years ago Germany was derided as the sick man of Europe. Sky-high wages, short working hours, inflexible labour laws, powerful unions and generous benefits meant business costs were prohibitively high, eroding Germany's competitiveness.
Since then, however, Germany has undertaken a painful series of structural reforms. The government has liberalised labour laws, making it easier for companies to fire workers, extended working hours and slashed benefits.
Meanwhile, corporate Germany has implemented its own cost-cutting, trimming much of the fat from the private sector. The reforms hurt. Growth rates plunged, costing former chancellor Gerhard Schroder his job, but in the end German industry was left fighting fit compared with other European countries.
As the first chart below shows, Germany's real effective exchange rate - a measure of international competitiveness that factors in both exchange rate and inflation - has fallen over recent years, indicating a gain in competitiveness. As a result Germany's exports boomed, with the country's current account balance swinging from deficit into a surplus worth a massive 7.8 per cent of GDP on the eve of the financial crisis in 2007 (see the second chart). That transformation has exacerbated global economic imbalances, but German government officials insist the country's current account surplus is not the consequence of depressed domestic demand, but rather the fruits of Germany's painful structural reforms.
'We have done the job we were asked to do,' says one senior official, who argues it would make no sense at all for Germany to pursue global economic rebalancing by deliberately undermining its own competitiveness.
Instead other leading economies need to restore their own edge by implementing the same sort of reforms that Germany instituted. Germany's economic virtue should not be punished at the insistence of less prudent G20 members, they say. That argument will cut little ice with US politicians, who accuse Germany of failing to do its bit to fight the global slump and complain that German firms are unfairly benefiting from America's stimulus efforts. With such a wide difference of opinion, there is little chance of a meeting of minds in Toronto this weekend. But at least the spotlight on Germany makes a change from bashing China.