Donald Trump has declared war. Not on terrorism, nor on the “cheating” Chinese, not even on Mexico. Instead, the US President appears to have decided that his main international adversary will be a loyal ally to the U.S.: Germany. Recently, Berlin has had to bear the brunt of Trump's anger on international trade and security, through which, at least according to the President, the United States is supposed to be taken advantage of.
At the end of May in Brussels, Trump essentially kicked down the door on unsuspecting European leaders by turning a NATO summit designed to appease him into a tirade against Germany and its ‘very bad' export policies. The problem according to Trump: Germany ‘exports too many cars to the United States, and that needs to be stopped. (The majority of German-brand cars sold in the US are actually assembled in America. The same is true for Japanese automobiles.)
But even though Trump's policy ideas usually don't line up with mainstream economics wisdom, in this case, broadly speaking, he is actually right. Germany really does export too much, and this hurts Europe, America and the world economy as a whole.
Excess German exports create unemployment, industrial decline and debt in Southern Europe and all over the world. All the while, the heavily export-reliant German economic model is unsustainable, and poses substantial risks for Germany's and Europe's future.
But even though it hurts their allies, partners and their own future, the majority of the German political and business establishment, as well as the population appears to be rather proud of their export economy, and have no plans to alter their approach. This also means that Germany won't be able to lead Europe, nor will it be able to emerge as a global middle power – at least as long as it resists calls for a dramatic shift in its economic policies.
This time, Trump is with the mainstream
When Trump declared Germany's ‘huge' trade surplus ‘very bad’, he actually voiced a position which is perfectly in line with mainstream economics. Albeit in a more sophisticated manner than the current U.S. President, but economists on the left and right, in Europe and in America have long been warning about the detrimental effects of Germany's economic policies. Not to mention more diplomatically worded, yet clear messages from the previous US administration, the International Monetary Fund and the European Commission, carrying the same message: when it comes to the imbalance in exports and domestic consumption, Germany should change course.
The crux of the problem is the German trade balance and the current account. The latter includes the trade balance, net income from abroad and net current transfers. Generally this means first and foremost revenues from trade, foreign investment and foreign lending. Simply put, this indicator gives a decent overview of the income a country earns from its foreign economic relations in a given year. (Of course, a full cost-benefit analysis of a country's international economic relations in much more complex. For example, even though the United States has been running a current account deficit since the 1980s, it would be hard to categorize it as a loser of the global economic system, regardless what Trump says about this.)
As for the current account, the Germans really are the champions of the world. In nominal terms, the German current account surplus in 2016 surpassed that of China, often thought of as the most powerful export-superpower. Relative to the size of the economy, the German surplus is roughly twice the Chinese. In other words, the Germans sell a lot more stuff to the outside world and they make a lot more money on the international economy than the other way around.
The usual German answer? It's not their problem that they produce better cars, buses, planes, trains, wind turbines, chemical products, pharmaceuticals, health care equipment, precision tools, etc., than the rest of the world. And no one should expect them to be ashamed about the quality of their industries. Other countries shouldn't complain, but buckle up and produce better goods.
They aren't cheaters, but they're not that innocent either
The Germans, however, easily forget the fact that it's not only the ingenuity of German engineering that propels their export juggernaut. Normally if a country runs such an enormous current account surplus, its currency strengthens against the currencies of its trading partners, which decreases the price competitiveness of exports. If Germany were still using the Deutschmark, its value vis-a-vis the dollar and other European currencies would rise. Which would mean that when denominated in other currencies, German export products, for example BMW cars, would become more expensive. This would lead to people buying less BMW cars abroad. Hence, German exports would decline.
But Germany no longer uses the Deutschmark. The Eurozone as a whole, however, displays a lot less stellar export performance than Germany. In 2016, Germany accounted for roughly 21 percent of Eurozone GDP, but 29 percent of its exports, which means that it punches well above its economic weight when it comes to trade. Since the other Eurozone countries are relatively weaker and have to deal with a number of rather pressing economic problems, the price of the Euro does not reflect the German export prowess; it reflects the generally mediocre economic performance of the Eurozone. Simply put, this means that the Euro is much weaker than the Deutschmark would be today. The German economy benefits heavily from this, for German producers are able to export in a technically undervalued currency. Which means that BMW cars are less expensive abroad than they should be under 'normal' international economic conditions.
Another reason for the weakness of the Euro has to do with the ultra loose monetary policy of the European Central Bank. Again, in a vacuum, Germany's economic performance wouldn't warrant the ECB to essentially print money and keep interest rates at zero. But given the sluggish performance of the Eurozone as a whole, the ECB needs to stimulate the European economy. The stimulus measures, however, weaken the Euro further. This is not Germany's ‘fault,', but it benefits heavily from it.
This is the main reason why Donald Trump and his advisers accuse Germany of unfair trade practices, and they are not far from the truth. Even though the Germans don't ‘cheat' on purpose, they are indeed by far the largest beneficiaries of the Euro.
But this doesn't only hurt the U.S. economy. In fact, the biggest losers are the other member states of the Eurozone. For they, lacking their own currencies and an independent trade policy (this is a European common policy, managed by the EU), are unable to guard their markets against German exports. It is a recurring conclusion of critical analyses of the Euro-crisis that the main reasons behind the crash in the South are not only the failed macroeconomic policies of Southern Eurozone members, but that the Germans, making use of the common currency, were able to flood the European market with their -- admittedly higher quality -- export goods.
The European debt spiral, created and financed by German savings
There are two prevalent counterarguments to this. First, why do the Italians, the Greeks or the Portuguese buy German goods, when they could buy local? But it is not hard to see why: in an open, integrated and free European market economy without inner borders, duties or customs, consumers will choose the products offering the best value. And if the products with the best value come from abroad, local industries will suffer. Which leads to industrial hollowing out and social and fiscal problems.
The second retort is why don't the Italians, Greeks or Portuguese produce better goods themselves, so that they wouldn't be destroyed by the German industry? It is hard to argue against this point, and there is no dispute in this regard: Southern European political and business elites, as well as societies as a whole are responsible for their economic fate. (Expert opinions of course diverge as to what extent the local societies and elites on the one hand, and international economic structural forces on the other are to blame.) But this won't solve the core problem, namely that German export dominance and the austerity policies mandated by Berlin actually prevent these economies from developing more sophisticated and competitive industries. In fact, quite the opposite is happening: German (and increasingly, Chinese) imports coupled with austerity actually eradicate the few industries these countries have left.
While the Germans have been running a huge current account surplus with the rest of the EU, the Southern countries have had to finance their deficits through debt. For if consumers buy more foreign than local goods in a given country, money flows out of that country. Outflows had to be compensated somehow, which led to an unsustainable debt spiral.
In other words, due to its overwhelming export-dominance within the Eurozone, Germany has crippled its European partners and pushed them into a debt spiral. Which debt spiral was financed by German banks, with German savings. Then when the Southern countries finally cracked, they were forced to follow German-designed austerity policies instead of help or stimulus. This is the main reason that almost a decade after the Lehmann shock, the Eurozone is still pretty much in a permanent crisis, albeit the situation is much less dramatic than a couple of years ago.
Germans do save too much
The second, equally serious problem is that the Germans don't put the money they earn on foreign trade to use. More precisely, households save the money and don't spend it. German household consumption has traditionally been weak, households earn lower incomes than they could in a more balanced economy, and they prefer to save their earnings to spending it.
It's not only a problem of households. The German State not only preaches fiscal prudence to the rest of the Eurozone, it practices it almost religiously. Over the last three years, the federal budget ran a surplus. In the preceding two years, it was roughly in balance. Only in the deepest years of the crisis, in 2009 and 2010 did the German State let loose its coffers, a bit. But those times are long gone: in the first couple of months of 2017, Germany's current account and budget were running record surpluses.
To which the Germans say: if others were so prudent as them, they wouldn't be in the situation they are in. Some arguments could be had about the moral and cultural background of German fiscal responsibility, but from the perspective of economics, the situation is a bit more complicated than that.
The third reason behind the German export juggernaut's success is that German incomes are relatively weak. German wage growth has been lagging behind productivity growth since 1995. In plain English, this means that German employees receive a lower and lower share of the benefit of their work, and companies get an increasingly larger one. This is of course beneficial for German companies, for their price competitiveness can be maintained, and they are able to invest more. On the other hand, it is detrimental for the wealth and welfare of German society at large.
This hasn't always been the case, and the disconnect between wage growth and productivity growth is not a coincidence. Although nowadays it is fashionable to describe the history of the German economy as a perpetual success story lasting since World War II (or even the 19th century), in the 1990s, the German economy, and more specifically, German industries were struggling under the weight of the costs of reunification, technological change and increased international competition.
It wasn't always like this
It wasn't until the early 2000s that German industry found its footing again. The prime reasons for the resurgence were the so-called Hartz welfare system reforms and related wage bargains between the government, companies and labor organizations. In short, these reforms and bargains were designed to cut back on social security and unemployment payments, loosen the job market, boost employment, and before all else, limit wage growth. The ultimate aim was to strengthen declining German competitiveness and revitalize German industry.
(It speaks volumes about the German way of economic management that these reforms were aptly named after their main architect, then-Volkswagen chief Peter Hartz. In other words, the industry were dictating the terms.)
Another important factor for low wage growth was the gradual but unprecedented decentralization of wage bargaining during the 1990s. The loss of bargaining power for labor organizations [trade unions] roughly coincided with the gap opening up between wage growth and productivity growth.
The Hartz reforms and the early-2000s bargains had two effects. First, the Social Democratic Party, under the guidance of which the reforms were passed, never really recovered from the dramatic loss in popularity it had to endure for cutting down the welfare state. Second, German unit labor costs declined, especially in relation to other developed countries, and with them German export competitiveness improved dramatically.
Low wage growth had an additional effect. It stifled the second economic mechanism which (apart from exchange rate policy) would've been able to compensate for the international economic imbalances Germany were producing. If a country over-exports and earns ample foreign income from that, domestic wages and prices tend to rise. This raises unit labor costs, or in other words, makes German goods more expensive to produce. This has the same effect as a strengthening currency: it makes foreign consumers buy less German products, and thus eases German export dominance.
But the Germans did suffocate wage growth deliberately, so this effect couldn't take hold. Moreover, due to the longstanding troubles within the Eurozone, as well as low domestic demand, inflation has been near zero in recent years, even though German exports were booming. As such, inflation did not put pressure on wages. (Due to historic reasons, inflation is treated as the worst anathema in German economic policy, which approach had been duly followed by the ECB until recently.)
Germans need to spend more
Currently, Germany's export dominance tears the Eurozone apart, and destabilizes the whole world economy. While the Germans are able to flood the European and global market partly due to the weak Euro and low domestic wages, excessive German exports kill jobs and create chronic trade and current account deficits elsewhere. It is illustrative of the depth of this problem that Germany alone makes up 84 percent of the European Union's current account surplus.
The obvious solution would be for the Germans to stimulate domestic consumption. If the Germans were consuming more Italian, Greek or Portuguese goods from the income they earn from exporting their own goods to Italy, Greece and Portugal, there wouldn't be a problem: trade would be balanced (or at least less imbalanced). But, again, reality is a lot more complicated, and not solely because the Italians, Greeks and Portuguese, due to their own economic policy failures, are unable to compete with the Germans.
For the recipe advocated, and in some cases forced upon other Eurozone countries by Germany calls for the whole of Europe to essentially become Germany: be more prudent, save more, make the labor market more flexible, carry out structural reforms to stimulate competitiveness. However, this relatively simple recipe is not able to cure the ills of European economies for two simple reasons -- apart of course from the third, biggest one, that politically they couldn't be pushed through as easily as the German political establishment had hoped.
First, structural reforms can only provide one pillar of growth. Even if the Greeks started to produce higher quality products tomorrow, it wouldn't matter much, as long as there's no demand for those products. That's exactly why the austerity policies advocated by Germany are particularly detrimental. It's beyond question that Greece and other Southern European economies could use ample structural reforms. But as the Germans forced their sort of extreme fiscal belt-tightening on them, they essentially destroyed the last resort of these economies: domestic consumption. All the while, Germany itself is not willing to stimulate the European economy by spurring consumption. And without consumption, it is really unrealistic to spur economic growth.
Second, from a systemic perspective it is completely unrealistic to expect the rest of Europe to follow the German model. If everyone is prudent and saves while no one is spending money on consumption, then whom to sell the products to? If Germany's wishes were to come true, Europe would essentially become the oversized Germany of the world economy: one large bloc which over-exports, and hence suffocates other economies. (This is already true to some extent, as the recurring ‘fortress Europe' narrative suggests.) Politically, this would lead to a global backlash against Europe. In economic terms, in a world economy dominated by the neo-mercantilist Trump administration and a still heavily export- reliant China, this would lead to global catastrophe.
Economists (mostly foreign) have long been pleading with the Germans but to no avail: German consumption is not rising. The first reason is, of course, that if wages are relatively low, there are obvious limits to household consumption. The second, bigger problem is that regardless of their income level, Germans are generally not willing to spend freely. This has deep cultural roots, the effects of which are bolstered by the aging of the German population. As societies age, they tend to spend less and save more for retirement. This might be reasonable from a personal perspective, but on a macroeconomic level, it holds the economy back.
The third, and currently perhaps the gravest issue is that the German State is even less willing to spend than households, even though it can borrow money practically for free. Fiscal prudence and a balanced budget is a sacred cow especially for the stronger governing party of the coalition, the Christian Democratic Union (CDU) and its finance minister, Wolfgang Schäuble. Unless the German State starts to spend more freely, imbalances will remain.
However, there were some encouraging signs in this regard recently: since the refugee crisis, Germany has had to spend more on caring for and integrating the roughly one million people who arrived there from the Middle East and Africa. This has already shown up in German GDP: currently, roughly half of German growth is made up by a rise in government spending related to refugees.
Nevertheless, this previous example also shows that in spite of its world-beating export sector, the German economy as a whole is not nearly as strong as it is usually made out to be. The prime reasons for this is that, again, domestic demand is weak, while export reliance is high. And that's the full circle: the same conditions which allow for the German export sector to flourish actually make the country's economy as a whole more vulnerable, less sustainable, and on the long run, weaker.
The German economic model has its clear limits. Growth in international trade has been sluggish recently, and the volatilities in prices make life ever more unpredictable for exporters. More importantly, the very global imbalances spurred by over-exporting nations such as Germany (along with China and Japan) threaten to undo the achievements of the Post-WWII international free trade regime and turn the world back toward protectionism and populist mercantilism. In other words, an export reliant economic strategy can only deliver limited benefits to an economy on the long-term, while it can be self-destructing on the systemic level, for it feeds societal and political forces which are hostile to the very free trade policies which make export-reliant strategies possible and profitable in the first place.
The heavy reliance on exports is of course also very risky. If the Trump administration really took a decisive turn toward protectionism, or the recently fraught EU-China economic ties would deteriorate, the German economy would suffer considerable costs. The limits of and risks of export-reliance show up in the data as well: German GDP growth has been lagging behind the OECD average, as well as American and British growth; while it has been more volatile in recent years than the growth rates of other large economies.
This undermines Germany's European and global political influence as well. For what sort of aspiring international power allows itself to be at the mercy of the trade policies of the US and China? Although German chancellor Angela Merkel, in response to Trump's Germany-bashing, appears to have been cultivating recently an image of Europe which is more self-reliant and self-dependent, it would be hard to decouple from, and resist the United States as long as it's by far Germany's largest export market.
In this situation, Germany's bargaining position is second best, which makes Merkel's plans at least questionable. Germany's posture also has profound consequences for its internal European role. As long as Germany is vulnerable from the outside, while promoting economic policies inside the EU which are actually destroying its own European allies, it is hard to envision any sort of closer European unity and/or German leadership taking hold.
Additionally, the German economic model is not only risky and unsustainable from a global structural and macroeconomic perspective. It is also ill-equipped to deal with some of the more imminent challenges of the Twenty-Firs Century.
First, the backbone of the German (export) economy is made up of small- and middle sized, often family-owned enterprises (the so-called Mittelstand). The German economy's reliance on these SMEs is much higher than in other developed economies. The Germans are of course proud of this, and an economy dominated by strong, successfully exporting, technologically sophisticated family firms might appear to be the ultimate utopia for many. However, these smaller companies usually excel in very narrow fields, hence are rather vulnerable to shifts in market conditions. Moreover, smaller companies are not able to take advantage of economies of scale or scope, have less resources for investment, and generally have a harder time obtaining financing. In other words, their capacity for innovation and improvements in efficiency is limited.
Second, both the direct and the indirect contribution of industry is relatively high in the German economy. Industry, however, creates lower-quality and lower-paid jobs than services. Moreover, industry jobs have come under intense pressure recently from emerging Asian competition on the one hand, and from technology and automation on the other. Even though Germany tries to stay ahead of the times by investing in so-called "Industry 4.0", a "smart, automation-, big data- and AI-based" manufacturing concept, this alone might not be enough to preserve their industrial lead. A recent analysis by the Berlin-based Mercator Institute for China Studies (MERICS) concluded that emerging Chinese companies, heavily backed by the government, have been developing their technological base rather rapidly, and are outspending the Germans on innovation by a large margin. If the current trends are to continue, Chinese firms will be able in the near future to penetrate high-tech markets currently dominated by Germany, South Korea, Japan and other advanced economies. According to MERICS, Germany is among a handful of countries with the highest exposure to future competition from China's own version of Industry 4.0.
Thus, when put into wider perspective, the German success story is in fact not that remarkable, while the sustainability of the German economic model in its current form is at least questionable. Lagging domestic consumption, heavy export-reliance, increased international competition and flagging domestic investment point toward future struggles.
Of course, these problems are not imminent yet. For now, the German economy is fine: Chinese consumers are snapping up German products, the Trump administration is yet to make its opening salvo on trade, unemployment is at a record low, the Mittelstand is thriving, and while Chinese competition is getting heavier, it is far from threatening for the economy as a whole. The latest quarter proved to be a surprisingly good one for the whole of the Eurozone, which eases the pressure German austerity is putting on the rest of the continent. Moreover, the Germans appear to be loosening the belt as well, for the refugee crisis forces the federal government to do so. For now, everything appears to be rosy.
Swept under the rug
However, the temporary, cyclical upturn of Europe's economic fortunes might only serve to sweep the real, structural problems under the rug. The majority of Germans, including the leaders of the CDU and most of the economic elite appear to be unwilling to admit that running a sizable current account surplus and a balanced budget at the same time is a problem - face the fact that it's their problem.
Although the Social Democrats have recently warmed up to the idea of fiscal loosening in Germany and more generally in Europe, the CDU appears to be on track to solidify its leadership role in the coalition in the upcoming federal elections in September. This would preserve the current structural imbalances within the Eurozone and in the world economy as a whole, also limiting the potential scope of the revitalization of the European economy. The best one could hope for is that the newly elected French president, Emmanuel Macron will be able to persuade Merkel to support his own plan, which would give a helping hand to struggling Eurozone economies in the form of a common investment stimulus scheme.
As long as the Germans are unwilling to change course, it is at least questionable whether they can actually lead Europe, either from an economic or political perspective. Traditionally, the leading powers which created the rules of, and provided for the maintenance of order in a given international system (the so-called hegemons) have provided a market for, and protection to their lesser partners for the sake of stability. This is how the United States rebuilt Europe and Japan after World War II. The Germans, however, are unwilling to provide either of the aforementioned essential international public goods. Unless she, her party and her country change course, Angela Merkel won't be able to create a stronger and more self-dependent Europe.
The European Union is obviously much more complicated and balanced than your ‘usual' international system, and its internal conditions are not exactly favorable to hegemony. Even if they were, the Germans perhaps still wouldn't be ready or willing to assume that role. But the problem today is not that of a looming German hegemony in Europe; but that Germany if unwittingly, but actually does more to harm, than to unite the continent.