Germany: A Look into Europe’s Economic Powerhouse

While the U.S. and the Eurozone have suffered from low productivity and high unemployment since the global recession in 2008, Germany has been able to sustain its economic success over the years in becoming Europe’s economic powerhouse. Not only has the German economy recovered quickly with an ever-growing export industry and record-low unemployment, it has done so while most other European economies remain in a downward spiral. While other nations are trying to combat a multitude of economic challenges, Germany has skilled workers, low borrowing costs, a balanced budget, and a growing housing market.  Its trade relationship with Russia will be vital in the coming months as global powers attempt to control the crisis in Eastern Europe.

            After the Second World War, Germany was in ruins with much of its infrastructure and capital stock destroyed. However, the country still had a skilled workforce and was technologically advanced for the time. These factors proved to be the foundation for rebuilding its economy. Following the establishment of the Deutsche Mark as the legal tender in 1948, Germany experienced rapid industrial growth under a social market economy. The new system emphasized individual freedom and improving efficiency of social functions of the state, such as the education system. By the 1960s, growth was beginning to slow. It was only in the late 1980s that West Germany’s economy finally began to grow more rapidly again. The fall of the Berlin Wall was the beginning of another tumultuous period for Germany. Some feared that the unification of East and West Germany had been unsuccessful with productivity reaching historic lows in 1996. In 2003, Germany was again suffering from a recession and was in a state of seemingly irreversible decline until a year later. The economy performed sluggishly in terms of both growth and unemployment until 2005. The increase in government debt as a result of unification caused consumers to lower their expectations of future wealth, reduced consumption, and it is likely that the concurrent higher payroll taxes increased unemployment. The central bank also reduced money supply growth to deal with inflation, leaving annual inflation below 2 percent from 1995 through 2010.

            Although a historical analysis is beneficial for some background, it is critical to examine the years since the Great Recession in order to fully understand Germany’s success. According to President Obama’s economic report to Congress released in March, the U.S. economy recovered from the recession faster than any other country except for Germany. The U.S. and Germany were the only two countries where GDP had returned to pre-crisis levels. The difference in the recovery period between the two countries is in the unemployment figures; the U.S. unemployment rate skyrocketed from 4.5 percent in the first quarter of 2007 to a high of 10 percent by the end of 2009, while the German unemployment rate actually declined over the same period, only briefly rising from 7.4 percent to 7.9 percent in late 2008 and early 2009. In addition, U.S. employment fell 5.6 percent while German employment fell only by 0.5 percent before resuming an upward path.

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            Why was only Germany resistant to the same adverse effects that impeded growth for so many other advanced economies? For one, while the U.S. suffered from a decline in domestic demand caused by the collapse of the housing market, Germany did not experience a housing bubble. The drop in output was driven mostly by declines in world trade as the effects of the crisis spread globally. Another factor is the level of employment prior to the recession. Employment rose less than expected in the preceding expansion, given changes in GDP and labor costs. Employers were uncertain about whether the boom could be sustained if at all and therefore hired less than expected for an accelerating economy. Consequently, they were able to avoid costly layoffs during the recession. Another tool available to employers in limiting these layoffs was the use of ‘working time accounts.’ A working time account enables employers to take overtime hours out of employees’ regular working hours within a specified period. Workers had built up a large surplus of these accounts by the time the recession hit. By keeping workers employed at low hours until these accounts were reduced to zero, employers were able to delay the impending costs of layoffs. In addition, the government covered part of the lost salaries saving nearly 500,000 jobs since the recession.

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            The foundation of Germany’s success is its export and manufacturing industries, which accounts for over half of its total GDP. Currently the world’s third largest exporter, Germany has the world’s fifth largest economy in terms of GDP at purchasing power parity. Much of its industrial success can be attributed to two manufacturing sectors. The first, heavily dominated by small and medium-sized manufacturing firms, includes companies that build sophisticated machines required by emerging markets. The second sector includes Germany’s auto industry. Automakers such as BMW, Porsche, and Audi are central to the German economy, composing about 20 percent of GDP and 11 percent of total exports. Vehicle parts alone make up 4.1 percent of Germany’s total exports. Sales of high-end cars in particular have recently picked up in new markets such as China’s, which alone accounts for 25 percent of BMW’s global profits.

            Some believe Germany’s economy is overly dependent on exports and vulnerable to the fluctuations in the global economy, but so far this has not been the case. The country’s success as an exporter has instead strengthened the economy. More exports have generated more profits, created more jobs, and ultimately raised domestic demand for consumer products.

            Apart from the manufacturing sectors of the economy, there are less obvious reasons that have led to Germany’s accomplishments thus far. The introduction of the euro implicitly gave Germany a competitive advantage. While Germany’s competitiveness has increased by nearly 20 percent since 1999, that of other Eurozone countries such as Greece, Ireland, Italy, Spain, and even France had stagnated. This means that when Germany competes against other Eurozone countries, it wins out, even in their home markets. In fact, about 80 percent of Germany’s trade surplus comes from trade with the rest of the European Union. The Eurozone’s weak economic performance and sovereign debt crises in several peripheral Eurozone countries have kept the value of the euro well below that of the deutsche mark if it still existed. If Germany were to abandon the euro, its currency would likely appreciate by a huge margin- 30 to 40 percent according to some experts. This gives Germany an enormous competitive trade advantage over countries with more expensive currencies. The extent of the undervaluation of the euro in Germany is so large that there is fear of the economy overheating and triggering inflation.

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            Germany’s economy continues to have a positive outlook with the arrival of more good news at the end of July. The number of registered jobless fell more than expected while retail sales rose sharply, data showed Thursday, suggesting higher confidence and increased spending. The data are likely to support calls for wage increases in Germany, given favorable employment data and low inflation. Such a move would hopefully help accelerate inflation in the Eurozone as a whole. This news comes while the European Central Bank is attempting to implement a new, more aggressive strategy to combat overly low inflation in the region. Germany is the Eurozone’s largest member and is the chief opponent of quantitative easing, which the ECB is considering using as a last resort.

            If Germany has such a fantastic economy, is it possible for the U.S. to adopt some of these strategies? It is possible but not likely. First of all, the U.S. does not have auto brands with enough appeal to compete in the Chinese market. It does however, have an edge in several high-growth sectors such as social media, entertainment, and technology. Realistically, given the high rates of investment in developing countries and with workers becoming increasingly skilled, the U.S. share of global manufacturing exports will continue to decline.

            For now, it seems like nothing can go wrong with Germany’s economy. However, the concerns about an over-dependency on exports could be true. An export model that relies too heavily on emerging economies, weak domestic demand, and a further weakening Eurozone could be detrimental in the future. Its accomplishments thus far have also come at a cost. While the government has found ways to keep its citizens employed, real earnings have fallen, indicating a failure to improve the standard of living. Productivity was also adversely affected, with GDP per worker decreasing by 5 percent, compared to an increase of 2 percent in the U.S. The tradeoff between maximizing productivity and employment is a problem that all economies face. In this case, the decision to maximize employment led to setbacks in terms of GDP. In addition, there still exists the view that fiscal austerity contributed to Germany’s postwar economic success. Today however, a shift away from austerity is necessary to generate sustainable growth in Europe, especially since Germany is in the best position to do so. Policymakers should not be worried about the threat of inflation as much as how to revive productivity levels in the region.