Germany’s economy. Odd European out

Date: 21/02/04

Germany is now a relatively poor member of the European club

GERMANY used to be one of Europe's richest nations. In the late 1980s its GDP per head was 20% higher than the average of the European Union. But estimates by The Economist suggest that Germany's GDP per head fell 1% below the EU average last year (measured at purchasing-power parity, to take account of differences in prices). Only four of the EU'S 15 members now have a lower income per head. The entry of new members into the EU on May 1st will help to spare Germany's blushes, because these countries' lower incomes will once again push Germany up above a new European average. Nevertheless Germany's relative economic decline has been alarming by any measure. And it looks as if it will continue.

Some of Germany's poor record can be attributed to the reunification of East and West Germany in 1990. At the stroke of a pen this produced a country with average incomes 13% lower than the former West Germany's. Yet this still left income per person for a united Germany 9% higher than the EU average. Since then Germany has been the EU's slowest-growing economy, with an average annual growth rate of only 1.4% - roughly the same as that achieved by feeble Japan over the same period. Japan's economy does at last seem to be perking up, with GDP growth of 3.6% over the year to the fourth quarter. By contrast, Germany's GDP rose by a meagre 0.2%.

Germany's poor economic performance is responsible for much of the under-performance of Europe relative to the United States. It has been common to lambast all European economies as sclerotic. Yet in many ways Europe excluding Germany looks a bit like America. For example, over the past decade GDP per head in the rest of the EU grew by an average of 2.3% - even faster than America's 2.1% average growth. European businesses are often accused of being inefficient and unprofitable, hobbled by high wage costs and red tape. Yet a new study by Goldman Sachs finds that, while corporate America's rate of return on capital is twice that in Germany, the rate of return in the rest of the EU is even higher. And though it is true that European labour markets are in general less flexible than America's, Europe outside of Germany has been creating just as many jobs as America. Over the past decade, employment has risen by an average of only 0.2% a year in Germany, against a rate of 1.3% a year in the rest of the EU, exactly the same pace of increase as in America.

Apologists argue that Germany has not done so badly given the heavy cost of reunification. But this glosses over deeper problems that existed well before reunification. Germany not only has high wage costs, high taxes and an over-generous welfare state, in common with many other continental European economies, it must also cope with the hangover from years of over-investment due to a subsidised cost of capital, thanks to the big role played by state-owned banks. This is why German firms earn such a feeble rate of return on their capital: they invested too much in the past. Now, German firms, just like their Japanese counterparts, are having to reduce their investment as capital costs rise towards normal levels. Germany has other factors in common with Japan. It suffered the biggest fall in share prices after the stockmarket bubble burst in 2000, and house prices have been falling for much of the past decade - just as in Japan.

Wurst to come?

A more efficient use of capital will be good for Germany's longer-term prospects, but for several more years necessarily higher borrowing costs are likely to depress investment and growth. This increases the urgency of labour-market reforms, which would help the economy to adjust with less pain. Even with reform, however, it looks all too likely that Germany's economy will get worse before it gets better.

Germany is now a relatively poor member of the European club.

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