Subject: Has Germany become Europe's locomotive? - CER
From: "Michael Andrews" <[email-masked]>
To: "Thad Brown" <[email-masked]>, <[email-masked]>, <[email-masked]>, "Hunter Biden" <[email-masked]>, "Eric Schwerin" <[email-masked]>, "Chris Heinz" <[email-masked]>, "Devon Archer" <[email-masked]>, "Neil Callahan" <[email-masked]>, "Rob Mitchell" <[email-masked]>
Date: Thu, 2 Sep 2010 11:48:58 -0400

At first blush this may seem to be a pure economic story but there is  
a powerful political risk component in that the Germans may not wish  
to be the economic locomotive since they feel the crisis was created  
by many governments profligate policy while Germany was prudent.

Michael

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Has Germany become Europe's locomotive?

by Philip Whyte, 2 September 2010

The German economy has been growing exceptionally strongly of late. In  
the second quarter of 2010, it expanded faster than any other economy  
in the G7 and faster than at any time since the country's  
reunification in 1990. Industrial output is surging. The rate of  
unemployment has been declining for over a year and is now well below  
the eurozone average (let alone levels in the US). Consumer spending  
and business investment are picking up – and households and firms are  
generally less burdened with debt than their counterparts in highly  
leveraged economies like the UK and the US. Germany, in short, seems  
to have emerged strongly from the Great Recession. Indeed, some  
observers think it has entered a self-sustained recovery – and that it  
is starting to act as Europe's 'growth locomotive'.

If this were true, it would be welcome. Over the past decade, Germany  
has not been a great source of demand for the world or the European  
economy: in real terms, domestic demand is only about 3 per cent  
higher now than it was back in 2000. For most of the noughties,  
Germany was structurally reliant on exports for its economic growth:  
without debt-fuelled spending elsewhere in the world economy, it would  
barely have grown at all. So any sign of a sustained recovery in  
German domestic demand would be good news for the country itself and  
the rest of the world. Not only would it reduce Germany's reliance on  
unsustainable (and hence destabilising) foreign profligacy. It would  
also allow the eurozone and the world economy to rebalance at a higher  
level of output and employment than otherwise.

Sadly, it may be premature to conclude that Germany has embarked on a  
durable, self-sustained recovery that will help to lift growth  
elsewhere. Much has been made of the scale of Germany's rebound in the  
second quarter of 2010. But it needs to be placed in context. Germany  
resembles a bungee jumper in the spring-back phase. It is rebounding  
faster than neighbouring France. But this is partly because it fell  
much further on the way down. The size of Germany's manufacturing  
sector has resulted in greater output volatility. Germany was hit  
disproportionately hard in 2008-09 when manufacturers scrambled to run  
down stocks, but it has since benefited as the stock cycle has  
reversed. Even after its recent rebound, however, German output is  
still lower relative to pre-crisis levels than in France.

Besides, the pattern of the recent upturn casts doubt on the view that  
Germany is acting as a 'locomotive' for other countries. The pick-up  
in domestic demand in the second quarter of 2010 came after three  
consecutive quarters in which household consumption fell. As for  
business investment, it is still a long way below pre-crisis levels.  
If Germany really had become a locomotive for the rest of the EU, net  
trade would be exerting a drag on its own economic growth. Yet the  
reverse is the case: net trade has boosted German GDP growth in three  
of the past five quarters. True, exports to Asia are making a greater  
contribution to growth. But Germany's recovery is doing little to  
rebalance activity in the EU. Indeed, Germany's trade surplus with the  
rest of the EU has risen compared with the first half of 2009.

There is a final reason to be sceptical about the prospect of Europe's  
largest economy becoming a locomotive for the rest of the EU: it is  
not clear that German policy-makers want it to become one. As far as  
they are concerned, the global financial crisis has discredited  
profligacy and vindicated German prudence. The lesson of the crisis,  
they believe, is that countries must learn to live within their means.  
For them, the direction of change is clear: it is for the erstwhile  
dissolute to shape up, not for Germany to become more spend-thrift.  
Any suggestion that Germany needs to adjust tends to be met with  
bemusement, irritation and contempt. Germany has no lessons to take  
(least of all from irresponsible Anglo-Saxons). And any attempt to  
hobble German 'competitiveness' will be fiercely resisted.

The hopes currently being vested in Germany may consequently be  
misplaced. The strength of the country's recovery is partly an optical  
illusion created by the depth of the downturn which preceded it. Much  
of the recovery is being driven by net trade. Domestic demand is still  
fragile and could weaken as the government's fiscal stimulus is  
withdrawn and the stock cycle becomes less favourable. And German  
policy-makers have yet to be persuaded that it is in their country's  
interest to reduce its reliance on export-led growth. In short,  
Germany is not yet acting as a 'growth locomotive' for the rest of  
Europe. And other EU countries, particularly in the highly indebted  
geographical periphery, may have to get used to the idea that the  
region's largest economy may not be about to become one any time soon.

Philip Whyte is a senior research fellow at the Centre for European  
Reform.