Time to change Germany's economic model

By: Thomas Fricke

The German economy contracted more dramatically during the last quarter than most other economies in the world. Three months ago, Angela Merkel, the German chancellor, and Peer Steinbrück, finance minister, boasted that Germany would be in a much stronger position than the US and others. And now this disaster.

 

Only two weeks ago at Davos. the chancellor praised Germany's economic system, its virtues and its budgetary consolidation. Now, nobody can deny that this crisis has hit Germany harder than others. On an annualised basis, German GDP contracted by almost 9%. In the US, the estimated decline during Q4 was 4%, similarly in Spain and France. Even the Brits got away with a projected decline of 6% annualised.

 

Nor does it make sense to say that German unemployment has been going up by less than US unemployment, since the US recession started earlier.  Early economic indicators and corporate announcements suggest that German companies will not rely on reduced working hours permanently, but that they will soon start cutting the number of jobs.

 

The most discomforting aspect about the steep decline is that the Germans had neither a real estate crisis like the Americans, the Brits or the Spaniards, nor was Germany a source of this financial crisis. So why then did this crisis hit Germany so much harder than others?

 

One explanation could be that government and central bank hesitated for too long until they reacted with a stimulus package and interest rate cuts to the unfolding disaster. Another, deeper, explanation is that Germany is now paying the price for a policy to force economic growth through cost competition, wage cuts, and a policy to maintain its position as the world's largest exporter. That strategy worked well for as long as the rest of the world experienced a historically unique boom, from 2002 to 2007, a period during export nations like Germany and China profited disproportionately. The trouble is that this advantage turns into a disadvantage, as globalisation spreads economic crisis very quickly.

 

Some people say that Germany will be the first to benefit once the economy turns up again. This is silly. The crisis is there now. And it is reasonable to expect that, for the foreseeable future, the Americans and others will not start to consume and buy German products to the same extent as they used to in the past.

 

Germany will have to reform its economic model urgently. If Germany had not accepted wage cuts, increases in health care contributions, and a large rise in value-added tax, the country would be a little less competitive today. But in return, it would have a stronger domestic economy now, and most importantly, the country would be better equipped to absorb a global economic shock.

 

Thomas Fricke is chief economist of Financial Times Deutschland. The original German text was published in FT Deutschand on Friday, 13 February, 2009.

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