The German Problem

After reading the economics press and official statements of the International Monetary Fund (IMF) and the G-20, hearing the laments of the European political class, and listening to the comments at international economy conferences, one could be forgiven for concluding that the world has a problem with Germany. With a current account surplus of over 7 percent of GDP, a restrictive fiscal policy, and a very low level of public investment, Germany is showing signs of operating in a parallel intellectual economic universe. The German authorities argue that the current account surplus and the fiscal balance are signs of strength and hence there is nothing to change or debate. The German press is even more radical, and as a result German citizens live isolated from criticism. The German position may make sense from the point of view of German society, yet it doesn't from a European or global perspective. But to change it, we must first understand it.

The key to the German view is that it is facing a very worrisome demographic decline. From its current population of about 81 million, projections point to a 20 percent reduction in 50 years, towards 65 million to 70 million in 2060—way below French population levels. Not only will its population be smaller, it will be much older. Currently, about 20 percent of the population is over 65 years old. In 2060, this percentage will reach 35 percent. The message is clear: The working-age population will decrease, and with it, Germany's potential growth. Faced with this dilemma, the reaction of the authorities is of maximum prudence: If potential growth is destined to be close to zero, save today to be able to spend tomorrow.

It's a comfortable position politically, because it satisfies the most important voters—those close to retirement age, worried about their pensions, and more likely to vote than younger people. But it is not the optimal position for the younger generations of Germany, of Europe, or of the world. The future need not be deterministic. Potential growth is the combination of population growth and productivity growth. Germany can act on population growth through policies that facilitate immigration and the integration of women and the elderly into the labor force—although there isn't much margin left and, if anything, Germany is moving in the wrong direction with the recent reduction of the retirement age (another sign that older generations are the most important politically).

Where Germany can act, and with plenty of room to improve, is in boosting productivity growth. The productivity of the German economy has collapsed in recent years. From an average growth of GDP per hour worked of 1.6 percent during 1995—2005, it has declined to only 0.5 percent from 2012 and zero in 2014.

The German miracle is not such. All German GDP growth last year was due to increased employment. And this increase in employment is based, to a large extent, on creating many fragile, low-wage, low-productivity jobs—a phenomenon that has also dramatically increased inequality.

This pattern of growth based on excessive savings—and excessive wage restraint (the IMF estimates that the real exchange rate in Germany is more than 10 percent undervalued)—is neither healthy nor sustainable for Germany, Europe, or the world. Instead of focusing on fiscal discipline, which is politically easier, Germany should focus on boosting productivity. To accomplish this, it should encourage structural reforms and productive investment, which is politically difficult. Germany's emphasis on recommending structural reforms to all European countries with problems is ironic, as it has undertaken no major structural reform itself since the labor reforms of the Schroeder government a decade ago. There are many areas for improvement: the liberalization of the services sector, especially trade and professional services; the rationalization and liberalization of the savings banks (Sparkassen) that limit the possibilities of financial investment of German savers and are highly exposed to political interference; and a reevaluation of its energy policy, too focused on renewable energy. These reforms would enhance potential growth and consumption and thereby promote domestic private investment.

The other area of action must be public investment. The German authorities and their economists torture the data to deny that Germany has a problem of insufficient public investment. But numbers do not lie. Public investment in Germany as a percentage of GDP is the second lowest in the Organization for Economic Cooperation and Development, and net public investment minus depreciation has been negative since 2003, reducing Germany's stock of capital. Forty percent of Germans bridges are in critical condition, according to the German Marshall Fund.

In a situation of zero or negative interest rates—German bonds are yielding negative interest rates up to the 6-year maturity and yield only 0.35 percent at the 10-year maturity—Germany's fiscal austerity is irresponsible, wasting a golden opportunity to promote public investment in productive areas that increase the country's potential growth and offset the demographic decline. In the current environment prudence is shown by investing, not by saving. IMF analysis shows that a program of public investment of 0.5 percent of GDP every year for four years, compatible with German fiscal rules, would generate a permanent increase in Germany's output of 0.75 percent of GDP, in turn benefiting the rest of the euro area.

Germany has the obligation to reduce its external imbalances and contribute to global economic growth. Fortunately for Germany, a program of reforms and public investment would meet both objectives and offset some of its future population decline. Such a program is much more costly politically than the current strategy of fiscal austerity and wage moderation. But it is high time that Germany stops being part of the problem and starts being part of the solution. It's time to stop saving and start reforming and investing, regardless of the political cost.