If Germany's economic model is the future of Europe, we should all be quite troubled. But that is where we seem to be going. The apparently successful reelection campaign of Angela Merkel, the Christian Democrat chancellor, promises "Germany's future in good hands." More, in other words, of the same. The policy response to the euro area crisis is likely to remain a program to induce member states to follow Germany's path to competitiveness: cutting the cost of labor. Make no mistake; that has been the basis of the nation's export success in the past dozen years, and exports have been its sole consistent source of growth in that period. But low wages are not the basis on which a rich nation should compete.
Since 2003 a falling unemployment rate has been the consequence of the creation of a large number of low-wage and part-time or flextime jobs, without the benefits and protections afforded earlier postwar generations. Germany now has the highest proportion of low-wage workers relative to the national median income in western Europe. Average wages increased by more than inflation and productivity growth in the past year for the first time after more than a decade of stagnation.
Ideally, a wealthy country should stay competitive through research and development, and capital investment. Instead, total gross fixed investment has fallen steadily in Germany, from 24 percent to less than 18 percent of GDP, since 1991. The recent Organization for Economic Cooperation and Development (OECD) Economic Survey of Germany states that German investment has been persistently well below the rate of the rest of the G-7 leading economies since 2001 (and not just because of the bubbles of the mid-2000s in the United States and United Kingdom). Even the employment mini-miracle and export boom since 2003 were not enough to induce German businesses to increase investment—and public infrastructure investment has been even more lacking.
The other way for a rich country to stay at the top of the value-added chain, and thus compete on productivity, is to invest in human capital—that is, to educate its workforce. In Canada, France, Japan, Poland, Spain, the United Kingdom, and the United States, the share of young workers with advanced education is at least 10 percent higher than in Germany—in most of them, 20 percent higher or more. Germany, moreover, is one of only two advanced economies in which the share of those aged 25 to 34 with higher-education qualifications is the same as, or smaller than, in preceding generations (the United States is the other). Germany has failed to invest in its public university system while the private sector has maintained but not expanded the supply of its famous apprenticeships.
The result is that Germany's productivity growth has been low compared with its peers. Growth in GDP per hour worked is 25 percent below the OECD average, whether one goes back to mid-1990s or looks at just the past decade—and whether or not one excludes the bubble years for the United States and United Kingdom. With these productivity numbers, it is no wonder German business is competing only by reducing relative wages and moving production east.
Examples of outstanding businesses from the Mittelstand sector—middle-sized, family-run companies—and their manufactured exports to China should not obscure the reality. As the Peterson Institute's Lawrence Edwards and Robert Lawrence show in their new book Rising Tide, manufacturing's share in total employment has fallen by the same amount in the past 40 years, about 15 percent, in almost all the advanced economies—including Germany. The only rich economies where manufacturing employment shrank less were Italy and Japan, neither engines of growth. The terms of trade for manufacturing—that is the relative value of manufactured goods from a country compared with all of its manufactured imports—have risen by the same amount for the United States as for Germany since 1990. There is no evidence for special manufacturing success in Germany.
Some might say the country is merely making the best of the situation in which richer economies find themselves in a globalized world—particularly in regard to downward wage pressure for low-skilled labor in the west. Certainly, it is not alone in its rising inequality and the reluctance of its corporations to invest. Such an assessment, however, blinds us to the gains to be had from a different kind of reform agenda that is possible for Germany and the euro area.
German underinvestment is the result of deep structural problems in the economy, which are not the fault of its now more flexible labor markets. The export obsession has distracted policymakers from recapitalizing its banks, deregulating its service sector and incentivizing the reallocation of capital away from old industries. Furthermore, public investment in infrastructure, education and technological development could help increase profitable private investment, which would lead to growth with higher wages.
Dependence on external demand has deprived Germany's workers of what they have earned, and should be able to save and spend. This leaves them dependent on exports for growth, in a self-reinforcing cycle. Most importantly, this means they move down the value chain in relative terms, not up. The pursuit of the same policy by its European trading partners will reinforce those pressures. Wage compression will not be a successful growth strategy for Germany's or Europe's future.