Getting Germany Past Internal Devaluation

Cheap labor is no basis on which a rich country should compete. Yet, that has been the basis of the lion's share of Germany's export success in the last dozen years—and exports have been the sole consistent source of economic growth for Germany over the same period. For too long, the idea that trade surpluses somehow prove a nation's economic worth has persisted in Germany. The resulting false sense of security has combined with the problems of Germany's southern neighbors in the euro area to make it seem that everything in the current coalition's economic policies, and with the German economy, is as good as it needs to be. But it is not.

No one can deny the mini-miracle in the German labor market in the last decade. The decline in the unemployment rate from 11 percent to below 6 percent, despite the North Atlantic and then European crises, is historic. As widely remarked upon, however, that came with the creation of a large number of lower wage and part- or flex-time jobs for the German workforce, and of jobs without the full benefits and protections of earlier postwar generations. Only in the last year has a wage increase exceeded the combination of inflation and productivity growth—that is, rewarded German workers in line with the worth of their labors. Germany has internally devalued its way to competitiveness.

Ideally, a wealthy country at the global technology frontier should be staying competitive by remaining at the cutting edge through research and development (R&D) and capital investment. Yet, total gross fixed investment has been steadily declining in Germany, from 24 percent to under 18 percent of GDP annually, between 1991 and the present. Even the unemployment miracle was not enough to induce German businesses to invest as much as their competitors. As the Organization for Economic Cooperation and Development (OECD) points out in its just released Economic Survey of Germany, this has been well below the investment rate of the rest of the G-7 economies since 2001, which has fluctuated between 19 and 21 percent despite their crises of the last four years (and so the difference is not due to the mid-2000s Anglo-Saxon bubbles).

The other way for a wealthy country to stay at the top of the value-added chain, and thus compete on relative productivity, is to invest in human capital—that is, to educate its workforce. Germany, however, is one of only two advanced economies in which the share of its 25 to 34 year olds that has attained tertiary education is no greater than among its 55 to 64 year olds (unsurprisingly, the United States is the other). This is not excusable as a case of coming down from a high level; Canada, France, Japan, Poland, Spain, the United Kingdom, and the United States all have at least a 10 percent higher share of young workers with advanced education than in Germany, most 20 percent-plus.

The result is that productivity growth in Germany has been low, not high, compared to its peers. Growth in GDP per hour worked is 25 percent below the OECD average, whether one goes back to mid-1990s or the last decade, and whether one excludes the crisis years or not. Given the declining hours worked by German employees, and the barriers to services competition in the country, the gap in annual GDP growth per employee overall and in business services versus Germany's peer group is closer to 50 percent. With those kinds of productivity numbers, it is no wonder that German business is competing by reducing relative wages and moving production east. But that ends up just reinforcing these downward trends.

Tales of outstanding Mittelstand businesses and large manufactured exports to China should not obscure the issue. As my colleague, Robert Lawrence, shows in his new book Rising Tide, the share of employment in manufacturing has declined by essentially the same amount, roughly 15 percent, in all of the major economies over the last 40 years (Australia, France, Germany, Netherlands, Sweden, United States...). Meanwhile, those advanced economies where manufacturing employment shrank by less were Italy and Japan—not the ones you want to emulate over the long term. Manufacturing terms of trade—that is, the relative value of manufactured goods from a country compared to all of its manufactured imports—have risen the same amount for the United States as for Germany over most of the last two decades. There is no evidence for special manufacturing success in Germany, even with stagnant real wages to boost the sector.

Thus, the debate over economic policy in Germany's upcoming national elections should be focused less on the structural reform of other economies, and more on what needs to be reformed at home. We should talk less about fiscal policy and the euro, and more about investment promotion and productivity: less self-reassurance through comparisons with crisis countries and more self-examination about actual performance. And most of all, less taking Germany's aging demographics as destiny, and more taking control of Germany's economic well-being.

Politicians and parties who want to arrest Germany's dependence on devaluation of its workers to grow should be advocating the following measures:

• Deregulate business and professional services. The barriers to entry in Germany's guild system are huge. New entrepreneurial business people and average German consumers overpay an accordingly huge amount for inefficient services, and more importantly little growth in service productivity. This is just throwing money away while excluding those who wish to get up the income ladder.

• Improve access to and increase investment in higher education. The large rise in students graduating with an Abitur (or FHR), from 37 percent in 2000 to 49 percent in 2010, is a welcome development. But it has to be accompanied by two forms of investment to make it work for the economy: First, the German universities have to be properly staffed and resourced to usefully educate the students who do come; second, the means of early tracking students have to be eased, so as to encourage some social mobility.

• Recapitalize the banking system and diversify corporate finance. The German banking system avoided some of the worst behaviors of its counterparts, and its decentralization proved an aid to weathering the crisis, much as in the United States. Nevertheless, the system remains deeply undercapitalized and highly localized. As a result, there is an insufficiency of risk capital in the German economy for new businesses in nontraditional sectors. This lowers returns and the rate of reallocation of investment into higher productivity industries.

• Rebalance the relationship between corporate profits and worker pay. The myth remains in some places that Germany is a worker's paradise. Compared to the United States or to Greece, of course it is, but not so obviously when compared to the rest of Western Europe or to what it should be. Growth in low-wage jobs and in corporate cash hoardings put pressure downwards on investment and consumption, reinforcing the dependence on exports. Corporate governance reforms should be put in that force companies to return to their investors stille Reserven and other cash that is neither invested nor given in pay deals. Profit sharing should be the norm.

In a volume ahead of the last German federal elections six years ago, I asked "Exportweltmeister—na und?" The answer turned out to be worse than I feared. Not only has the ongoing German obsession with exports distracted investors and policymakers from reallocating capital and deregulating services—that dependence on external demand has led to Germany depriving its own workers of what they have earned and should be able to save and spend. This is moving Germany down the value chain in relative terms, not up. It also is destroying the euro area by forcing internal devaluations throughout the south. But the real reason to stop this trend is that it will only further weaken Germany's own economic resilience.

The German version of this op-ed is available on the Die Welt website.