Wednesday, June 14, 2006

Ought Germany to remain the sick man of Europe?

The German economy is finally picking up. Part of this strength comes from exports. Despite all the hype about China, Germany is still the world's largest expoerter in absolute terms. But there is also a clear recovery in domestic demand.

You would have thought that this should be greeted with joy by Germany's euro partners. After all, a strong German economy is in the interests of the euro-zone. No way! Instead, Germany is attacked - notably by people such as Paul de Grawe and Wolfgang Munchau, both writing in the Financial Times - for pursuing a beggar-thy-neighbour policy, starving its own workers and so making other Euroland countries uncompetitive.

This is complete rubbish. German labour cost levels are the second-highest in Europe (after Belgian). German workers are hardly starved. What is true is that German labour costs have risen less rapidly than those of other countries.

But remember that Germany entered the euro at a rate vastly overvalued vis-a-vis its partners - about 20% overvalued against the French franc, for instance. Add to that the impact of globalisation and Germany's own structural problems. Moreover, by joining the single currency, Germany abdicated both monetary and (de facto) fiscal policy. The only way Germany could restore competitiveness was through reforms - which have taken place, even if possibly less than we would like - and through lower relative labour cost inflation.

But both of these methods are demand deflationary and painful. For the other Euroland countries, it would, of course, be much easier if the Germans could remain content to be the sick man of Europe, with permanently slower growth than anyone else. Then places like Belgium would not have to worry about trying to become more competitive. Hence the attacks on Germany.

Somehow, I don't think this is seen in quite the same way in Germany.

This is an abridged version of an article I've written for International Economy.


Blogger Lord Burnden said...

The German economy is rather like their football team. It may not get the praise of fashionable pundits but it sure as hell get the results.

10:32 pm  
Blogger Flavian said...

I think that you are completely wrong when you repeat the extremely wide-spread myth that Germany entered the Euro system at a too high exchange rate.

I lived in Germany between 1988 and 1991 and during this time I visited France a few times. One observation easily done was that all prices were significantly higher in France.

Now, that was prior to the introduction of the euro, but the Economist's Big Mac index indicated that Germany entered the euro system at an undervalued exchange rate.

If you compare the Big Mac price in Germany and France from 1987 until now you will see that the price has always been higher in France, though the difference has been sharply reduced.

8:56 am  

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