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Nov 13, 2013 | 18:31 GMT

Germany's Problematic Trade Surplus

Germany's Problematic Trade Surplus
(SEAN GALLUP/Getty Images)
Summary

Although the European Commission, after reviewing the economic developments in 16 EU countries, will likely urge Germany to take steps to reduce its trade surplus, it lacks the political will and tools to pressure Berlin into making changes in the medium term. However, fear of protectionism or the dissolution of the eurozone means that Berlin will likely try to curb its trade surplus eventually, albeit with limited success.

The commission announced Nov. 13 that it will review Germany's external trade position. Germany has been increasingly criticized by Europe and by the United States over its strong trade surplus. Germany is accused of undermining exporters in other countries and not consuming enough domestically to help troubled eurozone countries. But there are few measures to strengthen exporters in struggling countries, and it is doubtful whether a weakening of Germany's exporters and stronger domestic demand would have the desired results for exporters elsewhere, particularly in southern Europe. Even if the union's investigation does not have immediate consequences, it is significant because it focuses on Germany's economic model, which is based on a strong exports sector.

According to Eurostat, Germany has run a trade surplus since the early 1990s. As the surplus has grown, so has criticism of German trade performance, especially with the emergence of the European crisis. While troubled economies are pressured to lower domestic consumption and improve the competitiveness of their exports through unpopular labor market reform, Germany is blamed for not contributing its share to the rebalancing of the eurozone.

The Changing German Trade Pattern

While Germany has maintained its strong trade surplus, it is important to note the shift in its trade pattern over the past years. Germany's trade surplus is increasingly reliant on non-EU countries. Its surplus with the eurozone and the wider European Union has decreased since 2007 — with the European Union it has gone from 6.2 percent of gross domestic product in 2007 to 3.1 percent in 2012, and with the eurozone it has fallen over the same period from 3.9 percent of GDP to 1.6 percent of GDP.

German Trade Balance

German Trade Balance

German Trade Balance and Euros

German Trade Balance and Euros

Germany's industrial base has diversified its export markets relatively successfully to compensate for the weakness in Europe, mainly through higher exports to the United States and China. The share of German exports to the European Union has remained stable, but exports to the eurozone have decreased since 2007 while the share of exports outside the bloc has climbed.

Data on imports tell a similar story, supporting the claim that Germany has done little to help struggling eurozone countries through stronger domestic consumption.

Blame the Euro

The most potent tool to cut Germany's trade surplus would be to reintroduce a German currency. Although there is a relatively important faction of German voters that argues Germany should leave the eurozone because of opposition to eurozone bailouts, this is a step German leaders will want to avoid.

German Export Market

German Export Market

Sharing a currency with less competitive countries has helped Germany in several ways. First, it has facilitated access to European markets for German companies. (However, this has been less significant recently, as evidenced by a declining share of exports to eurozone countries.) Second and more important, being locked into a currency union with troubled countries enables Germany to profit from a relatively weaker currency than if it were outside the eurozone. Finally, the common currency disallows countries such as Italy and Spain to apply an independent monetary policy. Before the euro, these countries would manipulate their currencies to become more competitive. As the low sovereign interest rates show, Germany is seen as a haven in Europe. If it had its own currency like Switzerland or Sweden, it would face the problem of shielding its export industry from the appreciating national currency.

Limited Options

It is doubtful that measures can be taken to reduce Germany's trade surplus while benefiting troubled economies and stabilizing the eurozone as a whole. German export restraint and import stimulus will not necessarily translate into a strengthening of export industries in southern eurozone countries, such as Greece, that are struggling. The industrial base in those countries has been weak over a longer time period for a number of reasons, including relative inflexible labor markets and the relative weak transport infrastructure compared to northwestern Europe.

Data from the German statistical office shows that German labor costs, composed of wages and non-wage costs, were 32 percent higher than the EU average (47 percent higher in industry) in 2012. This suggests that Germany's competitiveness is tied to factors such as the specifics of the goods produced, quality and logistics. It would be difficult for other countries to take market share from Germany simply by lowering labor costs.

However, the fact that between 2001 and 2010 German labor costs increased at a slower rate than the EU average likely did play an important role in the weakness of German consumer demand for imports. The German statistical office notes that only since 2011 have labor costs in Germany seen a stronger increase than the EU average. Until 2011, France saw labor costs rise much faster than Germany, a fact that partly explains the widening trade deficit France had with Germany over that period.

For the past decade, Germany has had limited wage growth. This is partly the result of government policies introduced under former German Chancellor Gerhard Schroeder. A large part is also the agreement between labor unions and employers to limit wage growth in response to Germany's economic troubles in the early 2000s.

EU members have been pressuring Germany to introduce higher wages as a way to increase domestic demand. The introduction of a blanket minimum wage is one of the main topics of debate in the current coalition negotiations. While Berlin likely will introduce a minimum wage, it will be careful to set the wage at a level that keeps the costs for companies low. There are probably few sectors — mostly services — that would be affected by the introduction of a minimum wage, thus the effect on the export industry would be limited.

Moreover, the companies leaving Germany because of higher wages would likely move mainly to Eastern Europe. Countries such as Poland and the Czech Republic have an advantage because they already are tied into the supply chains of the German companies. However, because of these countries' strong dependence on German demand, they would also be negatively affected in the event German exports weaken overall.

Apart from setting a minimum wage, Berlin has little room to dictate wages in the private sector. The evolution of wages in Germany will depend on the pressure that labor unions put on employers. Because of Germany's resilience to the crisis, labor unions have been demanding higher wages, but the fact that the unions supported lower wage growth to sustain Germany's competitiveness in earlier years indicates that German labor unions will be wary of pressing for too much of an increase should the German export industry run into trouble.

Berlin could strengthen domestic demand through increased government spending. The country has a low fiscal deficit and could strengthen spending with relative ease. In addition, since the Social Democratic Party is likely to be a member of the next coalition government, the chances that government spending will be higher than it was under the previous center-right government are good. However, for the past few years Berlin has been a strong proponent of austerity to overcome the crisis, and it has national legislation in place aimed at curbing government spending, so the shift to more spending will likely be limited. In the longer term, the government will be investing somewhat heavily in transportation and energy infrastructure, but such spending is unlikely to help teetering eurozone economies.

If Germany was able to increase domestic demand, and thus imports, it is probably the countries from which Germany already imports the most — China, France and the Netherlands, for example — that would see their exports rise. Consumption of goods produced in struggling countries such as Greece or Portugal would be limited.

Apart from wage and fiscal policy, there is a hard-to-correct demographic factor that explains the strong performance of German exports and its weak domestic demand: its aging and shrinking population. A large portion of Germany's population currently is between the ages of 40 and 60. This productive age group generally has a high savings rate because it is preparing for retirement and has already made its large family investments. Though this development will likely weaken Germany in the long term, it is a factor that helps explain the country's current economic strength.

Because Germany has such an export-oriented economy, preserving the eurozone and Europe's common market is part of Germany's national strategy. This is why Berlin, after initially claiming it would not bail out other countries, has done exactly that on numerous occasions in recent years. It will not be pressure from European bureaucrats that will convince Germany to take measures to reduce its trade surplus; rather, it will be the fear of protectionism and the collapse of the eurozone. 

The crisis in the eurozone is undermining the European Commission's enforcement credibility. The European Union has a long record of failing to sanction noncompliant countries. Consequently, any agreement on this issue will be the result of a political negotiation between member states, most notably Germany and France, independently of announcements or threats from Brussels. Most important, the announcement of the investigation of Germany's export sector reveals a growing concern in the European Union regarding Germany's role in the continental bloc. The free trade zone, and the common currency subsequently, benefited Germany's export-based economy but also proved harmful to some of its neighbors. While the announcement is unlikely to have an effect in the short term, it is a signal that the European Union is getting closer to a crucial debate about its economic foundations.

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