September 30, 2019 BARRON’S 15
THE ECONOMY n By Matthew C. Klein
GermanyNeedsConsumerTherapy
Economic woes offer prime opportunity to encourage domestic consumption
GERMANY IS IN TROUBLE.
Andthelatestsurveysof
German companies, re-
leased this past week,
suggest that things will
onlygetworsewhilealso
perfectlyillustratingthe
vulnerabilitiesofthecountry’sflawedeco-
nomic model.
InAugust,theFederalStatisticalOffice
reported that gross domestic product
shrank in the second quarter. Then, this
pastweek,theIHSMarkitcompositeout-
putindex,whichtrackscurrentconditions
fortheeconomyasawhole,enteredreces-
sion territory for the first time since 2013
andiscurrentlyatitslowestlevelsincethe
middleof2012.TheIfoInstitute’s“business
expectations” index, also from this past
week,isevengloomier,withtheSeptember
numberatthelowestlevelsinceJune2009.
The proximate cause of Germany’s
weakness is the global manufacturing
slowdown that began almost two years
ago. Roughly 22% of Germany’s overall
economicactivitycomesfromthemanufac-
turingsector,andGermanmanufacturing
production is down nearly 8% from the
peakreachedattheendof2017,withmo-
tor-vehicle production down 14%.
The downturn is due tofallingdemand
forGermanexports.AboutathirdofGer-
many’s total output is consumed by for-
eigners, which means the country is vul-
nerable to changes in global conditions,
including China’s credit tightening and
changes in U.S. Federal Reserve policy.
Fallingexportsofmanufacturedgoodsrel-
ative to imports have subtracted more
than a percentage point from Germany’s
GDPgrowthoverthepastyear.Totalex-
port volumes have been essentially flat
since the end of 2017.
ThedeepercauseofGermany’scurrent
troublesisthereforeitsdependenceonthe
restoftheworldtobuyitsmanufactured
goods. If Germans spent more on them-
selves they could easily offset the recent
declineinforeigndemand.Unfortunately,
Germansocietyhasspentthepastseveral
decadesstiflingdomesticspendinginthe
name of “competitiveness.”
Thecompetitivenessfetishhasitsroots
inthetwinshocksofreunificationandthe
liberationofCentralandEasternEurope
fromCommunism.By1997,GermanPresi-
dentRomanHerzogwaswarningthatthe
“ossification” of German society put the
countryindangeroffallingbehindthedy-
namic economies of the U.S. and East
Asia. His preferred solution was a “new
social contract for the future,” which in
practice meant lower worker pay, lower
taxes, lower unemployment benefits, and
cuts to health insurance.
Eventually, German business leaders
andpoliticiansfollowedHerzog’sprescrip-
tion. After subtracting inflation, average
hourlycompensationwasthesameatthe
end of 2010 as it was at the end of 2000.
There are fewer Germans with full-time
jobs today than there were in the
mid-1990s, with more than all of the net
increaseinemploymentcomingfrompart-
time workers. Those part-time workers
are often older Germans forced to take
low-payingjobsafterlosingaccesstoun-
employment and other benefits.
In a closed economy, cutting worker
pay is self-defeating because it reduces
purchasingpower.Germanbusinessown-
ers wouldn’t have benefited because any
cost savings would have been offset by
falling sales. At best, profits would have
beenflat.Germancompaniesavoidedthis
problembysellingtotherestoftheworld.
ThisiswhyGermany’stotaleconomicout-
puthasbeenabletogrowabout1.5times
as much as household consumption since
the beginning of 2005. The corollary is
that the change in the net operating sur-
plusofGermannonfinancialcorporations
has moved in lockstep with the country’s
trade balance for nearly 20 years. There
would have been no growth in profits
without export markets supplementing
Germany’s stagnant domestic economy.
Whileworkerpayhasbeenrisingrela-
tively briskly in the past few years, Ger-
many has remained as reliant on exports
asever.Foronething,thegainsforhouse-
holds have been partly offset by a sub-
stantial increase in the personal saving
rate.CharlesDumasofresearchshopTS
Lombardthinksthismaybecausedbythe
concentrationofGermanhouseholds’sav-
ings in bank deposits and pensions that
predominantly hold fixed income, both of
which now yield less than nothing.
At the same time, the German govern-
menthascontinuedtosqueezetheeconomy
throughexcessivetaxationandbystarving
infrastructure of investment barely suffi-
cient to maintain existing structures. The
German government’s budget surplus is
currentlyworth2%ofGDPevenasrealin-
terestrateson10-yeardebthavefallenbe-
low negative 2%. This isn’t prudence—it is
pointlessly leaving money on the table.
The contraction of Germany’s export
marketspresentsthecountrywithavalu-
ableopportunitytooverhaulitseconomic
modelbyhavingGermansspendmoreon
themselves. Germany has the power to
change, if Germans choose to do so.
email: [email protected]
Pattern of Profitability
The increase in German companies' free cash flow has tracked the country’s trade surplus.
Change since 2000.
Sources: Eurostat; Barron’s calculations
.
Trade surplus
Free cash flow
of German
nonfinancial
corporations
2002 ’04 ’06 ’08 ’10 ’12 ’14 ’16 ’
0
50
100
150
200
€
Spending Gap
German household spending hasn’t kept pace with export-driven economic growth
Sources: Eurostat; Barron’s calculations
Note: January 1991 = 100
GDP
Household
Consumption
1995 2000 ’05 ’10 ’
90
100
110
120
130
140
150