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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is chief economist at German bank LBBW and former chief ratings officer at S&P
Germany has not yet been relegated by capital markets in sovereign rankings. Despite the country’s economic weakness the Bund is still the undisputed euro debt benchmark. Its AAA-rating has a stable outlook with all major rating agencies. But this will not last for ever.
The simplistic view still shared by many German politicians is that high creditworthiness is a direct function of low debt. It is not. In fact, the public debt burden of highly rated advanced economies is substantially higher than that of lower-rated emerging markets. Other factors such as growth, productivity and innovative capacity play a critical role, too. And this is where Germany increasingly falls short.
There has been a drumbeat of disappointments in economic data from the country. All high-frequency indicators are pointing down again, from order books and industrial production to retail sales and confidence indicators. For two years now, the economy has been dipping in and out of contraction. Even so, the economy is not going anywhere.
Germany’s weakness has led to solidifying expectations of more rate cuts from the European Central Bank. The 10-year Bund yield, which briefly touched 2.6 per cent in early July has come down rapidly to about 2.25 per cent. This is testament to congealing economic pessimism that is forcing the hand of the ECB. The fact that other Eurozone-countries, such as France or Italy, have their own deepening challenges flatters Germany in relative terms and renders its benchmark status unassailable.
The main reasons for Germany’s structural stagnation partly reflect adverse megatrends beyond direct governmental control. The first factor is the end of globalisation and the second is a daunting demographic profile. Added to that is the self-inflicted wound of continuous underinvestment.
Germany benefited like few other countries from China bursting into the world economy. When China joined the World Trade Organization in 2001 the country needed just the stuff in which German companies excel: investment goods, machinery, vehicles. Exports went through the roof. In 1999, a little more of a quarter of all things produced in Germany were sent abroad. By 2008, that share had reached 46 per cent of GDP.
But since the financial crisis, world trade and German exports went mostly sideways. China has gradually become a competitor rather than a client. Protectionist tendencies have been creeping into the world trading system. As external demand flattened, Germany’s economy came to a screeching halt.
German consumers have not taken up the slack. They have good reason to be thrifty: a rapidly ageing society with an unfunded public pension system. The large cohorts born in the 1960s are starting to drop off into retirement. During the next half-decade Germany will lose year after year a net 1 per cent of its workforce.
This trend is exacerbated through ever fewer hours worked. In no other OECD country do workers spend less time on the job. With labour input shrinking by some 1 per cent a year, labour productivity would need to rise by an equal amount for the economy to stand still. Unfortunately, productivity increases per hour worked have stood well below 1 per cent in recent years. The country’s fundamental speed limit for growth may lie below zero.
Sluggish productivity growth can also be attributed to decades of underinvestment in education and infrastructure. When European football fans descended on Germany this summer, quite a number of positive prejudices about the country’s transport system were shattered. That should not come as a surprise.
Since the turn of the millennium the public sector in Germany has spent on average only 2.3 per cent of GDP on investments. In the Euro area as a whole, it was almost 1 percentage point more, in France even 2 percentage points. The gap relative to peers has recently become smaller. But that merely means that Germany continues to fall behind, just at a slower pace.
If the AAA-crown were to be taken away from Germany it would not be because of too much debt. It would be because of a prolonged economic paralysis and a lack of appropriate action to address it. As policymakers increasingly recognise the fundamental roadblocks to growth, we can be confident that the fixation with balanced budgets trumping everything else will be overcome. Do not count Germany out just yet!