WITH Angela Merkel now certain to be named as the next German Chancellor, the time has come to assess the prospects for the largest European economy in the years ahead. After a brief bout of disappointment at the inconclusive outcome of the German election, the financial and business communities seem to have settled into a much more optimistic mood. The German stock market hit a three-year high last Monday, the Reuters Purchasing Management index leapt upwards, especially in the services sector, and the euro recovered strongly last week. Does all this hint that Frau Merkel could, after all, turn out to be a German Margaret Thatcher, who manages to unleash the enormous repressed potential of the German economy, as many commentators had suggested a few months ago? The answer is that investors and businessmen who feel optimistic about Germany will probably turn out to be wrong, as they have been consistently for almost a decade. The reasons for disappointment, however, will not be the ones commonly feared. Frau Merkel’s leadership qualities may have proved unimpressive during the election, but it is worth remembering that 25 years ago, Margaret Thatcher was also regarded as underwhelming and scarcely up to the job. A more serious worry than Frau Merkel’s lack of charisma, is the inherent instability of the oxymoronic coalition of conservatives and socialists over which she will now have to preside.
It is hard to see how the wealthy bankers and captains of industry who surrounded Frau Merkel during the election could reconcile themselves with the anti-capitalist rhetoric of Franz Müntefering, the most senior socialist leader after the resignation of Gerhard Schröder, who regards stock market investors as parasites and describes international financiers as “locusts”. But the history of coalition politics in postwar Europe has produced many strange bedfellows and there can be no disputing the longing of the German electorate for politicians to compromise and seek a constructive way out of the economic paralysis that has afflicted Germany for the best part of a decade.
What, then, are the real problems that make any improvement in Germany’s economic condition extremely unlikely in the year or two ahead? There are at least three reasons to believe that the German economy will deteriorate even more instead of improving under Merkel.
First and foremost is the total lack of understanding, at every level of the German political, business and academic establishment, of the link between supply and demand. German economists simply do not acknowledge that the great threat to their country today is not inflation, but lack of demand. Only when the Germans understand this, as the Americans did in the mid-1930s and the Japanese did in the late 1990s, will they accept that stimulating demand must now take precedence over every other economic objective and that the deflationary policies identified with the heyday of the Bundesbank in the 1970s, or with the early years of the Thatcher Government, are precisely the opposite of what Germany now requires. As long as the sort of proactive demand management practised by the US Federal Reserve, the Bank of England and the Bank of Japan, are treated as the work of the devil, there can be no hope of economic recovery in Germany, regardless of whether Frau Merkel turns out to be a strong or a weak leader, and irrespective of which reforms she may or may not attempt.
Once the link between demand growth and economic recovery is acknowledged, Germany’s second great handicap becomes clear. The economy’s vaunted success in exports points straight to its Achilles’ heel. In the past five years, German businesses have become addicted to exports. This addiction is likely to prove painful in the short-term because it has left Germany very exposed to next year’s probable downturn in the global business cycle, discussed last week on this page. Moreover, it has lulled Germans into a false complacency about their economic position.
Germany has done quite well in exports since the late 1990s, but much of the out-performance, in relation to France and other European countries is simply an arithmetical result of Germany’s weak domestic demand. This was demonstrated in a perceptive analysis published last week by the HSBC European economics team. Because Germany is France’s biggest single market, very weak consumption in Germany has naturally undermined French export growth. On the other hand, Germany’s export figures have been artificially flattered by the relatively strong consumption growth in five of its biggest export markets: France, Britain, America, Spain and China (in order of importance). Using OECD figures that take account of disparities in market growth, HSBC shows that Germany’s export performance has actually been no better than that of other European countries. And the future is more ominous. What little prosperity German industry has enjoyed in the past few years has been based on unsustainable growth of demand in four of its main markets — Britain, America, China and Eastern Europe. All of these are now slowing or are likely to slow substantially in the year ahead.
To make matters worse, Germany’s dependence on exports is dangerous in the medium term because it has meant ceding effective control over the economic future to foreign policymakers and has made Germany more vulnerable than any other major economy to unexpected global shocks, ranging from the bursting of the dot-com bubble to the terrorist attacks on New York. The addiction to exports is pathological in the long-term because it has encouraged Germany to remain more dependent than any other advanced economy on manufactured goods, such as cars and machine tools, whose prices are relentlessly falling as competition intensifies from Korea, China, Brazil, Poland and other emerging industrial powers. Germany’s determination to make the highest-quality manufactured goods, its refusal to become a post-industrial society is also its fatal flaw.
Germany’s refusal to acknowledge the primary importance of demand management also suggests a third reason why the Merkel government is doomed to failure. Frau Merkel, instead of emulating the Thatcher experience, wants to apply Thatcherism back to front. Mrs Thatcher spent her first four years fixing demand in the British economy and only turned to radical supply-side reforms after her re-election in 1983. Her privatisations, the big income tax cuts, the labour market legislation and, above all, the decisive confrontation with the miners union all occurred from 1984 onwards, by which time the economy was growing at 4 per cent a year. Frau Merkel wants to do the opposite. Instead of focusing on the German economy’s demand side, she wants to start with deflationary structural reforms — higher taxes, reductions in job security, cuts in pensions — and not even think about the damage these will do to consumer spending.
It is unlikely that Mrs Thatcher would have done this. She understood that many of her reforms would only deliver positive results in a buoyant economy. As a politician she also knew that she could not fight on too many fronts. Politically controversial supply side reforms and union confrontations would fail if attempted when the economy and the government were both weak.
Mrs Thatcher’s successful leadership was not just a matter of radicalism and courage, but also of pragmatism and good timing. To do the right thing at the wrong time, to take reforms in the wrong order, can be worse than doing nothing.
As German politicians of left and right try to stitch together their contradictory economic programmes, they would do well to bear this in mind.
