Economic vulnerability and underestimation of risks : The need for reform in modell Deutschland.

January 31, 2018

INTRODUCTION.

 

     “German Economy Beats Forecasts, Heads for Best Year Since 2011” (Skolimowski, 2017) “German economy ‘going great guns’ as growth picks up further in Nov” (Reuters, German economy "going great guns" as growth picks up further in Nov, 2017) “German Economy Seen Coasting Even as Coalition Talks Crumble” (Look, 2017) Even amidst the prominence of German election, the German economy did not fail to dominate the headlines as soon as data on the nation’s economy was released in November. With the quarter not only experiencing a 0.8% rise in the seasonally adjusted gross domestic product (GDP) but also beating the 0.6% median forecast with PMI figures for November predicting a 0.9% growth in the fourth quarter, there is evidently a preponderance of accolades. This recognition is undoubtedly justifiable but also contains the threat of overshadowing parallel headlines such as, “German economy faces risks of overheating, experts warn” (Jones & Chazan, 2017) and “German economy facing bigger risks than investors may think: Bundesbank” where the German Central Bank itself has cited deep worries about investors and households underestimating the financial risks existing in the country due to the eight-year growth run comprising of low interest rates and high value investments. This has actually increased the economy’s vulnerability (Reuters, German economy facing bigger risks than investors may think: Bundesbank, 2017). When an economy characterized by its prolonged period of economic boom is warned by its own Central Bank of impending fiscal and monetary instability, there develops a need for its economic model to be reviewed. But is there a certain German economic model? Yes, the Modell Deutschland or the German Economic Model has represented an economy that was has been held up as a remedy for its European neighbours for the fallout of the 1970s economic crisis (Back, Klobes, & Scherrer, Introduction, 2005) but has also been called the Sick Man of Europe and then subsequently Europe’s Economic Superstar (Dustmann, Fitzenberger, Schönberg, & Spitz-Oener, Winter 2014). The model has emerged as a winner with its fundamental elements being seeming impossibly antithetical to outsiders: muscular unions and corporate efficiency; high-cost workers who can compete in global manufacturing; generous unemployment benefits and low levels of unemployment; and a fragmented base of independent small-and-medium manufacturers—the Mittelstand—being able to compete on the highest levels of productivity and efficiency (Phillips, 2015). But even with the model producing glorious figures (as evidenced in Figure 1), it is in dire need of reforms, especially in the contemporary world scenario. Financial Times accurately stated this need for this need in their article titled, “Germany’s economic model needs an upgrade” (November 17, 2015) – “Since the crisis, however, despite the shifts in the economic landscape, its model has barely changed.” This paper would henceforth attempt to explore the reasons of, “Why the German Economic Model needs to Reform?”

 

Figure 1. The Expanding German Economy

Source: Bloomberg

 

The following section of the paper would elucidate the characteristics of the German Economic Model and the third section would seek to analyse the reasons for reform of the Model. Previous literature on this subject complimented with quantitative analysis, primarily in the form of own graphs with values retrieved from World Bank, Deutsche Bundesbank, and Statistisches Bundesamt (Destatis), has been employed to evidence this study.

 

What is the German Economic Model?

An embodiment of the term, “social market economy” (Petersen & Esche), the Modell Deutschland has been described as a, “successful marriage between international competitiveness and social consensus” (Back, Klobes, & Scherrer, Introduction, 2005). Unlike the Anglo-Saxon and French models in which, to a certain extent, economic performance is in conflict with social protection– it is one thing or another – the German economic model aims, in a false kind of paradox, not only to reconcile, but beyond that – to create a dynamic balance between competitiveness and the need for social protection (Fabre, 2012)

At the micro level, the organization of German firms and the institutional environment in which they operate is important, especially in manufacturing. Many German firms have excellent capacities for making incremental improvements to their products and production processes, partly because works councils, backed by relatively strong trade unions, give the workforce some measure of job security and a voice in management decisions that makes it easier for firms to enlist their cooperation. Therefore, many German producers have a reputation for high quality, which allows firms to compete on quality as well as price in markets for goods.

 

 

Figure 2. YoY Manufacturing, value added (constant 2010 US$). Germany 1991-2015

Source: Retrieved from World Bank. Manufacturing refers to industries belonging to ISIC divisions 15-37. Value added is the net output of a sector after adding up all outputs and subtracting intermediate inputs.

 

The result is a form of stakeholder capitalism in which firms are responsive to the concerns of their employees and other firms as well as shareholders, and hence more resistant than their British or American counterparts to an exclusive focus on the price of the company’s shares.

 

At the macro level, parallel sets of institutions and policies enhance the operation of these institutions at the micro level. Although weaker than they once were, in tandem with works councils, industry-wide trade unions are capable of coordinating with strong employer’s associations on wage levels that encourage skill formation and restrain increases in unit labor costs.

Figure 3. QoQ Index of Labour Costs. Germany 1996 Q1 – 2016 Q4

Source: Own graph. Values retrieved from Deutsche Bundesbank. The labour cost index measures developments in labour costs per man-hour worked.


 

Figure 4. YoY Unemployment Rate (in %). Germany 1991-2016

Source: Own graph. Values retrieved from Statistisches Bundesamt (Destatis) 2017.


 

However, effective wage discipline also depends on supportive macroeconomic policies; and, in keeping with this, German governments have generally been reluctant to implement expansionary fiscal policies, lest they encourage higher wage settlements. For many years, the Bundesbank also policed this system by threatening to impose restrictive monetary policies in response to inflationary wage. Efforts to hold down the external value of the currency have also been central to promotion of the export sector, initially under Bretton Woods and then the European Monetary System.

 

The combination of these institutions and policies at the micro and macro levels of the German political economy have given rise to distinctive patterns of economic performance, marked by a large manufacturing sector and levels that comprise nearly half of the German GDP (Hall, 2015).

 

Why the German Economic Model Needs to Reform?

Marcel Fratzscher, president of the German Institute for Economic Research, asked the following question: “Can you guess the country to which the following facts apply? Economic growth and wage growth have been below average over the past 20 years. More than one in five people have only temporary, low-wage or marginal jobs. Wealth inequality is among the highest of Western countries, and the government is depleting its public wealth by investing too little in infrastructure and education.” And unabashedly answered, “Germany” (Fratzscher, 2017). This brutal portrayal of one of world’s biggest economies demonstrates its major flaws. Even though Financial Times on November 17, 2015 published an article stating that the German Economic Model needs an upgrade but the Modell Deutschland had started losing its position as a showcase of capitalist achievements by the beginning of the 1990s which saw the competition between the capitalist and the socialist societal systems end and that between the different capitalist systems such as the US, increased (Back, Klobes, & Scherrer, Conclusion, 2005). This leading member of the Eurozone, in spite of having maintained stable economic growth and development, faces some critical challenges which call for an immediate reform in its model.

 

Aging Society

In the coming decades, Germany’s total population is set to decrease. Depending on how many people immigrate, it will fall from 81.5 million to between 72 and 76 million by 2050. As the population declines, it will also, on average, get older. Currently, 21 percent of the German population is at least 65 years of age, making Germany’s population one of the world’s oldest, ranking third behind Japan and Monaco.

 

Declining Investments

For some time, investment has been a weak point in Germany’s economic development. Net investment, meaning the difference between annual gross investment and annual depreciation, is critical to increasing production capacity. In the early 1990s, nominal net investment in Germany was about 160 billion euros a year. However, between 2012 and 2014 net investment decreased to roughly 40 billion euros.

 

Figure 5. Age Dependency ratio, old (% working population). Germany, Japan, USA 1990-2015

Source: Own graph. Values retrieved from World Bank. Age dependency ratio, old, is the ratio of older dependents--people older than 64--to the working-age population--those ages 15-64. Data are shown as the proportion of dependents per 100 working-age population.

 

Export Dependence

High dependence on exports has its drawbacks; an exceptionally strong downturn in the global economy would lead to below-average slumps in production. This became particularly clear in 2008, when the global economy crashed (Petersen & Esche). Europe’s southern nations have tamed their current account deficits but German surplus was set to hit a record 8.4 per cent of gross domestic product in the year 2015 (View, 2015)

 

 Figure 6. Foreign Direct Investment, net inflows and outflows. Germany 1990-2015

Source: Own graph. Values retrieved from World Bank. Foreign direct investment refers to direct investment equity flows in an economy. It is the sum of equity capital, reinvestment of earnings, and other capital.

 

 Figure 7. YoY Value of Exports and Imports. Germany 1990-2016

Source: Own graph. Values retrieved from Statistisches Bundesamt (Destatis) 2017.

 

Added to the aforementioned trouble are wages monitored to preserve competitiveness, domestic savings parked abroad as debt, and ignorance of bureaucratic hurdles, shortages of skilled labour and crumbling infrastructure. Also, Angela Merkel’s commitment to fiscal prudence may be hard to shake. That does not, however, preclude change in the private sector. Germany could start its reform with boosting domestic investment. It has an abundance of savings; the government should do more to employ these funds at home. A fresh look at banking may be the key to this. Liberalising the services industry would create investment opportunities. Labour productivity in professional and financial services has not increased in almost a decade. An end to ownership and qualification regulations would open up the sector to much-needed federal and international competition (View, 2015).

 

CONCLUSION.

With the dominance of large companies, a strong export orientation, and an education system of highly skilled workers forming the basis of the German Economic Model, these characteristics have definitely led to economic growth and development (Back, Klobes, & Scherrer, Conclusion, 2005). But as Philip Whyte is his, “Why Germany is not the model for Eurozone” states - “Its lop-sided growth model has served Germany less well than many observers believe.” The country has enjoyed great success in creating jobs, and its households are not mired in debt. But workers have seen little financial reward for their sacrifices over the past decade, and much of the capital that Germany has exported has gone to waste (Whyte, 2010). Also, the processes of globalization and corporate restructuring have seriously affected the German economy, many jobs have been lost or transferred to suppliers and contract manufacturers. Therefore, even the Modell Deutschland still exists and has brought success to the German economy, within the contemporary world, it is dire need of some critical reforms in order to sustain.

BIBLIOGRAPHY

Back, S., Klobes, F., & Scherrer, C. (2005). Conclusion. In S. Back, F. Klobes, & C. Scherrer, Surviving Globalisation? Perspectives for the German Economic Model (pp. 225-235). Dordrecht: Springer.

Back, S., Klobes, F., & Scherrer, C. (2005). Introduction. In S. Back, F. Klobes, & C. Scherrer, Surviving Globalization? Perspectives on the German Economic Model (p. 2). Netherlands: Springer.

Dustmann, C., Fitzenberger, B., Schönberg, U., & Spitz-Oener, A. (Winter 2014). From Sick Man of Europe to Economic Superstar: Germany's Resurgent Economy. Journal of Economic Perspectives—Volume 28, Number 1, 167–188.

Fabre, A. (2012). The German Economic Model: a strategy for Europe? Paris: Fondation Robert Schuman.

Fratzscher, M. (2017, November 27). Germany is no poster child for economic growth. Retrieved from The Washington Post: https://www.washingtonpost.com/news/theworldpost/wp/2017/11/27/germany-economy/?utm_term=.9c9dc554c7f6

Hall, P. (2015). Fate of the German Model. Brussels: Social Europe.

Jones, C., & Chazan, G. (2017, November 8). German economy faces risk of overheating, experts warn. Retrieved from Financial Times: https://www.ft.com/content/aae0e00c-c48e-11e7-a1d2-6786f39ef675

Look, C. (2017, November 20). German Economy Seen Coasting Even as Coalition Talks Crumble. Retrieved from Bloomberg: https://www.bloomberg.com/news/articles/2017-11-20/german-economy-seen-coasting-even-as-coalition-talks-crumble

Petersen, T., & Esche, A. (n.d.). Preserving an Old Model in a New World: German Economic Policy. 21-29: Bertelsmann Foundation.

Phillips, M. (2015, August 9). Germany’s bizarre version of capitalism—where bosses and workers actually cooperate—is winning. Retrieved from Quartz: https://qz.com/452076/this-just-in-german-capitalism-has-won/

Reuters. (2017, November 23). German economy "going great guns" as growth picks up further in Nov. Retrieved from Business Times: http://www.businesstimes.com.sg/government-economy/german-economy-going-great-guns-as-growth-picks-up-further-in-nov

Reuters. (2017, November 29). German economy facing bigger risks than investors may think: Bundesbank. Retrieved from Nasdaq: http://www.nasdaq.com/article/german-economy-facing-bigger-risks-than-investors-may-think-bundesbank-20171129-00103

Skolimowski, P. (2017, November 14). German Economy Beats Forecasts, Heads for Best Year Since 2011. Retrieved from Bloomberg: https://www.bloomberg.com/news/articles/2017-11-14/german-economy-steams-ahead-as-euro-area-recovery-gains-ground

View, F. (2015, November 17). Germany’s economic model needs an upgrade. Retrieved from Financial Times: https://www.ft.com/content/c0d13422-8a05-11e5-9f8c-a8d619fa707c

Whyte, P. (2010). Why Germany is not the model for Europe. London: Centre for European Reform.

 

 

 

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