A 'Prudent' Team Player: Germany Asserts Itself on the World StagePublished: November 23, 2010 in Knowledge@Wharton
In Germany, it is a season of anniversaries. In early October, the country marked 20 years since the official reunification of West and East Germany, an event set in motion by an even bigger one -- the fall of the Berlin Wall 21 years ago in November 1989. Although West Germany was then Europe's economic superpower, it was generally a European team player.
But since moving from Bonn to Berlin following reunification, the country's government has been increasingly exerting its will on the global stage. The style of Angela Merkel, Germany's conservative chancellor since 2005, has been less pugnacious than that of her predecessor, Social Democrat Gerhard Schroeder. Still, a growing irritation among German voters that the country is footing much of the bill for what they see as irresponsible behavior by fellow eurozone members has given her a new sharpness.
Earlier this year, Merkel delayed Germany's backing of Greece's 110 billion euro ($150 billion) bailout package, which the European Union eventually approved in May. More recently, in late October, driven partly by the potential threat of legal challenges by Germany's constitutional court, she successfully extracted an agreement in principle in Brussels (the seat of the European Union) to alter the treaty governing how the EU will rescue debt-ridden member governments beginning in 2013. And when her call for private-sector creditors to shoulder some of the costs of future rescues frightened bond-market players and angered other European leaders, Merkel was conspicuously unrepentant. Later, her office clarified that she was referring to future rather than current debt, but even so, Franklin Allen, a Wharton finance professor, argues that this was strategically "the wrong way around." Scaring potential investors is hardly likely to encourage them to invest in sovereign debt, he says.
Merkel stepped into the fray again in mid-November by being among the louder EU voices pushing for a financially wobbly Ireland to accept an EU and International Monetary Fund bailout package to calm market jitters that threatened to destabilize the euro. After initial resistance, Ireland acquiesced. Bloomberg reported that the package will total as much as 60% of Ireland's GDP, compared with 47% for Greece's package earlier this year.
The Bigger Stage
Meanwhile, Merkel is working to establish Germany's position on a bigger stage. In the run-up to the Group of 20 two-day summit in Seoul in November, she sternly reminded trading partners that the economic crisis had been built on speculation. Some viewed her remarks as a reaction to ongoing complaints from the U.S. and France about the enormity of Germany's trade surplus -- a source of pride at home -- and its propensity to save rather than consume.
Interviewed in the Financial Times on November 8, Merkel rejected the U.S.'s proposal to set maximum levels that trade surpluses and deficits are allowed to reach. "The greatest danger that threatens [the world economy] is protectionism, and we are still not taking enough steps to ensure genuinely free trade," she told the newspaper.
In part, Merkel's stance is driven by political pressures at home. Her year-old center-right coalition government, formed by her Christian Democrat Union party and the Free Democrats, is slumping in the polls after months of in-fighting among coalition members over tax cuts and public protests over nuclear energy policy. There is also growing pessimism in Germany that its fabled stability and prosperity are increasingly vulnerable to outside pressures, particularly at the eurozone level, as the need to bail out struggling members multiplies -- a fear that has only grown with Ireland's recent crisis. "Merkel has many strong qualities, but she is in a very difficult position," notes Allen. "She needs to show willingness to act on Europe's behalf, but this is giving her big problems at home."
These conflicting needs have caused Merkel to behave unwisely, Allen adds, citing the delays she forced during the passage of the Greek rescue package. "Many of Europe's problems have been worsened by the way she has handled things."
Yet analysts concede that Germany has good reason for its seeming self-righteousness. Take the country's resilience during the global economic crisis. The country plunged into its deepest recession for six decades, and export orders from big trading partners, like the U.S., plummeted. GDP growth shrank in 2009, from around 1.5% to -5%, according to the Organisation of Economic Cooperation and Development. But Germany has bounced back, with strong demand for its high-quality goods, such as automotive products and machine tools, in emerging economies like Brazil and China.
While other economies -- especially many of Germany's eurozone partners -- remain steeped in gloom, Germany is doing relatively well. In mid-August, the federal statistical office announced that the nation's GDP had grown by 2.3% in the second quarter of the year, well ahead of forecasts and representing the fastest pace of growth since reunification. There was a sharp slowdown in the third quarter, announced on November 12, to 0.7%, but the mood remains upbeat, and the country's council of economic advisers predicts 3.7% GDP growth for 2010 overall and 2.2% for 2011.
How has Germany managed to do so well in the face of such gloom elsewhere? Allen believes it is because Germany has taken a different approach than the likes of the U.S. The country's strategy, he notes, is based on "prudence" -- avoiding the perils of debt, large deficits and over-inflated property bubbles -- and a national penchant for saving and thrift. The result has been an economic model that is not reliant on financial services and speculation. "There is a profound difference between the German and American approach, and Germany's has proved more correct," Allen says.
Spend, Spend, Spend
The optimism extends to consumer spending. On November 10, the federal statistical office reported that consumer spending increased 0.6% in the second quarter of the year, after contracting for the previous three quarters. With bullish predictions from retailers for a strong Christmas season, and the country's council of economic advisers predicting a 1.6% rise in consumer spending for 2011, analysts foresee a recovery that extends beyond exports to the domestic sector.
There is a healthy job market, too. Coalition politicians have been touting federal figures showing that unemployment in October fell below three million for the first time in 18 years. Seasonally adjusted, the picture was slightly less rosy -- 3.15 million registered unemployed, or 7.5% of the workforce. Nevertheless, compared with last year's 8.2% and a high of more than five million unemployed in 2005 -- and a 10.1% rate in the eurozone overall -- this was good news. A 7.7% rate for 2010 and 7% for 2011 is predicted. According to Christian Terwiesch, a Wharton operations and information management professor who is from Germany, it is "amazing" that the country's unemployment rate is now lower than America's -- which is close to 10% -- because traditionally it has been higher.
Importantly, a big rise in unemployment was avoided, thanks in part to reforms introduced during the decade before the crisis that were aimed at combating Germany's notoriously inflexible labor market. Co-operation between managers and workers' councils led to pay raises being sacrificed in return for jobs being protected. Germany, says Terwiesch, is "blessed with moderate unions.... Social consensus often overrides the political climate."
Also integral has been a program that promotes reduced working hours, under which subsidies are paid to firms that retain workers. The program, notes Terwiesch, has been very helpful in getting Germany through its worst days. While there has been a price to pay -- it cost more than 8 billion euro this year alone -- Terwiesch points out that the cost of laying people off would have been far higher, especially since many of those losing their jobs would have been older workers who would have had difficulty finding new employment.
That Germany's model has long been export-oriented and focused on sophisticated market niches has left its firms in a good position to ride the wave of demand. Saikat Chaudhuri, a management professor at Wharton who was raised in Dusseldorf, says that the role of the country's export orientation in the relative strength of its recovery should not be underestimated, since Germany was able to immediately benefit from the economies that emerged first from the crisis. "Germany's model is fundamentally a good one, and the relatively quick recovery is an indication of its strength," he says. "Contrast it with Britain, where the move from manufacturing to services has left it feeling pain from the problems in the service sector. With its strong manufacturing sector, Germany has a fallback. It is a very important balance."
Still, he agrees that Germany needs to ramp up domestic demand for imports, even though the local market is relatively small. But how can the country achieve this, when the co-operative model -- and its restraint on wages -- has helped the country's export-led recovery? Analysts note that positive economic news could sharpen worker demands, especially because wage increases in Germany have long been outstripped by inflation. In late August, the IG Metall union fired a warning shot with a demand for a 6% pay increase for steel industry workers, a considerable hike from the 2% it settled for last year.There have been murmurs from other unions as well, such as the Verdi union for public sector workers. In November, engineering and electronics company Siemens followed other German firms by pledging a bonus to employees, its first in many years.
Stimulation of domestic demand would fill a gap in Germany's recovery and please Germany's European trading partners. But Terwiesch notes that wage demands are a double-edged sword. Dealing with the tensions between stimulating domestic demand and maintaining export strength is "always a struggle" -- and the export market trumps the domestic one in size regardless.
Such tension draws attention toGermany's ability to diversify. Terwiesch argues that Germans need to learn to take more risks and become more innovative. "Outside the traditional areas of strength, entrepreneurship and innovation are weaker and not commensurate with the rest of the economy," he says. "A little risk-taking and pushing at the margin would not hurt, especially as the global landscape is changing and becoming more competitive." Germany, he states, "should be a leader in all industries and be strong in every single sector."
This would make Germany well suited for, say, green technology developments that require highly sophisticated technology, allowing it to leverage advantages it has honed in areas like automotive parts. What's more, Germany's government is stepping up its green tech support -- for example, by developing "feed-in" tariffs obliging utilities to buy energy generated by renewable means. "The international market wants German products," Terwiesch notes. "This makes it likely Germany can do very well on the green front."
Such an approach could also pay dividends in the biggest issue to confront Germany since reunification -- the huge gap between its western and eastern economies. Although few former East Germans would wish for a return to the days of the old regime (a recent poll showed 91% supported unification), the sharp disparity in wealth and prospects for easterners are a source of tension, forcing many young easterners to migrate west to raise their standard of living. On the western side, there is also resentment arising from the costs of reunification -- in 2009, net transfers totalled 80 billion euro from west to east.
Certainly, there is much to regret in the way reunification was done, experts say. Allen and Chaudhuri cite the costs of the currency conversion of 1990 and its effect on East German industry. As Chaudhuri notes, "Germany was a debt-free country until then." For Allen, the big issue is "the uneven spread of wealth." But Terwiesch is more focused on what has gone well. "That it worked was an amazing political accomplishment," he says. All point out that such momentous cultural change takes time to come to fruition. Allen suggests the problems in the east will take "10 to 20 years" to solve, with migration from east to west likely to continue.
Frank Trommler, former director of the humanities program at the American Institute for Contemporary German Studies and a professor of German at the University of Pennsylvania, says that while history has dashed the expectations of a better life for many of the older easterners, he sees hope in the younger generation, who will grow up without having experienced living in a country divided by a wall. What the former east needs, he adds, is a younger, more entrepreneurial generation -- but many have already left.
Both Trommler and Chaudhuri would like to see the pockets of relative prosperity in the east -- around Berlin, Leipzig and Dresden -- become hotspots for high-tech innovation. The east, says Trommler, "can be innovative, although it will take not 10, but more like 20 or 30 years. The west mainly includes older industry. If green or high-tech industry is sent east, this could create hope." Around Bitterfeld and Wolfen, once the hub of the East German chemical industry, renewable-energy companies are indeed springing up, but jobs remain in short supply even there.
Chaudhuri agrees. "The east needs special economic zones, not just subsidies." Such zones, he says, could make it easier to identify and nurture winners in sectors including semiconductors and alternative energy, although change will take time. He adds that he is a great believer in the potential of the east, particularly its "fantastic" educational institutions, such as Humboldt and Jena universities, which could benefit research-oriented sectors.
Meanwhile, Germany will need to address other glaring challenges. The first lies in its education system. Although the country's universities generally have prized academics over technical qualifications, it takes longer to complete degrees than in other countries, and few of its universities rank highly internationally. With such a system, says Chaudhuri, Germany is "shooting itself in the foot."
Terwiesch points out that in Germany, most innovation is done in firms, not universities, and government spending on research and development is low. What is needed, he says, is the creation of a type of innovation hub of the sort that has been successful at universities like MIT and Stanford.
Another challenge involves Germany's aging and shrinking population: The number of children per women dropped below the replacement rate in the 1970s, and some estimates say that by 2050 the population could decrease by as much as 14 million from the current 82 million. The resulting burden of rising pension costs and skills shortages looms ominously. A natural solution would be for Germany to make better use of its available workforce. A system that fails to take into account childcare needs ensures that women remain underemployed, experts point out. Immigrants, too, are also underutilized in a country in which they have often struggled to gain citizenship or have foreign qualifications recognized. "The tradition of viewing immigrants as second-class citizens is taking a long time to break," says Trommler.
At this juncture, Germany is in a state of flux -- doing relatively well in an economically troubled world and reaping the benefits of past reforms, but also laboring under Teutonic angst about a challenging future that will test what it hopes is an invincible export-driven growth model. In this sense, Merkel (whom Chaudhuri describes as "a masterful politician, but at times not bold enough") is representative of her electorate, even at a time when her popularity has dropped.
Still, even though Germany's relations with the rest of Europe are testy right now, the country has not fallen out of love with Europe, or indeed with being a member of the eurozone. Even with the likes of Greece on board, Germany gains a great deal from being in the union, observers say. "The euro has worked well for Germany despite loss of currency freedom," states Terwiesch. "As an export country, it is very pro-euro." Allen raises the possibility of Germany leaving the currency if Greece were to default. But Trommler and Chaudhuri think this unlikely, as does Terwiesch.
"The euro is a crucial part of making Europe a reality without a political structure," notes Trommler. And because "Germany wants to be at the heart of Europe," it is happy to remain a good member of the team, he says.