Why Christine Lagarde is right about Germany

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV Media network.

As French Finance Minister Christine Lagarde and European Commission President José Manuel Barroso have recently suggested, Germany must tackle its vast trade surplus and do more to boost domestic demand, writes Philip Whyte, senior research fellow at the Centre for European Reform (CER), in a March publication.

The following contribution was authored by Philip Whyte of the Centre for European Reform.

''Greece's recent fiscal travails have, slightly unexpectedly, thrown the spotlight on Germany's current-account surplus. In mid-March, France's finance minister, Christine Lagarde, urged Germany to do more to boost domestic demand – a call echoed by the European Commission's president, José Manuel Barroso. The German government and media are bemused and indignant. How can it be, they ask, that corruption and profligacy in Greece has turned into a trial of German discipline and rectitude? Anyway, what right do French politicians – and, for that matter, Anglo-Saxon commentators – have to lecture Germany? Wouldn't they be better advised attending to their own countries' manifold economic problems?

On one thing, everyone agrees. Germany's current-account surplus is vast. In 2009, it amounted to $169 billion – or 5.2% of German GDP. In absolute terms, this was the world's second largest current-account surplus after China's. Measured as a share of GDP, Germany's surplus was even larger than China's. A number of countries have even larger external surpluses relative to the size of their economies than either China or Germany. These include European states like Sweden and Switzerland, Asian ones like Malaysia and Singapore, and oil-producing countries like Norway and Saudi Arabia. But because the absolute size of their surpluses is larger, China and Germany have inevitably attracted the most attention.

At issue is what these current-account surpluses represent – and what, if anything, the countries that run them should do about them. Many policymakers and commentators in Germany believe that their country's external surplus reflects the 'competitiveness' of its economy. A Bundesbank official likened Germany to a country holding top spot in a football league. Pursuing the same analogy, Germany's finance minister, Wolfgang Schäuble, said it would never occur to him to ask an opposition team to weaken its side to make life easier for the one he supports. And the FT Deutschland's response to British commentators who expressed sympathy with Lagarde's position was to ask what on earth Germans were being expected to import from the UK: Walkers crisps, Doc Martens boots or Marmite?

A few years back, a former chief economist of the OECD, David Henderson, coined the term "do-it-yourself (DIY) economics" to describe "firmly held intuitive economic ideas and beliefs which owe little or nothing to textbooks, treatises or the evidence of economic history". DIY economics, Henderson believed, was ubiquitous. It was as likely to inform the world view of political figures, top civil servants, chief executives, commentators and eminent professors as that of the general public. DIY economics remains as prevalent as ever, as recent German responses to Lagarde's intervention surely prove. These responses are permeated with assumptions and beliefs that sound plausible to the uninitiated, but are just flat wrong.

The most pernicious of all – because it is the source of so much nonsense – is the tendency to think of countries as if they were companies, and of trade balances as if they were profit and loss accounts. The German economy, on this view, can be thought of as if it is Volkswagen. And its trade surplus shows that Germany is winning the 'battle for global market share'. But it takes only a moment's reflection to realise why this is an absurd way of thinking about the matter. One of the world's most productive economies, the US, runs a large external deficit, while some of the most dysfunctional and least productive, from Russia to the Democratic Republic of Congo (DRC), run surpluses. Surely no-one is suggesting that the US should make itself more 'competitive' by emulating the DRC.

Far from being signs of external strength, countries' current-account positions can be symptoms of domestic weakness. And here's the rub. Many of the countries that have run large current-account surpluses over the past decade have suffered from weak domestic demand. One of these countries is Germany. If it had been a closed economy, it would have been in a prolonged slump. As it was, Germany was rescued by the profligacy of foreigners. Between 1999 and 2007, 70% of the growth in its GDP was accounted for by net exports. However, the foreigners that kept the German economy afloat are now mired in debt. In many countries, households and governments are over-extended and need to 'deleverage'. The question now is whether Germany accommodates this process or resists it.

For the time being, the German government shows every sign of resisting it. It rightly urges the deficit countries to become 'more German'. But it fails to recognise that this is an impossible task if Germany does not become 'less German'. This does not mean, as Wolfgang Schäuble claimed, that Germany is being asked to reduce the quality of its products so that other countries can 'compete' (a ludicrous move that would only lower the living standards of foreigners who bought German products). It does mean that fiscal consolidation and private-sector deleveraging in previously profligate countries must, as a matter of arithmetic, be accompanied by a fall in Germany's external surplus. The odd thing about Germany's domestic debate is that few politicians or commentators seem to recognise this.

The notion that trade and current-account surpluses are badges of economic success is deeply pernicious – not just because it is false, but also because it damagingly portrays international trade as a zero-sum competition between countries. The world economy suffers from huge macroeconomic imbalances that need to be corrected. It should be obvious that this cannot happen if countries like Germany (but also the Netherlands and Sweden) are not prepared to allow their external surpluses to decline. Germany was not to blame for the recklessness of countries like the UK. No-one is asking it to reduce the quality of its excellent manufacturing. But Germany must stop fetishising its trade surplus and accept that the chronic weakness of its domestic demand is a problem for itself and the world economy.''

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