Germany shares British weaknesses

This is my latest Perspective column for Fund Strategy.

Some influential figures are suggesting a novel solution to Britain’s economic plight: it should become more like Germany. Although the German economy does have some enviable strengths such calls should be treated warily.

The German economy is not as strong as is often assumed. Indeed an irony of the calls to emulate Germany is that its advocates tend to miss how many of Britain’s weaknesses the country shares.

John Cridland, the director-general of the Confederation of British Industry, has called for Britain to promote its “forgotten army” of medium-sized firms so they can be like Germany’s Mittelstand. He favours more support from the banks and the government to make such firms more competitive.

Meanwhile, Maurice Glasman, an adviser to Ed Miliband, the Labour leader, has also suggested several German-style reforms. He wants more worker representation on corporate boards, more emphasis on vocational training, less focus on banking and making high-end manufacturing a priority

It is easy to see why such calls appear attractive. The German economy grew by 3.6% in 2010 and 3.0% in 2011, according to the International Monetary Fund (IMF) while Britain only managed 2.1% and 0.9% respectively.

Germany’s performance in relation to unemployment is also much better. According to figures from Eurostat the unemployment rate in Germany was 5.5% in December 2011, compared with 8.4% for Britain. Part of the reason for Germany’s lower figure is its short-time working schemes (Kurzarbeit) that keep workers in employment when times are tough.

In addition to the renowned Mittelstand, some of the best-known high technology large firms are German. Companies such as BASF, Bayer, BMW, Daimler, Siemens and Volkswagen are renowned the world over for the quality of their products.

If anything the eurozone crisis has made Germany appear even more attractive. It looks like an island of strength in the midst of a tumultuous region.

All of these points are true but they present a one-sided picture of the German economy. It has considerable weaknesses as well as genuine strengths. For a start Germany’s growth record over the past 20 years is not that good. It has roughly been in line with other advanced economies  – and that is not a particularly high benchmark. Admittedly Britain’s performance does not stand out either.

It also looks likely that this year is going to be even worse for Germany than for Britain. British GDP growth is forecast to hit 0.6% with Germany at only 0.3%.

A closer look at the composition of the growth reinforces the point that Germany has not been the resounding success some of its fans assume. In some senses Germany has been lucky as it has benefited from its strong exports to emerging economies. As the IMF’s annual article IV report noted in July: “The nature of the German recovery and its growth prospects are explained by the prominent role of external demand. More so than elsewhere by far, Germany’s crisis contraction and the recovery were driven by external demand.” The rapid growth of China and Russia were particularly beneficial for Germany. Overall Germany’s export-oriented economy contracted more than most of its peers but then also rebounded faster.

The highly cyclical nature of Germany’s economy also helps explain why firms were willing to use Kurzarbeit schemes. They could hold on to workers for a minimal outlay in anticipation of an economic recovery.

Nor is any discussion of German trade complete without considering the effect of its artificially depressed currency. If it had retained the Deutschemark its exports would have been much more expensive. Adopting the euro has given it a short-term economic boost but at the considerable cost of creating huge imbalances within the eurozone. In that respect it should be remembered that Germany is in the midst of a tumultuous region. It is likely that the cost of trying to stabilise the eurozone will be expensive and it may well end up failing.

Another consideration is that German living standards have stagnated for two decades. Real wages have hardly changed and welfare benefits have been cut. In contrast British living standards rose during the years of the financial bubble and are in the process of falling. Both countries are failing to deliver rises in living standards to their inhabitants.

Perhaps the least well understood aspect of the German economy is that it is also deindustrialising. According to figures from the World Bank the proportion of German GDP accounted for by industry fell from 48% in 1970 to 28% in 2010. The corresponding figures for Britain were 42% in 1970 and 22% in 2010. Britain started from a lower base than Germany and it has fallen to a lower figure. The British economy is also more dependent on financial services than Germany.

But the trend in the two countries is similar. Both have become a lot less geared towards industrial production relative to their economies as a whole. Many commentators would argue that deindustrialisation is natural as the world is reaching the limit of the amount of goods it can absorb. But such an argument ignores the huge distance to go before scarcity is overcome on a global scale. There is still massive scope for improving living standards by increasing global production.

None of these comparisons mean that there is nothing that can be learnt from Germany. There are many areas of technology and engineering where Germany is a world leader.

Nor is the intention to suggest that all is well with the British economy. Britain is suffering from relatively slow growth, deindustrialisation and an inability to consistently raise the living standards of its inhabitants.

The point is that in many respects the two countries share many common problems. Germany has a stronger industrial base but it is also entangled in the centre of the eurozone morass.

Both countries can learn from each other but neither provides anything like an ideal model for others to follow.