The downsides of German growth

The German economy grew at a rate of 2.2 percent in the second quarter of 2010, and while that is good news for Frankfurt bankers and the government of Chancellor Angela Merkel, a growing list of economists say that growth is coming at the expense of the rest of Europe.

"It is wrong to argue that Germany is the growth engine of the European economy, which is what we have seen argued in recent days," said Simon Tilford, chief economist with the Centre for European Reform, a London-based think tank. "It is right to argue that it is a drag."

This year's German trade surplus topped $ 77 billion through May, about 60 percent of that occurring within Europe. Restrained German wage growth - which actually declined in 2009 and is forecast to do so again in 2010 - made goods particularly competitive on international markets and spells bad news for European neighbors, like the Czech Republic, who seek to sell goods to German consumers, Tilford says.

In pursuing this path, Germany depends on continued growth of exports to keep expanding its economy. Not only is this unlikely, but if it came to fruition it would have increasingly detrimental affects on other European economies, which also depend on exports.

While German growth is typically considered good news for the Czech Republic, the growing strength of the crown against the euro - which cheapens eurozone exports and makes Czech exports more expensive - and stagnant German consumer spending make the long-term effects on the Czech economy harder to predict, economists say.

The second-quarter gains for Germany were the largest since reunification in 1990. If growth continued apace through December, it would lead to 9 percent growth for the year. German exports rose 28.5 percent year-on-year, returning to near pre-crisis levels, leading Merkel to refer to the shifts as a "small miracle."

In the second quarter, the Czech economy grew 0.8 percent, and this is good news in the short term for Czechs, says Vladimír Pikora, chief economist with Next Finance, a Prague-based investment consulting firm.

"About 40 percent of our exports go to Germany," Pikora said. "German growth now means the Czech economy will grow more in the second half of the year."

By limiting wages, the German economy is able to limit the production cost of goods, and thus make them more competitive on international markets. However, the effect is that German workers make less money and so spend less, handicapping countries that are dependent on exporting goods to Germany.

"That is where it affects the Czech Republic," Tilford said. 

The Organization for Economic Cooperation and Development (OECD) employment outlook report for 2010 noted that the number of Germans termed to be working in the "low-pay sector" rose from 16 percent of the population in 1998 to 21.5 percent in 2008 - the most recent year where statistics were available. About one-third of current job openings in Germany are temporary work. One recent poll saw four of five Germans respond that they were not benefitting from the recovery.

"The Germans don't consume enough," Tilford said.

While Germany runs massive trade surpluses with most of Europe, the Czech Republic actually runs a trade surplus with Germany. In 2009, the Czech Republic ran a 162 billion  Kč surplus. The Czech Republic is running an 89 billion Kč surplus through June of this year.

Several big name economic experts have argued that by limiting wages - which is done through informal government pressure on corporations and unions - the German economy is crippling recoveries elsewhere. Within the eurozone, artificially stagnating wages has an effect similar to devaluing a national currency elsewhere in the world, making exports cheaper when compared to neighbors.

"Something has gone fundamentally wrong with Germany's attitude toward the European Union," wrote the Hungarian-American investor George Soros in a recent essay. "By insisting on pro-cyclical policies, Germany is endangering the European Union. I realize this is a grave accusation, but I am afraid it is justified."

Nobel Prize-winning economist Paul Krugman has likewise criticized German economic and fiscal policy.

"Germany's consolidation policies don't just negatively affect the domestic economy; they also slow growth in other countries," he told the German daily Handelsblatt in June.

This effect is particularly harsh within the eurozone.

"The situation highlights the risks the Slovaks took going into the eurozone," Tilford said.

Pikora agrees, saying the effects are to be particularly hard-felt in struggling eurozone economies like Greece and Spain, adding, "But if these countries hadn't decided to have the euro, they wouldn't have these problems. They wanted to be like the Germans, but not to behave like the Germans."

Pikora added that some non-eurozone countries like Hungary have experienced similar repercussions in recent months.

"We can't and shouldn't hurry into the eurozone," he added.

The Czech Republic is somewhat cushioned as it maintains the right to manipulate the value of its own currency. One additional advantage of the Czech economy is that some of the country's exports to Germany are not considered consumer goods, but components that go into larger German products - car parts for German-built cars, for example. This would seemingly further cushion Czech exports against the tight pockets of German consumers.

However, as German workers will eventually demand benefits from the recovery in the form of more pay and the relative growth of exports is likely to decline, especially if recovery does not pick up elsewhere in Europe, even German manufacturers would likely face lower demand, thus hurting the demand for even nonconsumer-driven Czech exports.

In short, by keeping wages artificially low in the short term, the German economy is living on borrowed time, economists say.

"The German government needs to stop arguing that wage restraint is a good thing," Tilford said.

In the past year, Germany came under criticism from other European governments for emphasizing fiscal austerity at the expense of economic stimulus. Berlin's reticence to commit to a bailout plan for Greece further bolstered claims that the country was operating in its own interest at the expense of others.

The German economy is growing, and the unemployment rate has dropped to 7.6 percent from 9.1 percent at the beginning of the year, but many insist this success is just short-term and in fact may be a false dawn on the breaking of global recession. 

"I expect a slowdown next year," Pikora said.

As German policy has walked the line promoted by austerity advocates everywhere and has seemingly reaped the rewards, it is worth asking what is so wrong with keeping wages low and making your products competitive for international markets.

"There is vice in excessive virtue," Tilford said.

- Klára Jiřičná contributed to this report.

Benjamin Cunningham can be reached at
bcunningham@praguepost.com