Dogma and complacency put the German economy at risk

For an economy as export-dependent as Germany’s, trade wars are the ultimate nightmare: they throw sand into the wheels of global value chains, create uncertainty about future trade and reduce investment.

The current spat between China and the US has taken its toll on the German economy: in the second quarter of 2019, it shrank as a result of declining exports and car production, and the data currently available for the third quarter suggest things will become worse.

Most Germans remain fairly relaxed about the economic downturn. After all, Germany is near full employment; wage growth has been solid, if not stellar, at about 3 per cent a year for a decade; and the public purse is so full that its fast-ageing society can afford a debate about which pensions to increase first.

Such complacency may be ill-advised. There are three warning signs it would be dangerous to ignore. First, while German manufacturers are still highly competitive and the envy of the world, they are not investing enough in the future.

Productivity growth is markedly slower than it had been before the financial crisis; only the car manufacturers have so far bucked that trend. Private investment has only recently picked up after a long lull, leaving Germany’s net capital stock per worker roughly at the same level as it had been in 2002.

The stock of “knowledge capital” such as software and organisational expertise is growing more slowly than in the US or France, according to DIW Berlin, a think-tank. As a result, German technology is at risk of going of out date, with the diesel engine only the most prominent example. Germany also lags behind in innovation. The OECD notes that sectors in which the number of patents are growing fast (such as information technology security or semiconductors) are dominated by the US, China, Japan, Korea and Taiwan.

The second sign of complacency is in the poor state of Germany’s infrastructure. Its physical infrastructure is in dire need of repair, after two decades of under-investment. One in eight of its 40,000 bridges along major roads and highways is no longer in adequate condition, according to official assessments; some key bridges across the Rhine had to be closed to heavy traffic as a result, causing expensive delays.

Germany’s rail services fall a long way short of international clichés about their quality and punctuality. Fast fibre broadband is a niche product. And while other countries are rolling out 5G mobile networks, there are large swaths of Germany in which citizens are lucky to connect to a 4G signal.

The third sign is in the labour market. There are already more than 1m job vacancies, and the workforce is bound to shrink by up to 6m over the coming 15 years, net migration notwithstanding. What is more, the flow of migration from eastern Europe, Germany’s preferred pool of additional workers, is slowly drying up. As a result, there is a growing list of professions for which the country is seeking qualified migrants from outside Europe.

The improved quality of education in the past 15 years is running into a serious shortage of teachers. At the same time, there is untapped domestic potential such as women working only part-time jobs, retirees willing to take part-time work and low-paid workers wanting to upgrade their qualifications.

These challenges have something in common: they arose because of a lack of political ambition, creative reforms and sufficient investment when times were good. They also all provide Germany with unique opportunities: the downturn focuses minds and the low interest rates that come with it provide the ideal backdrop for bold investments.

Some good ideas are already in the making, such as helping workers with additional training; modernising and extending rail tracks; putting together a climate investment package; and helping indebted municipalities so they can invest. But these are the low-hanging fruit. The tough nuts to crack will be changes to the tax code to give married women stronger incentives to work more; initiatives to improve early childhood education and childcare; and stronger integration efforts to bring foreign-born women into the workforce.

Germany also needs to change business tax codes to provide incentives for private research and development, equity funding and to help start-ups find investment. Most importantly, it needs to put together a credible, long-term and sizeable investment plan so that private companies, in turn, invest in their own capacities. Ideally this would happen alongside the rest of the EU, to meet challenges such as climate change, and to master the technologies in which the US and China currently lead.

What is missing, as so often, is the political will. The German centre-right need to let go of their obsession with balanced books, which is economically illiterate and harmful to the future generations it is meant to protect. They won’t. The Social Democrats would need to focus on investment and private businesses, not redistribution and the public sector alone. But they lack direction and leadership.

As chancellor, Angela Merkel failed to prepare the economy for the future, and her grand coalition does not currently have the numbers for another term. The best political hope are the Greens, the party most willing to challenge Germany’s dogmas.

The writer is chief economist at the Centre for European Reform.