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At first blush this may seem to be a pure economic story but there is
a powerful political risk component in that the Germans may not wish
to be the economic locomotive since they feel the crisis was created
by many governments profligate policy while Germany was prudent.

Michael


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Has Germany become Europe's locomotive?

by Philip Whyte, 2 September 2010

The German economy has been growing exceptionally strongly of late. In
the second quarter of 2010, it expanded faster than any other economy
in the G7 and faster than at any time since the country's
reunification in 1990. Industrial output is surging. The rate of
unemployment has been declining for over a year and is now well below
the eurozone average (let alone levels in the US). Consumer spending
and business investment are picking up – and households and firms are
generally less burdened with debt than their counterparts in highly
leveraged economies like the UK and the US. Germany, in short, seems
to have emerged strongly from the Great Recession. Indeed, some
observers think it has entered a self-sustained recovery – and that it
is starting to act as Europe's 'growth locomotive'.

If this were true, it would be welcome. Over the past decade, Germany
has not been a great source of demand for the world or the European
economy: in real terms, domestic demand is only about 3 per cent
higher now than it was back in 2000. For most of the noughties,
Germany was structurally reliant on exports for its economic growth:
without debt-fuelled spending elsewhere in the world economy, it would
barely have grown at all. So any sign of a sustained recovery in
German domestic demand would be good news for the country itself and
the rest of the world. Not only would it reduce Germany's reliance on
unsustainable (and hence destabilising) foreign profligacy. It would
also allow the eurozone and the world economy to rebalance at a higher
level of output and employment than otherwise.

Sadly, it may be premature to conclude that Germany has embarked on a
durable, self-sustained recovery that will help to lift growth
elsewhere. Much has been made of the scale of Germany's rebound in the
second quarter of 2010. But it needs to be placed in context. Germany
resembles a bungee jumper in the spring-back phase. It is rebounding
faster than neighbouring France. But this is partly because it fell
much further on the way down. The size of Germany's manufacturing
sector has resulted in greater output volatility. Germany was hit
disproportionately hard in 2008-09 when manufacturers scrambled to run
down stocks, but it has since benefited as the stock cycle has
reversed. Even after its recent rebound, however, German output is
still lower relative to pre-crisis levels than in France.

Besides, the pattern of the recent upturn casts doubt on the view that
Germany is acting as a 'locomotive' for other countries. The pick-up
in domestic demand in the second quarter of 2010 came after three
consecutive quarters in which household consumption fell. As for
business investment, it is still a long way below pre-crisis levels.
If Germany really had become a locomotive for the rest of the EU, net
trade would be exerting a drag on its own economic growth. Yet the
reverse is the case: net trade has boosted German GDP growth in three
of the past five quarters. True, exports to Asia are making a greater
contribution to growth. But Germany's recovery is doing little to
rebalance activity in the EU. Indeed, Germany's trade surplus with the
rest of the EU has risen compared with the first half of 2009.

There is a final reason to be sceptical about the prospect of Europe's
largest economy becoming a locomotive for the rest of the EU: it is
not clear that German policy-makers want it to become one. As far as
they are concerned, the global financial crisis has discredited
profligacy and vindicated German prudence. The lesson of the crisis,
they believe, is that countries must learn to live within their means.
For them, the direction of change is clear: it is for the erstwhile
dissolute to shape up, not for Germany to become more spend-thrift.
Any suggestion that Germany needs to adjust tends to be met with
bemusement, irritation and contempt. Germany has no lessons to take
(least of all from irresponsible Anglo-Saxons). And any attempt to
hobble German 'competitiveness' will be fiercely resisted.

The hopes currently being vested in Germany may consequently be
misplaced. The strength of the country's recovery is partly an optical
illusion created by the depth of the downturn which preceded it. Much
of the recovery is being driven by net trade. Domestic demand is still
fragile and could weaken as the government's fiscal stimulus is
withdrawn and the stock cycle becomes less favourable. And German
policy-makers have yet to be persuaded that it is in their country's
interest to reduce its reliance on export-led growth. In short,
Germany is not yet acting as a 'growth locomotive' for the rest of
Europe. And other EU countries, particularly in the highly indebted
geographical periphery, may have to get used to the idea that the
region's largest economy may not be about to become one any time soon.

Philip Whyte is a senior research fellow at the Centre for European
Reform.