The Forever Surplus

Hard to say whether it’s Brexit or the Trump election or just the clock running out, but one of the good things that seems to have come out of all the recent shakeups is that pressure is mounting on Germany to do something about its persistent, huge, and growing current account surplus – specifically its trade surplus. Though you wouldn’t know it from the domestic press – which prefered instead to run cherry-picked pictures implying that everyone was systematically giving Trump the cold shoulder – the trade surplus was something of an uncomfortable issue at the recent G20 in Hamburg. No one’s taking any coordinated action on it now, but it’s clear the world is starting to get impatient.

Which is why it’s all too predictable that we’re now seeing the same kinds of editorials starting to come out of Germany that we did out of Japan in the 1980s. You may be familiar with the genre: first, admit that running a persistent current account surplus is a probably a bad idea, so as not to seem economically illiterate, but stay fuzzy on the reasons. Then imply that in this particular case, the surplus might not really be the typical "imbalanced" example anyway, it’s just that [country] is unusually economically prudent and productive owing to specialness. Finally, agree that it would be nice to rebalance, but list all kinds of reasons why it’s probably not going to be politically expedient for a while, so people may just have to wait.

A recent piece by Clemens Fuest hits all of these notes and may well be the mad-libs prototype for German editorials over the next couple of months.

Despite the vitality of the German economic engine, and the role it plays in fueling growth and maintaining stability in the eurozone, criticism of the country’s massive external surplus is mounting. As the Economist put it recently, Germany “saves too much and spends too little,” making it “an awkward defender of free trade.” So what is Germany to do? The answer depends on whether economics, or politics, is guiding the decision-making.

Straight from God to the press, people.

And then:

But the truth is, there is no compelling economic reason for Germany to do anything differently. If Germany has any reason to change course, it is primarily for political reasons.

Actually, there are pretty compelling economic reasons for Germany to "do anything differently," but they’re all in the future, and we know that humans are bad in general at taking the long view. It’s a classic case of "seen and not seen." Observe:

The surplus has surged for one reason: prudence. Germany faces the prospect of a fiscal crisis as its population ages and its workforce shrinks. It needs to prepare for a projected decline in pension contributions and growth in health-care costs. … At the moment, it makes more sense to invest the additional savings abroad, because population aging in Germany limits the potential for useful investment at home, and other markets are growing faster.

So the idea seems to be that if Germany is exporting demand now, it’s only because it knows it will not be able to much longer. Eventually, demand inside Germany will grow dramatically, and we’ll rebalance then. That makes a certain amount of sense – especially with regard to healthcare, since Germany isn’t a world leader there but the US, a current debtor, is. The trouble isn’t so much with the idea as the duration. Running surpluses for a while makes sense if you’re going to turn around and spend it. But if "turn around" is arbitrarily far in the future, then at some point the paradox of thrift kicks in, and the foreign markets you’re "investing" in aren’t producing as much as they would be if you’d been buying from them all along. The question isn’t so much whether they’re "growing faster" as whether they’re growing as fast as they can or should be. If you invest in something that’s growing, rather than something that’s growing but faster, then you made defensible but ultimately wrong choice, and you end up with less to spend than you would have if you’d made the right choice.

Look at it another way: if the foreign markets were growing faster for natural reasons, their interest rates should rise. That’s what typically happens when there’s suddenly a lot of demand (relative to supply). More demand means higher prices – including for money. And yet we’re not seeing much pressure – like, pretty much none at all – on interest rates to rise. It’s only quite recently that central banks are starting back into rate hikes. That’s a sign that this demand that’s getting exported isn’t natural. There seems to be an unlimited "supply" of it (har, har) and an unlimited capacity to absorb that – which we know can’t be. Whatever’s happening with Germany’s (and China’s and Japan’s) "invested" money isn’t behaving like a normal investment.

Then we get what would seem to be contradictory evidence:

From 2001 to 2005, for example, Germany’s average current-account surplus was 2.4% of GDP, and average domestic investment was just under 20% of GDP. During the five-year period that ended in 2016, the surplus climbed to 7.3% of GDP, but investment remained constant at 20%.

The argument here seems to be that Germany actually is increasing domestic investment, or we would expect the percentage to shrink with an expanded surplus. That is, if Germany’s economy is growing, but the percentage of that expanding economy that’s being invested domestically holds steady, then domestic investment is getting bigger. 20% of "bigger" is bigger than 20% of "merely big," after all. But this is pulling the wool over our eyes, because it provides no actual evidence that Germany is growing by that much – it just says that its current account surplus is growing. That could mean that the economy as a whole is bigger, but it could also mean that the economy’s structure has changed. Let’s say – and we’ll say it because it’s actual reality – that over the timespan he’s talking about Germany barely grew at all. There’s a lot of fluctuation around 2008 that can make the pattern hard to see, but Germany grows on average by 1% – sometimes even less – over the time horizon that he’s talking about. To the point – it’s been growing a lot slower than its current account surplus has. Therefore – NO, actually, holding domestic investment steady at 20% does NOT imply that domestic investment has been growing at any kind of satisfactory rate. In fact, by some reckoning, though German exports have surged by 115%, Germany has grown at one of the worst rates in the G20 – hovering around 1.2% per annum. All of which just means what we already suspect – that the German trade surplus is not an engine of growth.

Then we get some more prevarication:

Germany certainly could help struggling eurozone economies if it bought more of their goods and services. But more imports and a lower surplus would also drive up interest rates, which is bad for highly indebted countries.

Again, this doesn’t exactly address the question on the table. Driving up interest rates is certainly bad for highly indebted countries, but then again, so is lack of economic growth. If we’re trying to do no damage whatever to "struggling eurozone economies" then whatever we’re doing now clearly isn’t it! The question is whether eurozone interest rates would go up faster than economic growth rates in this scenario. It seems doubtful that they would, given that we have good reason to believe that the whole problem in the "struggling eurozone economies" is too much demand. Germany could really help by importing some of that.

But we shouldn’t be glib about it – because this won’t really get at the underlying problem. He’s right that rising interest rates will ultimately hurt the struggling economies by driving up the value of the Euro – which would sort of limit the outlet for demand to Just Germany, which might not be enough. The problem is that Germany needs to simultaneously rebalance with a foreign market (the US) and a "domestic" market (the rest of the Eurozone), and the existence of the Euro makes it basically impossible to do both at once. So, I concede this is complicated, and there might not really be any good solutions on offer. The point is just that it’s really sort of mendacious to argue that the status quo which everyone can see is not OK is somehow OK just because there might be a bad sideeffect to trying something different. It’s a classic dodge.

Then there are similar prevarications on some of the remedies.

For example, Germany could try to stimulate domestic consumption through more rapid wage increases. But, aside from the minimum wage, the government does not set pay scales.

Not directly, no, but honestly COME ON. If there’s one thing about the German economy that has, throughout the postwar era right up to the present, been the envy of Europe, it’s the almost supernaturally harmonious labor market. If you had to point to one thing that drove the 1950s Wirtschaftswunder, that would be a good candidate. Germany cut a deal with its workers following the betrayals of the NSDAP years. Companies and trade unions would negotiate in good faith for the good of the country – and they have. German workers have, by consent, been underpaid since Reunification – to help finance Reunification. It is not a side-effect of Reunification, it is a result of deliberate policy choices to help fight the rampant unemployment that the country suffered from as a result of Reunification. They were the right policies for the right time, and they’ve been enormously successful, and now that they are counterproductive, they should be shelved. Germany is really very good at consensus politics. The government might not set wages directly, but signalling a new consensus around pay increases would results in pay increases. Generally speaking, such increases are not a hard sell in any country – and here we’re talking about one with a solid welfare state and living memories of extremely generous unemployment benefits that could presumably be brought back in the event of another uptick in unemployment. High wages and an overly-generous welfare state were a bad fit for 1990, but they’re a really good fit for the present.

Finally, it closes on this extremely lame bait-n-switch:

But, in terms of addressing global macroeconomic imbalances, Germany’s critics will be disappointed by such measures. Germany represents 4.4% of global GDP. So a reduction in its external surplus, even by as much as 2.5 percentage points from the current level of 8.5% of GDP, would have a minimal impact on the global economy.

Yes, that no doubt would have been true in 1997 when Germany still issued its own currency from its own bank, but at the moment Germany just so happens to be a member of this grotesque supercurrency called the Euro, and the whole bleeding basis of the argument the world is having is the widespread belief that Germany’s misaligned economic performance relative to the rest of that currency zone drives the overall value of the Euro higher than is ideal for the "struggling economies" to recover whilst the "struggling economies" keep it from rising high enough to rebalance Germany’s trade surplus. Germany may be only 4.4% of world GDP, but it is – at 20% – the clear lion’s share of Eurozone GDP (runner up is the UK at 17% – and they’re not in the Euro). So it is more than a little misleading to talk of Germany as though it were an independent actor. It may be only 4.4% of world GDP, but since it dominates the Eurozone, it has an outsized influence on the worlds secondmost important currency. Which is to say, its current account surplus matters.

So, this article sounds plausible on a superficial read but is actually quite misleading. I expect we’ll be seeing a lot of this as Germany pushes back against pressure to rebalance.

The thing is, rebalancing isn’t just good for the rest of us, it’s good for Germany too. The reason people can’t see that, really, is that it’s too tempting to think of national economies by way of analogy with individual spending – but it just doesn’t work. Or, actually, the analogy is perfectly apt – but only if you recognize you’re talking about a hypothetical world where there are only 200 or so individuals. If I, as an individual among billions, save more than I spend every year, I’m doing right by myself – but only because my individual savings are so small and corporations are happy to use mine and everyone else’s savings as debt to help themsevles grow. That benefits all of us, because when I want to spend my savings, if the economy has been growing in the meantime, there’s more available to buy when I cash out. It’s quite a different thing if I live in a village of only 200 people that produces and consumes all its own goods, and there is no meaningful class distinction between producers and consumers (we’re all equally both). In this situation, if I only ever save, then the paradox of thrift kicks in and my savings mean less gets produced than would have if I’d been spending. Because in this situation not spending means not signalling to the other villagers that there is need to produce more. The net result is that by the time I’m ready to spend my money, there’s less to buy than there would have been if I’d been spending and stimulating. As a consequence, I finish life with fewer toys than I could have had – and so does everyone else. That’s too simplistic – in the real world other countries can of course take advantage of savings that one country is "not currently using" – but over a long time horizon it really does approach the analogy with the village.

The problem with the current world economy is that things seem stuck in a really bad disequilibrium where the normal balancing mechanisms can’t kick in. It’s understandable that commentators in Germany would get a little defensive: whatever’s wrong with the world isn’t all Germany’s fault, and since Germany has generally managed its economy better than almost anyone else in the last 20 years, it can seem that the world wants to punish it for success. But "understandable" doesn’t mean "helpful," and articles like Fuest’s aren’t helping. The point in correcting Germany’s trade surplus now is to avoid having to do it later, when it’s harder and more painful. Since Fuest doesn’t seem to want to correct it now, I think we can fairly ask "when, then?" His essay doesn’t seem to have an answer – and that’s the crux. Because you really, honestly can’t run a trade surplus forever.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>