03 July 2013

VP Rehn's blog: Germany - 'Wachstum durch Wandel'

14 years ago, The Economist wrote of Germany: “As economic growth stalls yet again, the country is being branded the sick man (or even the Japan) of Europe, inevitably casting a cloud over Europe’s single currency". Germany was criticised for its "byzantine and inefficient tax system, a bloated welfare system and excessive labour costs".

At the start of the euro in 1999, Germany was undergoing a dual adjustment process to unification, with unemployment rates in eastern Germany still around 20 per cent, and to the opening and integration of markets of its central and eastern European neighbours. This process coincided with the introduction of the euro and led to the fact that the eurozone periphery was experiencing falling sovereign risk premia at a time when financial markets were integrating in the EU. The increase in the capital flowing from the core of the eurozone to its periphery came as debt, not Foreign Direct Investment, and it went disproportionately into non-tradable sectors, contributing to overheating.

It has been argued that the necessary economic rebalancing could be engineered in a symmetrical way between current account surplus and deficit countries. However, the reality is more complex, as the eurozone is not a large closed economy, but a large open economy.

The structural shifts over the last 20 years imply that peripheral eurozone countries are less integrated into Germany’s trade structures than is commonly thought - more dynamic domestic demand in Germany would have only a very limited direct impact on the current account of countries such as Spain, Portugal or Greece. Overcoming the current crisis thus depends to a large degree on the capacity to turn around structural economic imbalances, in all countries in Europe. This is why structural reforms are so important: to improve the functioning in our goods, services, labour and capital markets.

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