economics

May 11, 2010

Europe’s Stragglers Find Villain: Germany’s Competitiveness

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By BRIAN BLACKSTONE

FRANKFURT—Greece and Europe’s other intensive-care economies face a threat that can’t be solved by cutting public spending or raising taxes: a loss of competitiveness.

And in the eyes of those struggling economies, the villain is Germany—the euro zone’s largest economy—which has emerged in recent years as the region’s most competitive. By raising the competitive bar, Germany makes it that much harder for its neighbors to compete to sell their goods and services at home and abroad, a factor that in turn affects their ability to grow out of their current debt-laden holes.

To be sure, German wages are high, but even higher productivity means it is relatively cheaper to hire workers and produce high-value manufactured products there, even compared with traditionally lower-cost Greece, Portugal or Spain.

“Competitiveness is the key issue in the whole debate” over state finances, says Peter Jungen, chairman of Peter Jungen Holding GmbH, a company that invests in start-ups, and chairman of Columbia University’s Center on Capitalism and Society.

France’s finance minister, Christine Lagarde, caused a stir in Europe last week by openly questioning Germany’s export-dependent growth model, and suggested it consider policies to spur domestic demand.

“Clearly Germany has done an awfully good job in the last 10 years or so, improving competitiveness, putting very high pressure on its labor costs…I’m not sure it is a sustainable model for the long term and for the whole of the group,” she said in an interview with the Financial Times.

By keeping a lid on labor-cost growth, Germany’s exports are able to compete on price despite a high euro. But that comes at the expense of market share for others in the euro zone, critics say. Whereas Germany rang up a €136 billion, or about $185 billion, trade surplus last year, Spain, Greece and Portugal all ran sizable deficits.

Germany countered swiftly. Economics Minister Rainer Bruederle called it unfair that Germany was criticized when other countries had “lived beyond their means and neglected their competitiveness.”

There are three ways for countries to make their products attractive globally: rein in labor cost growth; improve productivity; and devalue currencies. The last option isn’t available to the euro zone, which has a single currency that is, by most measures, still overvalued. The first two, though helpful over time, imply economic pain for years.

Germany has already suffered through that process. Faced with the tech-bubble collapse a decade ago and low-cost competition from Eastern Europe—and tagged as Europe’s “sick man” in the early 2000s—German industry trimmed wage growth while the government enacted tough policies aimed at getting people off long-term unemployment.

It paid off. According to the European Commission, since monetary union in 1999, unit labor costs in Germany have fallen about 15%. They rose 3.5% in Greece over the same time period, 10% in Spain and 13% in Ireland and Portugal.

That doesn’t mean German workers come cheap. Their manufacturing wages and benefits are among the highest in Europe, at about €34 an hour, according to the Institute for the German Economy in Cologne. Greece’s are half that; Portugal’s even lower. But those countries still lost ground because productivity in Germany rose more quickly than in much of Southern Europe. That means German companies could produce more for less.

“You have to align your wages to productivity gains,” said Michael Heise, chief economist at Allianz SE.

Europe’s fringe has to do much more than restrain labor costs, economists say. Spain needs to find new sources of growth to replace the housing bubble that drove growth—unsustainably, in hindsight—over the last decade. Ireland will have to make do with smaller contributions from real estate and finance. Greece must cut the size and salaries of its public sector.

Until that happens, growth will be very slow, as evidenced by sharply higher unemployment in all three countries.

That has a big effect on state budgets. Spending cuts and tax increases, especially by Ireland and Greece, have been heartily endorsed by European officials. The aim is to bring double-digit deficits as a share of GDP to less than the EU’s 3% limit in just three years. There is just one problem: They won’t do much good unless economies are growing, bringing in tax revenue and easing pressure on social spending.

“If countries are not competitive enough and cannot devalue their currencies, economic growth declines, and so does the ability to bring their fiscal houses in order,” said Nicolaus Heinen, an economist at Deutsche Bank Research.

That risk is even more acute if economic growth plus inflation—or nominal GDP—doesn’t keep pace with interest rates governments must pay on their debt, a particular problem for Greece given the high premium Athens must pay to sell its bonds.

Germany isn’t making things any easier. The metalworkers union IG Metall recently accepted a new contract with very low wage growth to protect jobs, an indication Germany is doing all it can to maintain its cost edge.

“It’s good for German exports, but the flip side is Greece and Ireland and Spain have to do even more in terms of labor-cost deflation to catch up,” said ING Bank economist Carsten Brzeski.

To be sure, even Germany’s economy faces some headwinds. Productivity fell almost 5% in 2009 as employment stayed high in the face of a big output drop. In contrast, productivity in the U.S. and China, two big competitors in the global market for high-value manufactured goods, is rising.

Meanwhile, Germany’s politically popular job-support measure, known as Kurzarbeit, may turn out to be a major drag on competitiveness. Under that program, Berlin picks up the tab for some of workers’ wage and social-insurance costs, keeping them in their jobs. But it prevents resources from being moved from one sector to another. “We’re buying social peace but we’re facing a future loss of innovation,” said Mr. Jungen.

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