Why the wheels fell off Germany's economic model

Angela Merkel’s desperate efforts to safeguard thousands of German jobs at the embattled carmaker Opel last week was a potent symbol of the sad truth laid bare by the credit crunch: what was meant to be the mighty strength of Europe’s largest economy — its productive, high-quality, export-friendly manufacturing sector — has left it more, not less, vulnerable to the worldwide recession than the rapacious Anglo-Saxon countries.

It was never meant to be like this. A reunified Germany, at the heart of an expanding European Union and single currency, was supposed to offer a decent, stronger alternative to the “casino capitalism” that Germans have long thought of as represented by the US model that they love to hate. When the credit crunch first broke in the autumn of 2007, bringing banks such as Northern Rock down almost immediately, the Germans allowed themselves a quiet chuckle of schadenfreude along the lines of “we told you so.”
But that was before the financial crisis swept through Germany’s banking system, which turned out to have had its tentacles deep into the sub-prime mortgage market in the US. And it was before the collapse in world trade that Germany had previously depended on to drive its economy.

Britain’s economy is in a mess, but it is not nearly as bad as Germany’s. The UK economy shrank by 1.9 per cent in the first quarter of this year, the worst performance since the early 1980s. But figures this month showed Germany, the largest economy in Europe, contracted by an incredible 3.8 per cent in that three-month period, easily its worst post-war drop and one that has shocked Germans. The government expects the economy to shrink by 6 per cent this year — worse even than Britain’s expected decline of 4 per cent.
“There is a worldwide financial and economic crisis and Germany has been very badly hit because of its long-standing policy of wanting to become the world’s number one exporter,” explains Berlin’s Deputy Mayor and Economy Minister, Harald Wolf. “There has been a dramatic drop in export orders for industry and that will have appalling consequences for jobs. Our banking system is also full of toxic assets so it is far too soon to talk of any recovery.”

Germany is a bigger manufacturer of goods than Britain. The sector makes up a quarter of its economy whereas in Britain or the US the figure is more like 15 per cent. This is because German firms have worked hard to remain competitive in world markets in recent years and to make high-quality products that people want to buy. Exports accounted for 60 per cent of German growth in recent years. The flipside is that it is has got slammed now that other countries don’t want to buy from Germany any more. Exports are expected to drop by a fifth this year.

High unemployment

German unemployment, which fell dramatically in the couple of years prior to the recession, is on the rise again. It is currently about 3.5 million, or 8.2 per cent, and experts fear it could rise back to the level of five million that it fell from in recent years. Unemployment in Britain, of course, started rising at the beginning of 2008 but, at 7.1 per cent, it is still lower than in Germany.

Many employees have been put on short-time working, with their pay being topped up by the government, but analysts warn that this is masking a rise in joblessness. “Under German labour law, firms cannot just sack workers and instead they simply send people home, on sharply reduced wages to twiddle their thumbs until they are re-hired,” says Nick Parsons, of NAB Capital. Jobs are rapidly being cut all across German industry, but particularly in the state of Baden-Württemberg, where carmakers such as Daimler-Benz are situated, and in Bavaria, which is home to BMW and Audi.

It is not just the carmakers themselves that have suffered a massive drop in orders but also all the makers of parts that supply them. Germany’s machine-tool makers have also suffered greatly due to the collapse in world trade.

Germany has become the world’s biggest exporter and sold a lot of machines to China, which the Chinese were using to manufacture goods to sell back to the west.

Collapse in orders

Many of these machine makers make up Germany’s Mittelstand of small and medium-sized companies. They have not only suffered from a collapse in orders; they are heavily reliant on banks for finance, so have struggled to raise credit to tide them through the recession.

Other businesses are in trouble too. Arcandor owns one of Germany’s big department store groups, Karstadt, as well as the catalogue retailer Quelle and the Thomas Cook travel company. It, too, is struggling to raise credit and analysts fear it may go under. But critics say that, like Woolworths in Britain, the firm has long been badly managed and the recession has been the last straw. The authorities certainly seem unwilling to use any state funds to bail out the company, even though it employs 56,000 people. Berlin’s mayor, Klaus Wowereit, said last week: “We are now seeing that several large firms, which already had structural problems before the financial crisis, are trying to solve them with the help of the taxpayer.”

But Opel, General Motors’ German subsidiary, is more likely to get some federal funding to help it to break away from its struggling US parent. The government was locked in talks with potential buyers last week, although critics argue that Germany’s — and Europe’s — car industry has long suffered from over-capacity, so throwing public money at Opel is a waste of time.

Meanwhile, German banks are struggling under an estimated £800 billion of toxic waste relating to the sub-prime mortgage crisis. “In fact, the German banks contributed actively to manufacturing these problems. They made a lot of bad bets,” says Dennis Snower, head of the respected Institute for the World Economy (IfW) in Kiel, northern Germany.

Snower is very critical of the plans of the government of the chancellor, Angela Merkel, to encourage the banks to create their own “bad bank” in which to park their toxic assets.
He thinks the plan is too complicated, lacks transparency and will not solve the problems: “It’s a terrible proposal that will create off-balance sheet bad banks and not do anything.”

Harald Wolf agrees. He says the government’s reluctance to use any public money to combat the problem is a mistake: “This means the problem could drag on for 20 years and we could have zombie banks like the Japanese did.”

All of which means Germany could struggle to return to export-led growth if otherwise decent firms go under during the recession for want of credit to tide them through the slump and allow them to invest in new products.

Germany’s long-running problem is that it lacks domestic demand to take the place of its lost export demand. Consumer spending has barely grown at all in real terms in the past decade, whereas exports rose 80 per cent over the same period. The government’s big increase in VAT last year hardly encouraged people to spend more. This explains why it, in common with other “surplus” countries such as Japan and China, has slumped so deeply and suddenly into recession. It relied on other countries, such as Britain and the US, to run trade deficits as the flipside of its huge trade surplus. If all countries were like Germany and sold more goods than they bought, the world economy could not function.