The Agenda

The Overrated German Economic Model

Adam Posen of the Peterson Institute for International Economics has written a blistering critique of the German economic model:

Ideally, a wealthy country should stay competitive through research and development, and capital investment. Instead, total gross fixed investment has fallen steadily in Germany, from 24 percent to less than 18 percent of GDP, since 1991. The recent Organization for Economic Cooperation and Development (OECD) Economic Survey of Germany states that German investment has been persistently well below the rate of the rest of the G-7 leading economies since 2001 (and not just because of the bubbles of the mid-2000s in the United States and United Kingdom). Even the employment mini-miracle and export boom since 2003 were not enough to induce German businesses to increase investment—and public infrastructure investment has been even more lacking.

The other way for a rich country to stay at the top of the value-added chain, and thus compete on productivity, is to invest in human capital—that is, to educate its workforce. In Canada, France, Japan, Poland, Spain, the United Kingdom, and the United States, the share of young workers with advanced education is at least 10 percent higher than in Germany—in most of them, 20 percent higher or more. Germany, moreover, is one of only two advanced economies in which the share of those aged 25 to 34 with higher-education qualifications is the same as, or smaller than, in preceding generations (the United States is the other). Germany has failed to invest in its public university system while the private sector has maintained but not expanded the supply of its famous apprenticeships.

The result is that Germany’s productivity growth has been low compared with its peers. Growth in GDP per hour worked is 25 percent below the OECD average, whether one goes back to mid-1990s or looks at just the past decade—and whether or not one excludes the bubble years for the United States and United Kingdom. With these productivity numbers, it is no wonder German business is competing only by reducing relative wages and moving production east.

I share Posen’s misgivings about the German model. Yet from a social perspective, Germany’s creation of a large number of low-wage and part-time or flextime jobs has much to recommend it. The U.S. has also created a large number of low-wage and part-time or flextime jobs in the post-crisis period, but the German unemployment rate is substantially lower than that of the U.S. One valuable result is that a larger share of the German workforce has been spared the scarring effects of long-term unemployment. (Indeed, Posen is keenly aware of the damage being done by high unemployment levels in the U.S.) Posen acknowledges that German policymakers are operating under constraints, yet he insists that there is a better way:

German underinvestment is the result of deep structural problems in the economy, which are not the fault of its now more flexible labor markets. The export obsession has distracted policymakers from recapitalizing its banks, deregulating its service sector and incentivizing the reallocation of capital away from old industries. Furthermore, public investment in infrastructure, education and technological development could help increase profitable private investment, which would lead to growth with higher wages.

Dependence on external demand has deprived Germany’s workers of what they have earned, and should be able to save and spend. This leaves them dependent on exports for growth, in a self-reinforcing cycle. Most importantly, this means they move down the value chain in relative terms, not up. The pursuit of the same policy by its European trading partners will reinforce those pressures. Wage compression will not be a successful growth strategy for Germany’s or Europe’s future.

For now, at least, German voters seem content to stick with the devil they know. 



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