Why Britain should not view Germany as a role model for economic success

Germany's recent economic success has been much admired across Europe. But an examination of what Germany's model really entails suggest it is not necessarily something Britain should copy as it searches for success of its own. 

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Across Europe, policymakers are casting envious looks towards Germany. From a French perspective, the country’s persistent low unemployment rate is desirable; British policymakers long to copy its relatively robust growth and export performance; and from across the continent, the balanced budget that Europe’s largest economy projects for 2013 seems like something to strive for. But a closer look suggests the German economy might not be the model the rest of Europe thinks it is.

The media outside Germany has developed a nice narrative to explain how the former “sick man of Europe” turned into a new economic powerhouse. According to this narrative, in the early 2000s the German economy was stuck in recession, burdened with a huge welfare state and a sclerotic labour market. Desperate for a way out, then-chancellor Gerhard Schröder began radically deregulating the labour market, and cutting government expenditure and welfare payments. As a result, the economy was set free and started to grow briskly.

As is often the case with legends, the truth is slightly different. On closer inspection, economic and fiscal policies did not contribute much to German success. Rather, its success is a combination of three elements: wage restraint (which has improved international competitiveness); increased flexibility in working hours; and luck. Government policy has only marginally contributed to each.

More than a decade of wage restraint has increased German companies’ price-competitiveness relative to other Eurozone countries, which lacked a national currency that they could devalue. Flexible working times in the form of working time accounts have also helped the German economy to weather the global financial crisis. Firms could have their workers clock-in overtime during good times, and work less in bad times – all without additional cost.

But all this would not have mattered had Germany not been lucky with its manufacturing portfolio. The specific combination of capital goods, luxury cars, and chemicals, produced by German firms for decades, fitted well with demand from fast-growing emerging markets like China, Brazil, and Russia, which have powered the world economy for the past decade.

None of these elements had much to do with Gerhard Schröder. Wage restraint began in the late 1990s, half a decade before his government passed the “Agenda 2010” reforms in 2003. Flexibility in labour hours was negotiated on a plant or regional level between employers and unions, without government interference. And its industrial product portfolio was the result of over 100 years of manufacturing tradition.

But what about the supposedly great labour market reforms? In fact, they did not really make the labour market more flexible. The OECD has found that legal provisions for permanent labour contracts became less flexible during the Schröder years. Laying off workers is still complicated. Instead, these reforms mainly cut benefits to middle class employees who lost their jobs, putting pressure on them to take up any job, no matter how well it suited their profile.

The problem is that this performance came with grave side-effects. First, Germany now has one of the largest low wage sectors in Europe, with hourly gross wages as low as €4 (£3.50). For years, private consumption has essentially stagnated, and it has only started to recover over the past couple of years.

Second, German budget consolidation did not, on the whole, cut wasteful government spending, but rather productive capital spending. From 2003 onwards, German governments have neglected public spending in infrastructure, education, and research and development (R&D). Public investment has fallen short of depreciation. As a result, infrastructure has been deteriorating.

This is now being felt by German companies. Highway bridges are in such poor condition that lorries carrying heavy loads often have to make detours, while some transport infrastructure in waterways dates back to a century ago. It is starting to threaten competitiveness in global markets. As a consequence, productivity growth has been anaemic.

For Britain, there is little to be copied from German policies. Strong wage restraint is not necessary, as improved international competitiveness can be more easily achieved through the weakness of sterling. And the German path of budget consolidation should be avoided: even after the spending boom of the Blair-Brown governments, British infrastructure still leaves a lot to be desired. Setting the axe on public spending on infrastructure, education, and R&D will not help UK companies develop the products demanded in world markets. If Britain’s leaders are looking for a ready-made template for future economic success, they should not look to Berlin.

This article was first published by City AM. See more at: http://www.cityam.com/article/why-britain-should-not-view-germany-role-model-economic-success#sthash.liu027Ri.dpuf