Angela Merkel and German Exports

One of the big surprises in this recession has been Germany, both negatively and positively. Its economy was among the world's worst-hit. GDP is down 6.4 percent since its 2008 peak, and the depth of Germany's banking crisis is second only to America's. Now Germany is one of the first rich nations to emerge from recession.

Export orders are rebounding, GDP is up 0.3 percent in the second quarter, and unemployment started dropping again in July. So are things back to normal for Europe's biggest economy? That's what Chancellor Angela Merkel would like Germans to believe in the final stretch of the campaign leading up to the national election on Sept. 27.

Despite big questions about the sustainability of the export-driven economic model at a time when the major consuming nations, like the U.S., are in semipermanent decline, the chancellor insists that others could do worse than copy Germany's model. At the G20 summit in Pittsburgh later this month, she plans to tell the assembled leaders that they, too, should adopt the "social market economy." In August, a joint report by leading German economists defended the country's business model—including its dependence on exports for growth. Merkel herself insisted in July on a tour of German factories that Germany must remain "world export champion."

The question that few German politicians ask, however, is whether that model might itself be broken. The country's recent economic success has been almost entirely dependent on an innovative and super-competitive export sector, now generating 48 percent of German GDP, that has flooded the world with sophisticated products from industrial machinery to construction equipment and chemicals. The highly regulated domestic economy, on the other hand, has been virtually stagnant: 80 percent of Germany's GDP growth since 2000 has come from net exports, while domestic retail sales have been flat since the 1990s. The most striking feature of Germany's export prowess is that two decades of riding an unprecedented wave of global demand for German goods has utterly failed to kick-start any recovery of the domestic consumer economy, or increase long-stagnating wages. Instead, the country has racked up a rising trade surplus, reaching 6 percent of GDP in 2008.

These German surpluses, along with China's and Japan's, are the flip side of the debt-fueled booms in the U.S., Britain, Spain, and other countries with which Germany happens to have big trade surpluses. "It's not really coherent to argue that your model is the best when your export surpluses are dependent on the profligacy of others," argues Simon Tilford of London's Centre for European Reform. The fact that these countries now need to save more and spend less is one reason German exports are still 20 percent below last year's peak. Indeed, many of those countries hope to regrow their own economies off the back of rising exports.

In the past, Germany has taken steps now and then to fire up its domestic consumer economy, for example, by liberalizing telecoms and allowing weekday-evening shopping. But sectors like medicine, personal services, and education remain protected and starved of investment. Under Merkel, the average total tax rate rose from 50.7 percent in 2005 to 53.3 percent in 2009, drawing an additional €50 billion a year out of consumers' pockets. Impediments to entrepreneurship remain high; in the World Bank's index that measures the ease of starting a business, Germany ranks 84th.

Germany even has a small-business party, the Free Democrats, that has long protected many of the domestic sectors from reform. While changing these policies would be a slow and tedious process, it would ultimately help move both Germany's and Europe's economies toward a healthier balance.

Merkel's bravado is good electioneering but can't hide the need for reform. Bearish economists like Paul Krugman see Germany turning into Europe's Japan—an aging, shrinking country with an anemic domestic economy dependent on an explosive cocktail of accumulating export surpluses channeled into risky lending abroad. That would make Germany a drag on Europe's economy for years, if not decades.

And it's not even certain that Germany can once again export its way out of the present slump. Global green shoots don't signal anything near a robust recovery, and even Germany's own Bundesbank has warned that the country won't reach pre-crisis GDP until 2013. All that slack in Germany's economy could create a big problem for Merkel after the election. Her defense of the German export model, as well as her near-total abandonment of domestic reforms, make it clear that there is no plan B.

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