by Claus Vistesen: Copenhagen
Update: My calculations below have been revised slighlty to show average y-o-y figures in stead of the previous figures which showed average quarterly changes on a y-o-y basis.
In a previous post I have already made a big point out of not lumping the Eurozone together as one single economy here at GEM. At least, I argued that for analytical purposes we should be aware of the caveats involved in doing so. The damn thing about this, of course, is that it demands we look at all the Eurozone economies individually which can become a pointless and thankless task in and of itself. So we do indeed need to look at the aggregate state of the Eurozone whilst at the same time being able to grind it down to country level specifics and in terms of doing this we might want to start with Germany, the biggest member of the Eurozone which also accounts for a little under 30% of the Eurozone economy.
So what is it that is so interesting about Germany? Well, I have already highlighted in my previous post (linked above) that I believe demographics to be important in the sense that the course of Germany's growth will provide an important test case for a hypothesis on how demographics affect the macroeconomic environment. But also more generally the German economy is obviously pretty decisive in terms of overall growth in the Eurozone.
Consequently, as with the Eurozone as a whole in 2006, Germany has also come through the last year quite impressively compared to previous years. In fact, this impressive run in 2006 has lead many commentators to hail the return of Germany towards a sustainable recovery from the recent years of sluggish growth ... some have even talked about a 'goldilocks recovery.' However, I have always been rather reluctant to subscribe to this view and although there can be no denying Germany's impressive performance in 2006 I believe the underlying tale of Germany's growth composition is an important indicator of why we should not perhaps be so optimistic after all. As you might have expected I am going to anchor my analysis in demographics and I really want to stress that I don't do this just because of some sort of fundamentalist view that demographics are destiny to economic growth and performance. I do feel, however, that someone has to talk about this topic and quite frankly I am continuously surprised that noone seems to want to factor this aspect into their economic analysis, especially in Germany where the demographic changes and outlook constitute, after all, fundamental shifts in German society. Essentially, I will argue that the persistently sluggish growth in private consumption coupled with a growth path which is driven more and more by exports are, to a somewhat strong degree, symptoms which are endemic to an economy with a sustained process of ageing such as that which is to be found in Germany.
Consumption in Germany - Sluggishness or Outright Decline?
One of the most striking features of the German economy in the last 25 years with exception of the post-reunification boom is the continuing decline in household consumption growth. Let us scrutinize the facts for a moment.
The figure above from a paper by Adam S. Posen (summarized here by Wolfgang Munchau) shows this development with the exception of 1990 and the re-unification which is excluded in the figure. However, the time series ends in 2001 and I guess that we should also try to account for the period from 2001 onwards in order to try to get a full picture. Now; I should say here that the number crunching gets a whee bit complicated here but I still think we can get a pretty good estimate of the evolution of things. As such, my rough calculations on price adjusted private consumption expenditure figures from 2002 through 2006(Q1-Q3) show an average increase in private consumption in percentage change of previous year of 0.14%. However, if we exclude the first three quarters of 2006, during the years 2002 through 2005 Germany actually recorded a slight average decline in private consumption of -0.68% y-o-y. This should perhaps indicate that the impressive year in 2006 needs to be explained by other factors, like forward purchasing as a result of the VAT hike perhaps? Only yesterday the 4th quarter figures were released and they point to a strong growth stint in Germany and indeed in the entire Eurozone. However, these figures are still subject to revision, and it is worth bearing in mind that the OECD private consumption index (2000=100) shows for the same period (02-05) a stagnation in private consumption relative to 2000 PPP figures. Essentially, it should be quite clear though that private consumption growth in Germany over the past years has not exactly been rampant and the question of course imposes itself ... why is this? Ageing and demographics surely are not the only explanation but let me put it this way. The hypothesis of a strong life-cycle component of economic growth composition is in this case an 'all things equal argument' and in the broader picture sceptical consumers or not it we should only expect the process of ageing to weigh even heavier on the German consumer's propensity to save relative to consume.
Another related issue to the scrutiny of consumption is the contribution of demand to GDP growth. This has two aspects. First of all we have domestic demand's contribution to real GDP growth and secondly we have the total share of demand (private consumption) in nominal GDP. Looking at the former a recent IMF paper on Germany's exports' share in GDP growth which I will return to later provides a telling figure. Once again the reunification boom stands out as somewhat of an irregularity from the general trend.
As we can see in the figure the contribution of demand to real GDP is pretty volatile over the entire time series but if we factor out the reunification boom domestic demand's contribution to real GDP growth has steadily declined since 1994 and especially from 1999 and onwards we see that the emergence of an export driven growth path has become pretty clear. Moreover if we look at the total share of private consumption relative to nominal GDP calculations from the national account figures we can see that private consumption is now just shy of 60%. My concrete calculations show a 59% share of private consumption in nominal GDP between 2002 and 2006 a figure which is relatively stable y-o-y; that is to say, you have to go into decimals in order to track such a slight decline. This figure is of course in striking contrast to younger societies such as India for example where private consumption accounts for about 70% of GDP but also with economies such as the UK and the US where the consumption share of GDP is much higher than in Germany. Why? Well, take a look at the demographic differences between these countries and you should have a pretty good bullseye to go by I would say.
German Exports - Steady as She Goes?
Where Germany's private consumption growth, share of nominal GDP, and contribution to real GDP growth seem on the decline over a more or less extended time series, German exports have, especially since 2000, taken up the baton from domestic consumer demand in contributing to real GDP growth. As I reported in a previous analysis German GDP growth from 1999-2005 averaged 1.2% of which four fifths (0.8%) were due to net exports. By conducting a mirror of the consumption calculations carried out above my calculations show that net exports in Germany averaged a growth rate y-o-y of 1.32% between 2002 and 2006 (Q1-Q3). Between 2004 and 2006 the surplus in trade in goods and services has stood steady at 5-6% of GDP. Another interesting perspective on German exports come from a recent IMF paper (mentioned above) which sets out to explain the rebounding market share of Germany's export sector. The paper is excellently summarised by Wolfgang Munchau over at EuroIntelligence. Essentially, the paper argues that specific ties to fast growing trading partners and the successful exploitation of regionalized production and value chains have been strong contributors to the rebounding market share of Germany's export sector. Interestingly, the paper somewhat goes against the so-called global labour arbitrage theory which argues that wage moderation in developed economies have been necessary in order to compensate for the emergence of especially India and China on the global stage. Indeed, Germany has experienced considerable wage moderation from the mid 1990s and onwards. This is especially evident internally in the Eurozone where the decline in Germany real effective exchange rate has caused many to speak of a beggar-thy-neighbour policy conducted by Germany vis-à-vis its Eurozone colleagues. However, whereas the German exports indeed have been strengthened in an intra-zone perspective the paper dismisses this factor's contribution to the overall increase in Germany's export market share. This is interesting in so far as the general argument on the importance of global labour arbitrage which is also sometimes argued to be the source of exactly sluggish domestic demand in for example Germany and Japan.
Obviously, this remains a very powerful and potent global economic dynamic but we need to look at it alongside another global phenomenon, namely that of ageing and essentially the build-up of demographic imbalances as a result of countries' asymmetric paths through the demographic transition. The thing which stands out in the IMF analysis as the main reason for Germany's growing international export market share are the ties to fast growing trading partners. I don't believe that you need to think long and hard to guess that these trading partners include prominent global players such as India and China, but it is also interesting to note how the petroexporters are singled out by the paper. I find this interesting since some of the very recent news coming out on the Germany tends to suggest that these conditions are changing. As such, exports declined in December 2006 for the second consecutive month but, more importantly, one thing which is highlighted is how, for example, industrial products sold to China are declining as China is moving up the value chain and thus becoming able to produce these goods domestically. Once again, the evidence of another strucutural shift here is just one more reason why we should be very cautious in terms of hailing the sustainable and even goldilocks recovery in Germany.
Conclusion - Once again, strong circumstantial evidence
What I have essentially tried to argue above is once again the attempt to account for a life cycle component of growth in an ageing society. I am duly careful of course and as such the evidence is circumstantial and not conclusive but I do not think it is unreasonable to claim that demographics have somthing to say. In the case of Germany there might indeed be other factors at work holding down consumption but as Germany ages we should only assume that the life cycle consumption component will increase and as such the Germany economy may well become structurally even more biased towards a growth path driven by exports. In the end I am really not a fundamentalist and demographics are not destiny to economic growth but I am pounding away in order to clarify that demographics indeed do matter and that we need to understand how they interact with the macroeconomic environment.
In terms of Germany it is in many ways a good day to address this. The GDP growth figure for 2006 is likely to be upped to 2.7% and as such the proponents of the goldilocks recovery should feel vindicated. However, I am not optimistic about 2007 and the reason is not necessarily that Germany will plunge into recession but rather cautious given that the VAT hike which was in some ways necessary has been coupled with a vigilant ECB whose interest rate hikes may well depress private domestic consumption even more given the already strong structural forces which are in play. In 2006, domestic demand is likely to have contributed strongly to GDP growth but given the very special situation in 2006 where for example consumers have pushed forward purchasing before the VAT hike I just do not expect this rampant pace to be sustainable and I am even a bit pessimistic on the downside too. Also if exports are also set to run into difficulties there is no time for complacency I would say. Generally, the demographic outlook in Germany is of course set to have huge consequences for economic growth going forward and this is epitomized by the figure below taken from a research note from Deutche Bank (linked below). This is of course a model simulation but it should give an idea of what we are talking about.
The last intriguing point I would like to highlight is the angle provided by the paper from Adam S. Posen cited above which actually compares the economic performance of Japan and Germany since the beginning of the 1990s. As Munchau puts it in his summary ...
Japan’s stagnation began with an asset price crash; Germany’s was brought on by unification. In both cases, lousy economic policies made a bad situation worse.
Now, as you will read in the paper or in Munchau's well written summary we should not merely look at demographics and as such the need for structural reforms in both countries and following from Adam S. Posen's main points Munchau makes the following point ...
I have no doubt that Germany will eventually do the right thing, but Japan is currently ahead of Germany in terms of reforms. It is therefore rational to consider Japan’s long-term economic prospects as brighter.I have no doubt that this is true in the sense that both countries should pursue reforms, but reforms addressing what and why? This is the question I think. In fact, there can many good reasons to compare Japan and Germany and one of them is demographics since these two countries are amongst the oldest societies in the world. This is why I think that if you want to compare Germany and Japan from the beginning of 1990s and onwards you need to incorporate demographics and its impact. Otherwise you won't get the right story ... pure and simple!
References to figures:
1. Adam S. Posen - IS GERMANY TURNING JAPANESE?
2. Stephan Danninger and Fred Joutz - IMF Working Paper, What Explains Germany’s Rebounding Export Market Share?
3. Deutche Bank Research - The demographic challenge Simulations with an overlapping generations model