How Japan and Germany lost their glass slippers

They were the Cinderellas of the late 20th century, now, they've more in common with the Brothers Grimm
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The Independent Online


Once upon a time, Japan and Germany were at the cutting edge of economic performance. In the 1960s, for example, Japan enjoyed output growth of more than 9 per cent a year and Germany was happily chugging along at 4 per cent or so.

By the 1980s, growth in both countries had faded but, even so, a lot of people still thought of Japan and Germany as success stories, at least relative to America's perceived economic failure. After all, both countries offered reasonable growth with low inflation, sensible fiscal positions and current account surpluses. In contrast, the US offered a package of inflationary fears, huge government borrowing and ever-widening balance of payments deficits.

Japan and Germany appeared to have a fairy tale existence. They were the Cinderellas of the late 20th century, emerging from the rags of the Second World War to turn into economic beauties. Now, however, they've got more in common with the Brothers Grimm.

The US economy may be in a bad way and the UK may have its manufacturing recession but, for economic misery, Japan and Germany are in a league of their own. For the 1990s as a whole – measured from the last cyclical peak in economic activity – Japan has managed an annual growth rate of only 1 per cent. Germany hasn't done much better: growth there has averaged a mightily unimpressive 1.4 per cent a year. On the same basis, the US has managed growth of 3.1 per cent a year with the UK at 2.2 per cent.

If you think these numbers are bad, take a look at what's been happening more recently. Japan's year-on-year growth rate peaked at 3.6 per cent in the first quarter of 2000. For the third quarter of this year – based on the numbers published last week – GDP fell year-on-year by 0.5 per cent, a turnaround of more than 4 per cent in just over a year. In Germany's case, the numbers have been almost as bad. Growth peaked at a rate of 4.3 per cent in the second quarter of 2000 and has since fallen back in year-on-year terms to just 0.4 per cent in the third quarter of this year, again a loss of about 4 per cent.

Japan and Germany have had a shared experience: a structurally bad time over the past 10 years and a cyclically rotten time over the past 12 months. This is all a bit puzzling. The recent collapse in growth in both countries is not that different from America's experience. Yet neither enjoyed America's earlier boom. Japan and Germany seem to have the worst of all worlds. They can't enjoy a sustained cyclical expansion. But they have been hit particularly hard during the global economic downswing. "Another fine mess..." as Oliver Hardy might have said.

What's gone wrong? One shared problem is the beleaguered consumer. Consumer spending is shrinking in Japan and is teetering on the brink in Germany. One interesting similarity in both countries is the lack of any impact of looser fiscal policy on consumer behaviour. Japan has been loosening fiscal policy for ages and Germany had a go this year. Yet consumers have taken one look, have thought "oops, future tax liabilities" – perhaps not always to that level of sophistication – and have decided to increase their savings. As a result, the fiscal multipliers have been unusually small.

Beyond consumer spending, however, there are some key differences between the Japanese and German economies.

For Japan, one of the biggest shocks has been the fall in exports. Within the third quarter GDP release, they fell more than 10 per cent year-on-year. In Germany, exports rose almost 5 per cent over the same period. So, whereas Japan has been pulled down by problems elsewhere in the world – and, possibly, by problems with an overvalued yen – the same cannot be said of Germany. Indeed, the euro's weakness may have served to bail out German exporters over the past few months.

For Germany, the big downward surprise has come in the form of capital spending, which fell more than 5 per cent year-on-year in the latest quarter. Japan, in contrast, saw a rise in capital spending of 0.3 per cent over the same period. Within Germany's decline, all areas have been weak. Construction investment has been an open sore for the German economy ever since the end of the reunification bubble. More recently, there has also been a collapse in machinery and equipment investment.

So, although Japan and Germany have had a common consumer experience, their export and capital spending stories differ. Japan's story is tied up with the global downturn and the collapse in technology spending over the past two years. Japan may have performed poorly over the past 10 years but it has, nevertheless, retained its hi-tech abilities. As the hi-tech boom reached its zenith, so Japan's economy finally looked as though it was turning the corner, bailed out by strongly rising exports. That story has now gone badly wrong. Japan's collapsing export story is a legacy of the bursting of the global technology bubble.

In Germany's case, the collapse in capital spending is more difficult to explain. Everyone knows that German labour costs are high and that, as a result, there has been a steady exodus of capital spending out of the country. Yet, this story cannot possibly explain the collapse that has taken place over the past 18 months.

The peculiarity of this particular story is that Germany's capital spending collapse is very much a German collapse. It is not an experience shared by other countries within the euro area. So why should Germany be suffering so much? One aspect of Germany's problem is the old construction chestnut – which is, of course, a story specifically associated with the reunification hangover. More recently, however, it may be that Germany has suffered as a result of its membership of the euro.

When the Bundesbank was in control of German – and, for that matter, European – monetary policy, it tended to set interest rates for German needs, not for European needs. For the most part, this generated squeals of pain from other ERM members. But the Bundesbank was also free on other occasions to cut interest rates to very low levels if the German economy required a bit of monetary stimulus.

Over the past couple of years, this freedom of manoeuvre has disappeared. The ECB sets interest rates for Europe as a whole. Germany can no longer be treated as a special case. Interest rates may have been the right level for the Eurozone but, for Germany specifically, they may have been persistently too high. As a result, Germany's capital spending has been hit far harder than has been true for the Eurozone as a whole.

Japan and Germany are both in a mess. They have both provided poor economic results over the past 10 years. Their recent downswings, however, may have less in common than appears to be the case at first sight. Japan's story may ultimately reflect the bursting of the technology bubble. Germany's story may simply reflect its comeuppance after its prolonged period of monetary control over Europe as a whole.

 

Stephen King is managing director of economics at HSBC.

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