Stephen King: Germans are finally flying the flag. But will their optimism outlast the World Cup?

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The Independent Online

I spent a few days last week in Germany. Although many people have suggested I was there on a corporate World Cup "jolly", I sadly failed to get to a single match. The best I could do was to watch the England-Sweden match on a 14-inch TV in a rather hot hotel room in Munich. Given the quality of the match, perhaps this was a better option than paying for tickets.

Germany was a revelation. For the first time in years, there was a sense of vibrancy, of celebration, of unbridled optimism. This was true wherever I went. Munich, Frankfurt and Cologne were full of happy faces. Of course, should Germany be knocked out of the World Cup as opposed to winning it, this optimism might easily fade. And many of the happy faces weren't German: I saw plenty of cheerful Dutch, Argentinean and Japanese soccer fans.

Nevertheless, the Germans were happy. The most visible sign of national euphoria was the German flag: on my travels around Germany, the flag was flying everywhere. This is a remarkable thing: until this tournament, German celebrations have been typically understated: too many memories of the bad old days when flag flying meant something entirely different. But for today's Germans, despite the burden of history that will always be on their shoulders, flag flying is very much a celebration of the here and now.

Flags are not the best indicators of changing economic prospects. And nor are World Cups. (Then again, the World Cup was held in Japan four years ago and, ever since, Japan's economic progress has surprised virtually everyone.) However, it may be that national events of this kind do have an impact on people's "animal spirits", as Keynes once described the shifts in moods that can so unpredictably affect economic progress. So could it be that Germany, after years of economic struggle, is beginning to turn the corner, moving from a world of persistent economic stagnation to a world of growth and solid expansion?

Well before the start of the World Cup, there were signs of German economic progress. Structurally, German companies had begun to grapple with high labour costs. Their ability to do so was helped by the suddenly-credible threat of outsourcing: with plenty of workers available in central and eastern Europe who were prepared to work for wages lower than those in Germany, German workers had to wake up to the new, more competitive, economic reality. It's a process that has taken time, but has ultimately been rewarding: German exports have been growing remarkably rapidly in recent years.

Cyclically, the signs have also been a lot more encouraging. The most well-known of the German cyclical indicators is the so-called IFO survey, which has been racing upwards over the last 12 months after an earlier momentary lull. The survey covers roughly 7000 firms in manufacturing, construction, wholesale and retail and thus should provide a useful early indication of what's happening to industrial production and, more broadly, GDP.

There's something a bit odd, though, about the IFO results. According to the latest numbers, companies are almost manic in their upbeat assessment of the business climate (although it's worth noting that their expectations about future business conditions have begun to moderate a little). This doesn't quite fit with the output data, which have been nothing like as strong. It's true that GDP growth has picked up a bit and that, within total output, there's been a notable pick-up in capital spending. But if the IFO survey is to be believed, the growth numbers for the German economy really should have been a lot stronger.

One reason for this apparent dichotomy stems from globalisation. German companies may be doing well, but part of their success is a reflection of their spreading business interests in, for example, central and eastern Europe. So although their output and sales might be going up, it's likely that at least some of this good news will have an impact on Polish or Czech GDP, not German GDP. Meanwhile if profits success comes at the cost of lower wages, then it's not so surprising that happy companies don't necessarily lead to happy consumers.

Putting to one side Germany's likely progress in the World Cup, the key question for the German economy is for how long the latest period of good news can continue. Too often in the last 15 years, periods of economic success have been woefully short, with upswings followed all-too-quickly by downswings.

Have things changed? The competitive position has clearly improved. Angela Merkel, the German Chancellor, believes in reforms that should enable Germany to be better placed to cope with globalisation. And Germany finds itself in an economically-advantageous location, right next door to the increasingly dynamic economies that lie to Germany's east. These are all helpful factors.

The constraints, though, have not completely gone. Germany's progress has been partly at the expense of its western European neighbours: the French and Italians are not looking quite as cheerful as the Germans. Can Germany really sustain a decent recovery without progress in these other countries too? Germany, as with many other rich nations, has an ageing population which places a significant demographic constraint on its growth rate. With its export-driven growth, Germany is always vulnerable to a US slowdown. And, unlike the UK, Germany has been slow to embrace the higher levels of immigration that doubtless contribute to a more flexible and innovative workforce.

Put another way, while the uncertainty over Germany's progress in the World Cup has only a few more days to run, the uncertainty over its economic progress will go on for quite a lot longer.

On a sadder note, I'd like to offer some thoughts on David Walton, the external member of the Bank of England's Monetary Policy Committee who tragically passed away last week at the age of 43. He was an outstanding economist and, more importantly, a truly outstanding person. I first met him on joining the Treasury from university back in 1985, when I took over his role in the Treasury's economic briefing department. Apart from his impressive intellect, he demonstrated extraordinary patience and good humour as he helped me grapple for the first time with spreadsheets and the rudiments of the national accounts. I shall always be thankful for his help at that time. We went our separate ways a few years later as his career blossomed at Goldman Sachs and I headed off to HSBC but became reacquainted through his heavy involvement in the Society of Business Economists. I was delighted to discover that, despite the pressures of his many years in financial markets, he hadn't lost any of his admirable qualities. His intelligence, warmth and wit made the sometimes-dry subject of economics a lot more interesting. His death is a huge loss.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com

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