Hamish McRae: Five million reasons why Eurozone needs to boost consumption levels

Five million unemployed in Germany. Headlines matter and the fact that this stunning figure has been boosted by a change in the way the authorities calculate the numbers in no way diminishes its impact.

Five million unemployed in Germany. Headlines matter and the fact that this stunning figure has been boosted by a change in the way the authorities calculate the numbers in no way diminishes its impact. For German unemployment is not just a German problem. It is a problem for the entire eurozone and to a lesser extent for European countries outside the eurozone, such as the UK.

There is a perfectly respectable argument that Germany is a special case in that it has had to cope with the burden of reunification. But that was 15 years ago. You would expect by now that the former East Germany would have begun to be in OK shape to stand up on its own. We now know that the West Germans made huge policy errors at the time of reunification but even allowing for that, the economy ought to be doing better.

There is a further puzzle. The German company sector is doing rather well. Indeed on one measure, exports, Germany is the champion of the world. Last year, according to calculations by the Ifo Institute, it passed the US to become the world's largest exporter of goods, with $909.3bn (£482.9bn) against the US's $800bn. Add in service exports and the US is still larger than Germany - and note that one reason for this surge in exports is the overvaluation of the euro against the dollar. Nevertheless, it is still an extraordinary achievement and a stark contrast to the army of the unemployed. There can't be much wrong with the German private sector; the problem must be with the public sector.

By coincidence, these figures come at a time when the Lisbon Agenda - the effort to bring Europe's economic performance up to that of the US - is being relaunched. For those of us who believe that top-down efforts by government to improve economic performance are doomed to fail, this relaunch will seem a bit of a waste of time. But accepting that the original Lisbon programme has failed is a start, for until you acknowledge failure you cannot do anything about it. The uncomfortable question is whether Germany's experience will become that of the eurozone as a whole: good companies held back by poor governments, with the unemployed paying the price.

Mercifully, there are some modest grounds for hope, at least as far as Germany is concerned. Let's first get the bad news out of the way.

These new unemployment numbers have to be qualified in two ways. One is that the numbers are inflated by the Hartz labour market reforms, which among other things require people receiving certain types of benefit to sign on as unemployed if they are to continue to get them. That has added some 200,000 people to the register (see first graph). The other is that Germany's official unemployment figures are higher than the standardised European ones. They were at 9.9 per cent and while the new ones are not yet available, they will show unemployment still close to that level - the whole idea is that they should iron out statistical distortions.

Next, while of course the figures are still very bad, employment is creeping up. That is the result of special government schemes designed to boost jobs, for regular employment is still contracting (see next graph). Nevertheless, the rate of contraction is slowing and while some of the special scheme jobs are artificial, many are real - they just happen to be part-time and so don't qualify as regular employment.

Moreover, many companies have renegotiated terms of employment with their workforce to try to stem the loss of jobs. True, German labour costs are still very high both in absolute terms and by comparison with those of the other big European nations (third graph). But the pressure of the lower-wage economies in Eastern and Central Europe has forced reform and it looks as though the exodus of jobs and investment to the new EU member states is easing back.

The main problem of Germany is not on the production side but on the consumption side. The final graph shows how household consumption and retail sales have been negative for most of the past three years. It is not much fun to live in a country where living standards (or at least consumption) get a little bit worse each year but people who are frightened of losing their jobs are going to be careful about their spending. But if spending remains negative, it is hard for companies to grow and employ more people. Somehow the cycle has to be broken.

This is an issue for Europe as a whole - or rather for the eurozone, for the UK has no problem increasing consumption. Cut interest rates and up it goes. There have been a string of interest rate rises in an effort to cap the growth in consumption here and only recently do these seem to have much effect.

By contrast, there is not really much scope for cutting interest rates in Europe. If rates are 2 per cent and people don't want to borrow, why should they borrow at 1 per cent? And these are of course short rates. If you want to borrow long term, say for a house, euro rates are not so much lower than comparable UK ones. So even if the ECB were to cut rates, and at the moment it gives no sign of wanting to do so, it is hard to see there being much of a boost to consumption. Europe may get an emergency cut in rates were the euro to strengthen even further against the dollar but the purpose would be to try to hold the exchange rate down, not boost consumption.

If this line of argument - that the prime problem of Germany and much of the rest of the eurozone is consumption, not production - then the guns of the Lisbon programme are facing in the wrong direction. They should not be attacking blockages to progress on the production side of the economy - poor scientific education, lack of enterprise finance and things like that. Instead they should be fired at blockages on the consumption side.

These include high transaction costs for buying and selling of property, high marginal rates of taxation that encourage people to take more of the wage in leisure rather than pay, restrictions on shopping hours, poor consumer credit facilities and so on. These would be a necessary but insufficient condition for change - there have to be labour market reforms too. But while changes designed to increase consumption would not of themselves transform attitudes to spending, without them people are not going to ease up and spend more. And until they do so, the eurozone's growth will be stunted.

Already the private sector forecasters are cutting their projections for eurozone growth this year: numbers like 1.9 per cent are being shaded down to 1.7 per cent, with of course lower figures still for Germany. Growth at this level is insufficient to permit much of a cut in unemployment and the really frightening thing is that the eurozone may head into the next down-phase of the global economic cycle with double-digit unemployment in its largest economies.

Meanwhile, the German jobless numbers should concern us all. They may not be quite as bad as they appear and the export end of the German economy is as wonderful as ever. But all Europeans should ponder the paradox: the world's most successful exporter cannot create enough jobs to keep its people in work.