Hamish McRae: What we can learn from Germany

We need to learn from Germany. No, not how to recreate an engineering-based economy, though this is currently a fashionable notion, but rather how to maintain financial discipline through the global downturn and deliver solid growth as demand resumes. For Europe's largest economy has become one of its fastest-growing, racing up at an annual growth rate of 9 per cent in the second quarter. That growth has helped cut unemployment every month for the past 14 months and it is now down to 7.6 per cent, a wee bit below the UK at 7.8 per cent.

Of course, that growth will not be repeated over the year as a whole. The spurt is in part a reaction to a very sharp dip, as sharp as we have experienced in the UK. Nevertheless, for Germany to have lower unemployment than the UK does carry a powerful message. We have, with some justification, prided ourselves on our flexible labour market and during the boom years, we certainly created a lot of new jobs. We have also responded flexibly to the fall-3off in demand, with the private sector being innovative in shifting to part-time work and holding down pay, with the result that unemployment has risen less than expected. But the plain fact is that for German unemployment to be lower than that of the UK reverses the relationship of the past generation.

So we should learn from that. But what? Well, in the early stages of the recession the total was cut by government-sponsored employment schemes but the growth of employment over the past year has been a direct result of rising demand, particularly for exports.

There seem to me to be at least three lessons we should take away from all this. The first is that Germany is reaping the rewards for a decade of cold turkey. We can now see that it joined the euro at the wrong rate: the deutschmark was overvalued and wages and other costs had to be clamped down to allow inflation in the rest of the Eurozone to equalise costs elsewhere. After this decade Germany now has lower unit labour costs than most of the rest of Europe: it is hugely competitive. This has however been achieved at a price, which is very little rise in living standards for a decade. This has inculcated a culture of thrift, so that even when people have higher incomes they tend to save these rather than spend them.

Germany has come in for some criticism for this. If Europe's largest economy does not consume more, where will demand in Europe come from? The north/south divide in the Eurozone has become ever wider, with the Club Med countries allowing costs to rise and now unable to devalue their currency to get their competitiveness back. Slower growth (or even no growth) compounded their debt problems. Germany, by contrast, has its debts under control.

That leads to the second lesson. There is no need to run huge fiscal deficits to nurse an economy through recession. Germany went into the downturn with a relatively large national debt of more than 60 per cent of GDP, a contrast to the UK, which had less debt than 40 per cent. Germany's debts were in part a legacy of the costs of reunification, in part lax fiscal policies in earlier years. But just before the downturn the country had pulled itself back to fiscal balance, and this year it will have a deficit of 5.7 per cent of GDP, little more than half that of the UK. Bottom line: they have come through this crisis in better shape that we have because they have been more disciplined in their fiscal management.

And the third lesson? It seems to me that countries should not have grand plans to reshape their economies but simply focus on what they are good at. Germany is the world's second largest exporter of goods. So who is the world's second largest exporter of services? Well, actually it is the UK, second to the US. Germany has not planned to become such a successful exporter. Rather its companies, including its many middle-sized ones, have pursued excellence, with wonderful results. The UK and indeed the various other economies have chosen different paths, but that is fine too.

Finally, criticising Germany for unbalancing the Eurozone economy by exporting too much and importing too little, seems to me to be pointless. The country is not perfect in its economic management but there are things we – and the rest of Europe – can learn, especially that fiscal discipline need not lead to higher unemployment.

The bright side

Differing trends in UK finance confirm the "half-empty, half-full" pattern of recent months. On the empty side are the continuing low number of new mortgages, with the ITEM club – the independent economic forecasters who use the Treasury model – predicting a double-dip in house prices. The flow of funds to individual borrowers in the form of consumer credit is also weak. But if you look more generally at what is happening to money supply the numbers are not too bad. Money supply on both measures has been rising for the past months, suggesting that the cash pumped into the economy by the Bank of England has not been disappearing into some black hole. Companies may individually complain about getting bank loans but, taken as a whole, the company sector is cash-rich and investment is recovering. We are all just being cautious and who can blame us?

h.mcrae@independent.co.uk

For further reading

'The German Economy: Beyond the Social Market', by Horst Siebert, (Princeton, 2005)