Waiting for German Domestic-led Growth

Stephen Silvia

American University

Dr. Stephen Silvia is a Geoeconomics Non-Resident Senior Fellow at AICGS. He is a Professor of Economics in the School of International Service at American University, where he teaches international economics, international relations and comparative politics. He researches comparative labor employment relations, and comparative economic policy, with a focus on Germany and the United States.

Criticism of German domestic economic policy has reached unprecedented intensity in recent weeks.  The United States Department of Treasury and the European Commission have both called out Germany for its substantial current account surpluses and asked German policymakers to take steps to restore balance. Superficial commentary has explained Germany’s large surplus as a product of temperament akin to the fable of the ant and the grasshopper.  Germany is said to have discipline and drive, whereas the European periphery is depicted as feckless spendthrifts.  A deeper analysis, however, shows that structure and interest, rather than character, are better explanations of the imbalance. Uncovering the actual sources of Germany’s imbalance makes plain the unlikelihood of righting it any time soon.

Three developments account for Germany’s current account surplus: a surge in demand for producer goods from the world’s rising economic powers in Africa, Asia, and Latin America; weak German domestic investment; and soft domestic consumer demand. Of the three, domestic demand is the biggest component, and it drives domestic investment. So, it deserves the closest attention.

Why is German domestic demand chronically weak? In the old days, analysts attributed it to a vigilant Bundesbank. When the German central bank reigned supreme, its leadership – steeped in the conviction of German economic orthodoxy that price stability is paramount – made clear that it would respond to any wage growth deemed overly aggressive with monetary tightening sufficiently strong to neutralize its stimulatory effect. German trade unions perceived the threat as credible and practiced wage moderation as a result. The introduction of the euro ended this old equilibrium.  Monetary policy is now regionwide in scope, and the back-to-back financial and euro crises have undercut the credibility of any threat by European central bankers to raise short-term interest rates in response to forceful wage increases. Nonetheless, German trade union officials have not taken advantage of this novel opportunity to run up wages. Why not? It is not in the interest of their organizations to do so.

For decades, German trade unions have suffered steep membership losses. They have consequently pursued policies that curb membership attrition. In particular, since the early 1990s, Germany’s powerful union in the mechanical engineering sector, IG Metall, has exchanged substantial wage moderation for employment protection. Agreements that limit job reduction to attrition benefit only the small share of union members who would have otherwise been laid off. The rest, already secure in their jobs, simply receive lower wages. A preference for collective solidarity is the official explanation for this choice, but a strong organizational motivation also underlies it. Wage increases below the inflation rate in exchange for firing freezes not only saves jobs, but also curtails the loss of dues paying union members. If IG Metall only set wages for its own membership, the impact of this preference for employment protection to slow membership decline would be neutral on aggregate domestic demand. Since IG Metall is the pacesetter for wage increases in the entire economy, however, its leaders’ preference suppresses wage growth for Germany as a whole.

Last year, IG Metall managed to increase the number of its actively employed members for the first time since German unification in 1990. Still, the union is unlikely to abandon its policy of wage moderation because the demographics of the mechanical engineering sector are not conducive to rapid membership growth. There are no rival unions with the power or influence to change things.  The chemical workers union, IG BCE, is if anything more moderate than IG Metall. The leaders of Ver.di, the public and private service sector union, have moments of verbal militancy, but the union does not have the organizational capacity to see them through. Occasionally, a small union with skilled members in a key economic position, such as train drivers, will be able to secure sizable wage increases, but such successes are too small and too far between to affect demand. Consequently, the likelihood that Germany is going to generate domestic-led growth any time soon is about as high as the arrival of Godot. German managers know this. It is one reason why domestic investment has been lackluster for decades.

To be sure, the imbalance in the German current account is likely to recede somewhat in coming years. The investment boom in Africa, Asia, and Latin America has peaked, and demand has fallen sharply on the periphery of Europe. Still, these factors are too small to bring things even close to balance.  An expansion of German private-sector demand would be sizable enough to do the job, but it is unlikely in large part because the immediate imperative of organizational survival for German trade unions effectively precludes expansionary wage policy.

Stephen J. Silvia is author of: Holding the Shop Together: German Industrial Relations in the Postwar Era.  Ithaca, N.Y.: Cornell University Press, 2013.