An embarrassment of riches: Germany’s external surplus is set to fall
Nadya Mihaylova - 15 February 2017
Germany’s current account surplus has surged over the last few years to reach 8.5% of GDP, accounting for three-quarters of the overall Euro area external surplus. Germany does not consider this to be a problem, but the international community has long pressed for Germany to stimulate domestic consumption and hence its demand for imported goods and services. Help may be at hand: there are reasons to believe that that the surplus is set to fall materially over the next couple of years.
By various means, the German external surplus will erode to the advantage of its leading trade partners: the Netherlands, China, France and the US. However, a potential slowing in German exports is bad news for its eastern European supply chain – Poland, Czech Republic and Hungary – and for its foreign suppliers of energy and raw materials.
Historically, the convergence of interest rates after the creation of the single currency union imparted a huge demand boost to Germany arising from the release of credit constraints in the peripheral economies. More recently, Germany’s embarrassment of riches derives from several forces acting in combination. An attempted decomposition is shown in figure 1. Here are some of the underlying dynamics of the surplus, that enable us to identify the paths to its unwinding. The most significant explanation of Germany’s growing large external surplus since 2001 is the high savings propensity of Germany’s numerous 45-55 age cohort. It is expected, however, that the demographic component will slump as this age group moves towards retirement.
A second headwind for German savings is the crashing real interest rate as the ECB’s basement-level interest rates combine with the abrupt rebound in domestic inflation. Unusually, German consumer spending has sprung to life, consistent with reported surveys of rising consumer confidence and a jump in house price and rental inflation, partly due to net migration. Household consumption contributed more than half of the strength of GDP last year. Germany is at last stepping up its absorption of imported goods and services.
Third, labour market reforms in the early 2000s under chancellor Gerhard Schröder bifurcated the labour market and restricted wage growth in Germany, imparting a significant labour cost competitive advantage. As the German unemployment rate approaches 30-year lows, labour cost inflation is now working in the opposite direction, reducing its competitive advantage.
Fourth, Germany’s traditionally, and legally binding, adherence to budgetary balance and restrained credit provision to the private sector has helped to restrict import growth in the past. However, many leading politicians have softened their stances with regard to the public funding of infrastructure projects. Should Martin Schulz become the next chancellor in September, an uplift in government expenditure is a very likely scenario, with adverse implications for the external surplus.
Europe’s largest economy has also become more sensitive to the weakening trends in world manufactured trade volumes. As a trade-dependent economy – where foreign demand supports one in five jobs - Germany is particularly vulnerable. Moreover, Brexit poses an additional threat to German export levels as the UK is Germany’s 3rd largest trading partner, accounting for around 7% of exports. Lower UK demand for German goods implies negative impacts on corporate profits and a sharp deterioration of the trade balance.
Finally, temporary factors which have aided Germany’s trading position in recent years are likely to disappear. For instance, the lower price of oil has suppressed the cost of oil imports, despite the steady increase in the volume of energy imports (fig 2). The recovery of oil and commodity prices, in Euros, will reverse this impact. Oil exporting countries will benefit the most from this development, as Germany is highly dependent on commodity exports. Should the Euro begin to appreciate during 2017, as many now expect, then the competitiveness of German exports will erode further.
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