Germany: Europe’s Company Store

Two popular views of Germany have dominated the current debate about the European financial crisis. Both are wrong. The first view sees Germany as an economically virtuous island in a sea of European profligacy. This is the view of most German voters and of their chancellor, Angela Merkel. In this view, Germany was industrious and prudent while others (Greece, Ireland, Hungary) were profligate. Therefore, these countries should rebalance their accounts without a “bailout” from Germany. This view conveniently ignores that German firms and banks financed these imbalances and that absent external demand for German goods and capital, Germans would be poorer. To put it bluntly, Germany can profitably do what it does only if most others do not.

The second view, popular more recently even in traditionally Germanophile Ireland, is essentially the opposite: that Germany is venomous, visiting an economic “Versailles” upon indebted countries by obliging them to pay above market interest rates for rescues that go primarily to repay foreign banks, many of them, you guessed it, German. The problem with this view is that it tends to give Germany both too much credit for masterminding the European rescue plans–when it has made several concessions–while also ignoring Germany’s very real vulnerabilities.

A third view of Germany is more complex, but it has the advantage of being much closer to the truth. In this view, German is both hypocritical and more than a bit clueless. In fact, these things go together. Like most hypocrisies, deficient self-understanding lies at the root. Germans don’t know themselves very well. The best way to see this reality is step a bit beyond Germany and look at its economic relations with its European neighbors. The hope is that buy seeing the dimensions of the problem clearly, German voters and politicians will be more willing to share in the necessary adjustments.

_Germany’s Political Economy of Surplus_

Since at least the 1960s, there has been a tension between Germany as a co-organizer of European capitalism and Germany as the home of firms that compete very successfully in that system. In the former context, the German government tries to create order, but in the latter its powerful firms often sow disruption. The most common face of this disruption is that Germany tends to run very persistent trade surpluses with its partners. Its firms, on balance, outcompete those of its neighbors. Germany then had to learn to manage, sustain, and often finance the tastes of its key trade partners. In simple terms, and quite unlike the United States after the mid-1970s, Germany produced more than it consumed. Often, far more. It is, to use a term coined by Wolfgang Hager in the early 1980s, an “extraordinary trader.”

This baseline tendency was both masked and exacerbated by key events in the past two decades. It was masked insofar as German reunification led to an impressive inflow of capital from other places in Europe, partly to finance the rebuilding of Eastern Germany. So while Germany continued to run a trade (and therefore) current account surplus, it often ran in deficit on the capital account. But Germany’s proclivity towards trade surplus was exacerbated by other developments, including its own substantial wage moderation efforts but also the explosion of liquidity in the mid-2000s, as Germany’s very favorable borrowing terms spread to many other countries. Bond spreads dropped to very low levels as not only the EMU-based southern European countries but even non-EMU countries in most of Central and Eastern Europe also saw borrowing costs fall (as did even non-EU member Turkey). The roaring economy of the 2000s in much of CEE was linked at least in part to high liquidity.

But the strong Euro during this period continued to really focus German efforts on the supply-side. Wage gains remained modest and generally well below productivity trends. In other words, Germany quietly returning to a pattern that had been much commented in the 1980s but that had been less disruptive in the 1990s, when Germany’s always-robust export profile was obscured by capital inflows and a healthy appetite for imports from the Single Market. While these trends were more or less in plain sight, they were masked by liquidity, financed in no small part by export earnings of German firms recycled through German banks. With the financial crisis, this entire complex emerged as problematic.

_Germany as Europe’s Company Store_

In fact, Germany came, for a time in the 2000s, to operate much like the famous company towns of late 19th- and early 20th-century American mining districts. The mining town company stores were a bit more complex than the image handed down through popular music (“Saint Peter, don’t you call me, `cause I can’t go/I owe my soul to the company store.”). There was a level of exploitation, but one that generally needed to be kept within limits in order not to lose the miners whose labor brought the ore to the surface. Germany has walked an analogous line with the rest of Europe, ensuring that the terms of its exchanges did not grow so unfavorable for its partners that they sought other arrangements.

To illustrate, consider that American mining companies often had two distinct commercial relationships with their miners in the company towns. First, they certainly had a wage relationship in which miners dug ore in exchange for wages, whether in cash or company scrip. Second, they usually had a retail relationship in which the company store was the main source of supplies both for work (lamps, candles, clothes, tools, explosives) and for provisioning the home (food, furniture, clothing). In this way, wages paid out by the mining company often flowed back in the form of purchases of goods. In some cases, miners did end up in debt peonage to the corporation, though this was relatively rare unless the towns were extremely isolated and miners had no other options. The playing field was not “level,” but there were rules and norms that constrained all parties.

The analogy captures a number of features of Germany’s relationship with, in particular, Central and Eastern Europe (CEE) over the last decade. First, in terms of the “wage” relationship, Germany has been, by far, the largest investor in the region. Automobiles, and to a lesser extent, electronics assembly and even machine tools, have been sectors that have created many jobs through German investment. Moreover, it is clear that over time the quality of these jobs has improved. For example, Vera Scepanovic’s data shows that the high value-added portion of auto sector production in CEE rose from 400 million Euros in 1996 to 11.3 billion Euros in 2006, moving from roughly 15% of total sectoral production to nearly 40%. The vast majority of CEE auto production is driven by German investment. Make no mistake: lots of jobs in Central Europe remain dependent on German investment.

The “retail” relationship is then tied to this dynamic. Put simply, Central Europeans have always looked to German producers for high quality consumer goods and to German banks for the liquidity to purchase such goods. Even during the communist era, consumption booms were generally financed by access to foreign credits. At least five CEE countries have, at one time or another, run double digit current account deficits during the 2000s, and two (Bulgaria and Latvia) have been over 20%. That said, the very low wages in CEE are, in good company store fashion, a major reason why borrowing for consumption is so high. In short, Germany has run a very persistent trade surplus with the region and has, through its banks, helped to finance this surplus by boosting consumption spending (According to OECD data, Germany’s trade surplus, which averaged $54 billion between reunification and 2001, jumped to an average of $199 billion from 2002-08). Credit helped square the economic circle for CEE, which understandably wanted to see living standards rise but not see major wage increases that would erode its attractiveness to, well, German investors.

Analogies can tell us which features of a complicated relationship to look at more closely, but all analogies eventually run out of steam. Company towns disappeared. Germany will not. But German voters and politicians must understand the country’s core core dilemma if it is to manage it better. German voters have politicians on a short leash, fearing “appeasement” of profligate states that encircle them to the North (Ireland), South (Greece and maybe Spain), East (Hungary) and even West (Belgium). The result is that German politicians have to wait until the size and scope of the problem is so large that voters can see it. Until, in other words, it is too late. When Germany waits, the size of the problem grows, as does the pain of the adjustment. When this pain is borne exclusively by foreigners, Germany is resented. And so it will be until Germany’s behavior changes–until domestic consumption and wages grow and until Germany’s own banks clarify their balance sheets and share in the writedowns that must come. It will not do to whine that Germany is “being punished for making good products at a good price.” It is being punished for failing to see that its trade partners cannot sustain these levels of consumption, no matter how hard Germans try to lubricate it.