China was criticized a great deal in the past few years for having trade surplus due to cheaper exports resulting from its undervalued currency. But in recent years, they have realized that over-dependence on exports is not a viable option for long-term economic success. It has started making policies and reforms to increase spending among the people i.e. increase domestic spending.

Germany has come under the radar of the IMF and most importantly America for having large and persistent trade surpluses. Last year, Germany’s trade surplus was a mammoth 8.3% of GDP. At almost $300bn, Germany is being accused of piggybacking on other countries’ spending and of exporting job losses. Donald Trump has castigated Germany’s trade surplus as “very bad” and says—“we will stop this”.

Reasons and Consequences of trade surplus

Many Germans seem quite happy to be the “world champion of exports”. They attribute this “success” to the outstanding competitiveness of German companies, and the quality of their export products. Unfortunately, they are failing to grasp the main cause of the export surplus and its unsustainable consequences.

The heart of the problem

After the collapse of the Soviet Union, the traditionally strong German trade unions feared the massive outsourcing of jobs to Eastern Europe. Wages in the Eastern bloc were much lower, so there was a potential risk of companies moving their production sites to East. This would have led to rising unemployment in Germany. So, the trade unions thus agreed to intentionally keep domestic wages low to keep employment in the country. It is these suppressed German wages that lie at the heart of the problem.

German companies soon produced at comparatively lower prices than their counterparts in other countries. Consequently, German products, such as machinery or cars, became much cheaper and could easily be exported. The export surplus grew and money flowed into the country.

Other Reasons

Before the euro, a currency which is adopted by the 19 countries of the Eurozone, Germany had Deutschmark as their currency. But now, although the shared currency may be at a right level for 19 countries as a group, it is too weak to be consistent with balanced German trade. If Germany were still using the Deutschmark, it would be much stronger than the euro today, reducing the cost advantage of German exports.

Another reason for Germany’s trade surplus is the policies of their government, which suppress the domestic spending, hence they import less. In a slow-growing world that is short aggregate demand, Germany’s trade surplus is a problem. Several other members of the Eurozone are in deep recession, which high unemployment and no “fiscal space” (can’t raise spending or cut taxes).

The Greece’s case

In the case of Greece, Germany acts brutally. Greece is forced to increase taxes and reduce social welfare spending which has led to a continued stagnation of the Greek economy. Economic growth is low, unemployment remains high and the Greek people have to suffer tremendously under ever more cuts and deprivations. The Germans reckon that all this will eventually increase Greece’s competitiveness: the country will, at some point, be able to produce cheaply, export, and hence increase the flow of money into the country.

But Greece would need years of falling wages to regain competitiveness against German producers. Wages have already been cut significantly and falling wages, in general, create falling demand and hence lead to less economic growth: encouraging a downward spiral in an already existing recession is exactly the wrong thing to do.

Read this also: Germany’s Economic Model

There is much to envy in Germany’s model. Harmony between firms and workers has been one of the main reasons for the economy’s outperformance. Firms could invest free from the worry that unions would hold them to ransom. The state played its part by sponsoring a system of vocational training that is rightly admired.

What can be done?

For the past decade, Germany has had limited wage growth. This is the result of governmental policies. The other reason is the agreement between labor unions and employers to limit the wage growth. EU members have been pressurizing Germany to introduce higher wages as a way to increase domestic demand.

  1. The first thing Germany should do is to increase the wages of its workers. German workers deserve a big raise, and the cooperation of the government, employers, and union could give them one. Higher German wages would both speed the adjustment of relative production costs and increase the domestic income and consumption. Both would tend to reduce the trade surplus.
  2. Second, they should increase the investment in public infrastructure. Studies show that the quality of Germany’s infrastructure – roads, bridges, airports – is declining and that investment in improving the infrastructure would increase Germany’s growth potential. Infrastructure investment would reduce Germany’s surplus by increasing domestic income and spending, while also raising employment and wages.’
  3. Third, Germany could increase domestic spending through targeted reforms. The examples include increased tax incentives for private domestic investment; the removal of barriers to new housing construction; reforms in the retail and services sectors; and a review of financial regulations that may bias German banks to invest rather than at home.

Above all, it is long past time for Germany to recognize that its excessive saving is a weakness. Mrs. Merkel is absolutely right to proclaim the message of free trade. But she needs to understand that Germany’s surpluses are themselves a threat to free trade’s legitimacy.

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