Should the UK be more like Germany?
The UK's trade performance is dismal. The UK imports too much, doesn't export enough and runs a massive trade deficit. We are told we should all tighten our belts, buy British and work harder for less pay so that the UK can become an export-led economy with a lovely trade surplus, just like Germany. After all, that's the way to economic success, isn't it?
I must admit, the June 2013 trade figures from the ONS are not encouraging. The UK does indeed have a large trade deficit. Though it's improving:
But let's dissect this a bit. The EU trade deficit in goods for June 2013 has gone up quite a bit, while that with the rest of the world ("non-EU" in the table) has gone down by considerably more. So either the world is buying more of our goods while the EU is buying less, or we are buying less of the rest of the world's goods and more of the EU's. I wanted to know which it is, so I had a look at the Geographical Breakdown in the ONS's Pink Book issued in July. The data in this is a bit older, and it is current account not trade balance so includes earnings on investments as well as trade. But it's close enough. Here's the regional breakdown of the UK's current account, charted:
We can see from this that the UK is actually in surplus with everywhere except Asia and the EU, and that the deficit with Asia is reducing, undoubtedly because of the slowdown in the BRICS economies. In contrast, the deficit with the EU appears to be rising exponentially. It is easy to interpret this as being due to collapse of imports to distressed periphery countries. The ONS commentary says (my emphasis):
"In 2012, the current account deficit with the EU27 has grown to a record £83.2 billion mainly due to income switching from a £1.1 billion surplus to a deficit of £27.2 billion* and the trade in goods deficit widening £13.0 billion from 2011 to 2012....."
So falling EU imports do play a role, it seems. However, what is interesting is the countries with whom that deficit increased. From the ONS commentary again (my emphasis):
"The trade in goods and services deficit with the EU27 increased to £44.4 billion in 2012, largely due to increased deficits with Germany, Italy and Sweden, while the Netherlands switched from a surplus to a deficit......"
So much for our widening trade deficit being due to falling imports by distressed Eurozone periphery countries. The principal culprits are core Eurozone countries, and in particular Germany. Here are the UK's five largest creditor nations:
Not only is Germany the UK's largest trade creditor, it is buying less and less of our goods and services relative to our purchases of its goods and services. The June trade data show just how much our trade deficit with Germany is widening:
Nor is the UK the only country that has a large and widening trade deficit with Germany. Most of Europe does.
I'm certainly not criticising Germany for exporting lots of goods and services. Far from it. I think all countries should export lots of goods and services. But for all countries to export lots of goods and services, all countries also have to import lots of goods and services. A large and persistent trade surplus indicates that a country is continually importing considerably less than it exports. According to Michael Pettis this has nothing to do with cultural values of "thrift" and "prudence", and everything to do with keeping a tight fiscal stance in order to enable employment to grow without fuelling inflation (my emphasis):
"The high German savings rate, in other words, had very little to do with whether Germans were ethnically or culturally programmed to save - contrary to the prevailing cultural stereotype. It was largely the consequence of policies aimed at generating rapid employment growth by restraining German consumption in order to subsidise German manufacturing - usually at the expense of manufacturers elsewhere in Europe and the world.....
"One of the automatic consequences of these policies was that Germany began running large trade surpluses to generate domestic growth and higher employment".
- Pettis, The Great Rebalancing
Pettis goes on to comment about the disastrous consequences of Germany's concealed subsidy to manufacturing for its Eurozone trade partners, particularly Spain. But it is not just Spain that is affected. It is all of Germany's trade partners. After all, this post is about the UK's trade deficit with Germany, and the UK is not a member of the Eurozone.
The German subsidy of manufacturing was perhaps justified when it was the "sick man of the Euro", desperately needing to regain competitiveness. But now it is dysfunctional and damaging, not only to Germany's trade partners but also to Germany itself. In 2012 the Bank of International Settlements warned about the fragility of Germany's economy due to its export dependence:
"The greater an economy’s export dependency, the more it will suffer from declining growth in its export markets......
"China and the largest western European countries (France, Germany, Italy and the United Kingdom)....are likely to face a significant drop (of around 1 percentage point) in the growth of their trading partners..... Among these countries, Germany may be the most vulnerable."
And in the recent Article IV consultation, the IMF also warned about the effect of Germany's low domestic demand and over-dependence on exports:
"Given its high degree of trade openness, Germany is highly susceptible to a slowdown in external demand and/or elevated financial stress. At the regional level, euro area shocks could be transmitted via trade and financial channels. At the same time, the interaction between weaker economic activity and elevated financial stress in the euro area could be mutually reinforcing, owing to already strained balance sheets in a number of countries, and be further exacerbated by waning confidence or heightened uncertainty. A significantly weaker German outlook would in turn affect both regional and global growth prospects, primarily through the trade channel.....
"[Executive Directors] also emphasized that, given the size of Germany’s economy and its large external imbalances, stronger and more balanced growth in Germany is critical to a lasting recovery in the euro area and global rebalancing."
In other words, Germany's economy is terribly exposed to economic slowdowns in other countries, especially in the Euro area. Germany is slowly coming out of the recession caused by the Eurozone crisis, but a renewal of debt crisis in other countries, leading to further collapse of German imports, would be likely to stall its recovery and even push it back into recession, setting off a deflationary spiral in the entire Euro area and adversely affecting global economic performance.
The risk to the German economy is far more serious than the IMF report appears to suggest. As Pettis points out (op.cit.),
"As a necessary consequence of its trade surplus, the German banking system has accumulated substantial claims against the trade deficit countries of Europe."
The German banking system is highly interconnected, poorly capitalised and heavily loaded with the debt of its trade partners. The IMF again:
"Risks to domestic financial stability may surface owing to, for example, a shock to confidence by depositors and creditors in systemically important institutions, which by increasing risk aversion, could disproportionately suppress economic activity and trigger contagion more broadly.....
"Key priorities are further improving capital buffers, profitability, and efficiency of the financial system, and facilitating the adjustment of business models ahead of new international and European regulatory requirements. Directors also urged continued efforts to strengthen the surveillance of large cross-border banks and enhance coordination with supervisory authorities in key financial centers."
But bank reforms alone will not be enough. While Germany remains determined to hang on to its trade surplus, its banks will remain loaded with risky cross-border claims. It is not possible for Germany to reduce the risks in its banking system significantly unless it fundamentally reforms its economic policies. And if it does not do so, it risks a major banking system meltdown. Eventually its trade partners will become so indebted that they are no longer able to support the level of imports from Germany - or no longer willing to do so - and there will be a sharp deterioration in Germany's trade balance, resulting in huge losses for its banks. The UK knows all too well what the economic consequences of banking collapse feel like. Germany should look across the Channel and learn. Or learn from its own history. After all, it was collapse of the German and Austrian banking systems that triggered the Great Depression in Europe.
So the UK should stop moaning about its export performance. It really isn't that bad. Yes, the UK could do with cutting its trade deficit. But the way to recovery is to find its own identity, not to adopt the ways of others:
- John Maynard Keynes
In my view, no way should the UK aim to become more like Germany. Germany actually has a far bigger problem than the UK. A trade surplus of that size and extent is not sustainable. Germany desperately needs to undertake fiscal reforms to remove the hidden subsidy to manufacturing and improve domestic consumption. Without them, eventually the strains in the Euro area will become intolerable and there will be a disorderly breakup - and it will be Germany that suffers the most.
I hope that the new German government that will be elected in September will have the courage to make the necessary reforms. The trouble is that it is politically very difficult to make reforms when economies are doing well, even if that success carries the seeds of future destruction. As long as the people of Germany believe that they are doing everything right and other countries should take all the pain of economic adjustment, the structural reforms that Germany desperately needs will not be made and the German economy will sail blithely on towards an economic catastrophe of its own making. The biggest obstacle to reform is the self-satisfaction of the German people.
The sick man of the Euro - The Economist (1999)
82nd Annual Report - BIS
The Great Rebalancing - Michael Pettis
National Self-Sufficiency - John Maynard Keynes (1933) (h/t Unlearning Economics)
* The ONS says that the increase in the current account deficit is due to a large fall in credit income (earnings on foreign investments) relative to debit income (payments to foreigners on UK investments). Both have fallen, but credit income has fallen by much more. Here's the breakdown of the UK's current account relationship with the EU, again from the Pink Book. The widening income deficit is evident:
The ONS says that this change is mainly due to the Netherlands and Luxembourg switching from income surplus to deficit, although detailed figures (available from the Pink Book link above) also show a considerable fall in investment income from Germany. What would cause such a dramatic change? My guess would be that this is about capital flight, though the graph suggests that income is very volatile anyway. But if anyone has any better ideas, please do suggest them in the comments.