Is Germany really rebalancing?

Germany has rightly been criticised for its dependence on exports and its huge trade surpluses. In normal times, when economies are growing healthily, trade imbalances pose less of a problem. But these are not normal times, at least in Europe, and are unlikely to be for many years. Europe's economic prospects are poor. Governments cannot stimulate their economies by boosting public spending because their public finances are almost uniformly weak. Interest rates are already at all-time lows. Banking systems are hobbled with a lot of bad debt, holding back the needed recovery in spending and investment. In such circumstances, Germany's huge trade surplus - a large majority of which is with the rest of Europe - is far from benign. The surplus boosts demand and employment in Germany while draining it from the rest of Europe.

In response to foreign criticism, German politicians, policy-makers and economists have vocally argued that critics are exaggerating the country's export dependence and underplaying its contribution to the rebalancing of the European and global economies. Finance Minister Wolfgang Schauble and Bundesbank President Axel Weber claim that Germany's rising imports have helped pick up the slack caused by weaker domestic demand in the US and elsewhere. Others argue that the strength of German domestic demand in 2010 may be helping to nurse the crisis-hit eurozone economies back to growth. A German economy driven by domestic rather than foreign demand is certainly in Germany's and Europe's interests. But is it really happening?

Germany's current account surplus did narrow during the financial crisis, from almost 8 per cent of GDP in 2008 to just over 5 per cent in 2009. This meant that Germany exerted a less extreme drag on its trade partners in 2009 than in 2008. But the country's surplus rebounded to an estimated 6 per cent of GDP in 2010, with the IMF and OECD forecasting similar-sized surpluses in 2012. The proportion of Germany's trade surplus with the Eurozone is falling, but not by much - from 56 per cent in 2009 to 53 per cent over the first nine months of 2010. Germany's trade surplus with its eurozone partners is still on course to be around 3 per cent of GDP in 2010, while Europe as a whole will account for over three-quarters of the overall surplus.

The German economy did grow by a post-unification record of 3.6 per cent in 2010, with domestic demand (which rose by 2.5 per cent) accounting for around 70 per cent of the expansion. Imports did rise rapidly, but they were outpaced by exports. And it is so-called 'net exports' (export growth minus import growth) which determines an economy's impact on demand across the rest of the world. Far from contributing to a rebalancing of the European and global economies in 2010, Germany actually became a bigger obstacle to both.

 Moreover, the expansion of German domestic demand in 2010 was down to three factors which will not be repeated in 2011: a strong rebound in business investment from the previous year's lows; restocking by firms; and fiscal stimulus by the government. By contrast, private consumption - which accounts for over three-fifths of GDP - rose by just 0.5 per cent over the year. Germany's already high household savings rate increased further, suggesting that households remain cautious. It will only make sense to talk about the rebalancing of the German economy once growth in imports outpaces that of exports for a prolonged period of time. And this will require a robust recovery in private consumption.

Could it happen? The outlook is arguably better than it has been at any time in the last ten years. Unemployment has fallen sharply. As the labour market has tightened, wage settlements have picked up. Lower unemployment and higher wages should lift purchasing power, which should make people more confident about spending and persuade them to reduce the proportion of their incomes that they save. This, in turn, could trigger a virtuous cycle: businesses would become more confident about investing in the domestically orientated sectors of Germany’s economy, boosting demand for labour and further underpinning the recovery in consumption. Much will depend on what impact the inevitable normalisation of export growth combined with fiscal tightening has on consumer confidence.

Germany and the rest of Europe, especially the eurozone, have much to gain from a rebalancing of Germany's economy. Some Germans resent foreign criticism of their economic management and often try to deflect it by suggesting that rebalancing is already under way. The official data for 2010 suggests they have got ahead of themselves. But they could yet be right in 2011.