The current account is the sum of the trade balance (exports minus imports), net income from abroad (usually dividends) and net current transfers. As the trade balance is generally the largest of these components, a current account surplus usually implies that the nation is a large exporter and has a positive trade balance. This does not necessitate that the volume of exports is larger than that of imports; it only takes the monetary value of the exports/imports into consideration. Typically, nations which are exporters of manufactured goods and energy, like Germany, China, Japan, are the nations with a consistent current account surplus.
Together, Germany and China’s surpluses create dangerous forces in the global economy. In normal times, money should flow, relatively freely, from nation to nation. As a general rule, people save money in banks, and the banks lend that money to businesses, which use it to invest in new factories, services, and government bonds. Some nations have more money saved than businesses that deserve investment; the extra money goes to some other nation with more promising businesses. In theoretical models, these flows of money are self-correcting. If one nation attracts too much investment or another attracts too little, then their exchange rates will adjust, and the money will stop flowing from the cash-rich nation to the investment-rich one. With Germany, this hasn’t happened. There is a growing hoard of cash piling up.
A high trade surplus implies a significant reliance on exports which in turn implies a certain dependence on continuing trade with other countries. Needless to say, such countries might suffer harshly from a global economic downturn or if other countries for political reasons or otherwise elected to seize or reduce trade with the given country. But, at the same time they are the drivers of the world markets and exercise control over global trade at large. So, in February 2017, when Germany reported the world’s largest current-account surplus, of about €270bn (almost $300bn), beating even China’s; it surely was not going to go unnoticed. Everyone; the political leaders, economists as well as traders across the globe had their own say regarding the same. But, before getting to their opinions, let us first understand how Germany managed to amount such a steep surplus.
It is popular knowledge that the Germans have been pioneers in innovation and manufacturing. They produce quality products which everyone wants to buy. Hence it is no news that they have huge exports and consistent surpluses. Adding to this, are strict policies monitoring international trade, import tariffs on goods imported from non-European countries and various embargoes. All these keep the imports in check, thereby maintaining a supple surplus. But, Germany didn’t always have surpluses.
In the post-war years, West Germany, with much of its physical infrastructure destroyed, focused on investing in its own recovering economy. For decades, it imported roughly as much as it exported. But in the 1980s, West Germany’s economy first got out of whack as exports continued to grow but domestic investment began to decline. German reunification in 1990 then plunged the country back into a trading deficit: Suddenly the country had to rebuild eastern Germany, left derelict by four decades of communism. Investment in the domestic economy soared and stayed high throughout the 1990s. As a result, Germany still ran deficits with the rest of the world till as late as 2000. However, three key developments changed this scenario.
The first one was the introduction of the euro in 1999. Before 1999, any competitive advantage German firms built up over other countries would lead to more demand for the D-Mark, as foreigners exchanged their own currency to pay for German imports, thus driving up its value until German goods become less competitive again. But this is not the prevalent scenario. Since 2000, German unit labor costs have risen by about 20% to 30% less than its main Eurozone competitors. This means German exports have become roughly 20% more competitive, but there has been no change in the exchange rate. If Germany still had the D-Mark, it is almost certain that the increased competitiveness of German exports would have caused an appreciation in the German currency. This appreciation would have re-balanced demand – lowed export demand, and encouraged more German imports.
With the euro, however, German surpluses are now offset against deficits by other euro countries, and the exchange rate stays lower than it would otherwise be. The easy-money policy of the European Central Bank has been pushing down the value of the euro even more. That may help revive southern European economies, but is not something that Germany needs. Germans have never and will never admit but the introduction of the euro was a boon for them. No matter what anyone says, it is obvious that Germany does benefit from an undervalued euro; keeping its exports competitive.
The second development since 2000: Germany has simply done more than other euro countries to keep wages low with the aim of being and staying competitive. Mostly this was the result of consensual agreements between trade unions and corporate bosses in the export sector. Everyone agreed that Germany was not competitive and something had to be done about it. The government also helped with labor-market reforms that created a low-wage sector. Of late wages have started growing but they need to grow at a greater pace to have any significant impact on the trade surplus.
The third development was that German domestic investment, after booming in the 1990s, finally dropped and then stayed low for several years. Germany has one of the lowest public-investment rates in the industrialized world. It also has a perennially high household saving rate. So the problem with Germany isn’t so much that it is exporting too much but that it is spending too little. The extra capital saved, since it’s not invested at home, ends up abroad, where foreigners recycle it to buy German goods; thereby pushing up the surplus figures year on year.
But the question remains is the trade surplus really a problem? If yes, then whose problem is it? At the onset, one cannot find a problem with surplus. How could there be a problem with excess of money? It is a sign of commercial success and economic virility. But a large economy at full employment running a current-account surplus in excess of 8% of its GDP puts unreasonable strain on the global trading system. To offset such surpluses and sustain enough aggregate demand to keep people in work, the rest of the world must borrow and spend with equal abandon. But the imbalances prevail as other countries cannot keep up with the pace. The more they buy, the more indebted they become and as a result, their purchasing capacity drops.
Once the Germans reported the outrageous surplus, they were on the receiving end of numerous criticisms. They were criticized for exploiting the undervalued euro and being a free rider in the Eurozone. Their mercantilist policies of low wages and the regulations on import and export were also harshly condemned by countries all over the world- with the USA, being the most vociferous. President Trump, having already pulled America out of the TPP, and re-negotiating with NATO lashed out by casually remarking he might slap 35% tariffs on BMW cars. Trump and his advisors need to understand that international trade is not a zero-sum game, that is, if the US runs a deficit with Germany, it does not mean that the US is poorer. Nor does the size of trade balances reflect anything on the negotiating skills of the administration of a country. Although President Trump was correct in pointing out that the surplus is a problem, his faulty underlying arguments like blaming exchange rate manipulations let the Germans off the hook. Many Germans view the latest wave of criticism as a sign that others are merely envious of their country’s success, and they have angrily refuted arguments that Germany has tried to gain an unfair competitive advantage. Germany, they point out, does not engage in price dumping or direct export promotion, and its leaders do not target the euro
The Germany trade account balance between Germany and the US has remained pretty consistent over the years despite the substantial exchange rate swings. This is because of the integration of global value chains which makes industrial exports comprise many imported inputs, which means that the effect of exchange-rate movements on domestic prices and the trade balance has decreased substantially over time. Germany even declines exploiting the euro and states that the success and/or failure of its EU member states are totally independent of German activities and policies. It discards the criticisms and acknowledges the surplus as a success and owes to its export prowess and competitive pricing managed by the manufacturing champions. But I believe that the German defense of its surplus is as misinformed and misdirected as the criticisms it has received from the rest of the world. The German surplus does pose a threat to the world and itself, but what can be really done about it?
Theory dictates that Germany needs a stronger Euro which will provide impetus to the German importers and at the same time check the volume of German exports. But due to the poor southern Europe countries like Italy and Greece, who are under tremendous deficits, the ECB will not consider this as the way forward. A stronger euro would be catastrophic for them as they need a weaker euro to promote their exports and discourage consumer spending. The EU needs to balance between disparate economies using the same currency. So if regulating the exchange rates is not an option, they might look to redistribution of money from high-growth areas to low growth-areas; similar to what the US does among its states. It won’t be easy for EU since it has to manage different nations, but with a proper political and economic union, it can arrive at a solution. Germany has little control over the common currency but it can take steps that can counter the effects of an undervalued currency.
One strategy that can show quick results is a surge in the wages. China was successful in eroding much of its surplus when it decided to “pay more”. Although the wages have begun to grow in Germany, they need to be growing at a higher rate. This is because higher wages give consumers more money to spend on imports and at the same time make German goods more expensive relative to those of other countries.
The best option is to raise public investment and encourage private investment. At a time when interest rates are near zero, Germany has nonetheless balanced its budget since 2014, instead of upgrading its roads, bridges and broadband lines, for example. The economy lags behind in its readiness for digitization, ranking 25th in the world in average download speeds. To get firms to invest more at home, Germany should liberalize its service sector and other parts of the economy. Starting a new business is notoriously difficult in Germany: The country ranks 117th on the World Bank’s Doing Business report. Germany’s current account should thus focus on measures to liberalize the country’s services and remove other barriers to investment. To that end, Germany should improve its digital and transportation infrastructure; strengthen market mechanisms to encourage more renewable-energy development.
The bad news is that Germany probably can’t do much more than that, because the ultimate cause of its savings being greater than investment is beyond its control. Germany is an aging society, so people are saving in preparation for retirement. At the same time, firms are more reluctant to invest because they expect a smaller and older population in future. The good news is that at some point those aging Germans will actually retire and begin to draw down their savings, in part to buy imports.
The Germans must accept that the excessive surplus needs to be controlled. They need to implement corrective measures. This is because there is high chance that with time, as the cash piles up, it will bear risk not only to other countries but it could also harm Germany in an ugly way. A similar accumulation of extra cash in China is what had triggered the 2008 financial crisis, with China dumping cash into the US real estate and other properties thereby creating a housing bubble. So they need to be wary of the fact that the bigger the surplus, the trickier it will get. They need to contemplate the choices at hand and come up with effective result-bearing strategies. The Germans need to be accurate as well as prompt as they cannot afford to be wrong or late in their decision making. If Germany doesn’t take the correct steps to reduce its trade surplus, at some point, if past patterns predict the future, there could be the discovery of a bubble in Germany or somewhere else in the Eurozone, and cause a sudden market panic or a collapse of confidence, leading to stock-market collapse and recession. It could rend the Eurozone apart. Such a crisis might be a short-term boon for the United States, as investors seek their safety, but it would also cause consternation in the global economy.