The Economist on Germany 1

The Economist on Germany 1

Back above the bar again

Europe's biggest economy is performing strongly, but structural problems persist

AT THE start of last year Frank Lüngen had 500 vacancies on his books. By the end of it, the employment agency he runs in the eastern German town of Rosslau had 1,000 jobs to fill. Companies are complaining of a shortage of skilled labour, he says: there just aren't enough good people to go around.

Mr Lüngen's story is a typical one in the recovery of Europe's biggest economy. Germany had been ailing for a decade after post-reunification euphoria gave way to an almighty hangover; an upturn at the end of the 1990s was followed by deeper gloom. But now the colour is back in its cheeks again.

GDP grew by almost 3% last year, the fastest rate since 2000, and may do as well in 2007. It managed 3%-plus in the first quarter (see chart 1), despite a rise of three percentage points in value-added tax (VAT). This month The Economist's poll of forecasters showed prospects for the German economy were improving, with an average prediction for GDP growth in the year of 2.8%, sharply up from 2.3% in May.

In the past few years the main motor of growth has shifted. When the economy was at its weakest, in 2002 and 2003, exports kept it running. They continue to do well—in manufacturing exports, Germany is Weltmeister, or world champion, again. But for some time more oomph has been coming from domestic demand, chiefly investment. Construction—a drag on growth for a decade, after the post-reunification binge—has also picked up.

Even consumers, who once seemed determined to keep their wallets shut until doomsday, may be joining in. According to Klaus Fischer, of the retailers' federation in Berlin and Brandenburg, shop revenues in and around the capital fell for 13 straight years until 2005. Since then they have stabilised. At national level too people seem a bit keener to spend, despite higher VAT. Consumer confidence has rebounded.

Consumers are being buoyed by the labour market. More Germans have been working and, after years of wages trailing behind prices, pay packets are at last getting a little fatter. Confusingly, Germany has two definitions of unemployment, and both rates are falling fast. On the basis used by the Federal Labour Agency, unemployment was 9.1% in June, down from 10.8% a year before; on the International Labour Organisation's definition, which is comparable with other countries' figures, the rate was 6.4% in April, down from 8% 12 months before. That is well below France's 8.1% and not so far above Britain's 5.5%.

In the past year employment (on the agency's figures) has risen by 570,000. Unemployment has been falling faster still, partly because some people have left the register as jobless benefits have become more closely tied to jobseeking. Michael Burda, an economics professor at Humboldt University in Berlin, points out that in western Germany the number of unemployed has rarely fallen so far, year-on-year, since the late 1960s.

The obvious question is whether all this is merely a cyclical upswing or whether Germany has undergone some deeper, structural change. The obvious answer—too early to tell, but most likely a bit of both—is probably correct.

Start with the case for caution. If, as seems likely, Germany is close to the peak of an economic cycle, its recent record, though encouraging by past standards, is scarcely spectacular. It follows that its sustainable growth rate is less impressive still. Thorsten Polleit, an economist at Barclays Capital in Frankfurt, estimates that trend growth has been declining steadily for decades and is now only around 1.5%. “Has Germany's growth potential gone up?” he asks. “I don't think so.”

The rapid increase in employment can also be viewed from a less flattering angle. From the bottom of the cycle, in mid-2003, employment grew much less quickly than in previous upturns. And much of the early rise took the form of “mini-jobs”—part-time posts paying no more than €400 ($545) a month, regardless of hours (see chart 2). By contrast, employment in the “primary” labour market, where social insurance contributions are compulsory, is still well below what it was seven years ago (see chart 3). Unemployment is still around 4m. And the rate in eastern states is still double that in the west.
Open more hours

Nevertheless, something structural has shifted. Some of the changes are unmissable. On the high street, most restrictions on shopping hours have been swept away, although Sunday trading remains mostly illegal (railway stations, airports and petrol stations are important exceptions).

Slightly less obvious are the changes in corporate Germany's balance sheets. In essence, capital used to be cheap; the cost of it has now gone up. State guarantees for public-sector banks have gone, removing an implicit subsidy for their loans. The arrival of the Basel 2 accord on bank-capital requirements has forced banks to price their loans according to risk.

More is being demanded of equity capital too, even if German corporate governance still leaves something to be desired. Financial institutions have run down their old stakes in industrial companies—which were valued for cementing corporate relationships rather than as financial assets. Much of Germany's complicated network of cross-shareholdings has now been dismantled. Those stakes that remain are expected to produce a decent return. Meanwhile, a new, more demanding species of shareholder has appeared in the form of private-equity firms, which Franz Müntefering, a Social Democratic minister, once notoriously described as “locusts”.

The shifts in the labour market have been just as important as those in the market for capital. Partly, they are the product of reforms undertaken three or four years ago. They brought forth all those mini-jobs, stiffened the terms for unemployment benefit and made life easier for private employment agencies, like Mr Lüngen's, and temporary employment firms, such as Switzerland's Adecco, America's Manpower and the Netherlands' Randstad, now the market leader, as well as lots of home-grown German rivals.

Zeitarbeit, as temporary work is known, accounts for 1% of all jobs, but for perhaps more than half of all those created in the past year. One example of the new breed of employers is time & more, which specialises in health care. It has around 400 people on its books, of whom 300 are nurses; two years ago it had 250. Its founder, Bernd Sydow, who sold his firm to Adecco in April, says that it supplies almost all Berlin's hospitals as well as hospitals in other big cities. Around three-fifths of time & more's nurses are called on for stints of one to three days, often at short notice. Having reduced permanent staffing levels and carrying no reserves, hospitals turn to the agency as their requirements fluctuate. Mr Sydow reckons that eventually about 5% of his clients' nurses will come from an external pool.

Agencies such as Mr Lüngen's, in contrast, do not employ those for whom they find work, as Zeitarbeit firms do, but act as brokers. Last year such firms filled 62,000 jobs in the primary labour market, three times as many as in 2002. As well as running his own agency, Mr Lüngen runs his industry's biggest trade association (there are a handful), whose membership has risen from 23 when it was founded in November 2003 to more than 200.

Regulatory reforms explain only part of the change in the labour market. As companies have come under more pressure, workers' pay has been squeezed: as higher returns on capital have been demanded, the relative price of labour has had to fall. That managers can threaten to move work to central Europe or even farther away has strengthened capital's hand. As a consequence, while company profits have risen steeply, workers have done much less well. In the past six years, the share of wages in national income has fallen from around 60% to little more than 55%.

In part, this has come about through a loosening of Germany's system of industry-wide wage deals between employers' representatives and trade unions. This corsetry was never quite as rigid as it looked: variations on centrally struck wage deals at local level and in individual companies were already part and parcel of it.

However, agreements have become more flexible, notably since 2004. Martin Leutz, a spokesman for Gesamtmetall, the engineering employers' federation, refers to a “huge breakthrough” in that year's wage round, allowing companies to deviate from agreed terms on pay, bonuses and hours if this would secure or create employment, or keep investment in Germany that would otherwise go elsewhere—albeit with the agreement of workers' representatives. More and more companies, especially in eastern Germany, have chosen to bypass the central system altogether.

Moreover, negotiated settlements have been modest. Actual pay rises, indeed, have lagged behind inflation for several years. This year it looked as if labour might at last regain some of its old bargaining power, at least in the metal industries. IG Metall, the country's biggest union, demanded a 6.5% rise from the end of April. When Gesamtmetall said no, the union called short warning strikes.

The eventual settlement, reached in early May, covers 19 months, promising 3.9% in the first year and a further 2.1% in 2008, which can be postponed for up to four months. The average annual cost for the duration, according to Gesamtmetall, is 3.3%. That was the unions' best result for several years. With inflation at 1.9% it amounts to a real increase. But not a big one; and the metal industry has been doing particularly well, with export demand riding high. Workers elsewhere are unlikely to see their pay rise by as much.

At BMW's ultra-modish factory in the eastern city of Leipzig, where the line of 3-series saloons heading for the paint shop is visible high above the reception area, the effects of both sides of this new labour market are on show. BMW pays its Saxon employees, who turn out a car equipped to an individual customer's order every 80 seconds, according to the national contract. But they get fewer of the extra payments on offer to those at the carmaker's Bavarian plants, in Regensburg, Dingolfing and Munich, thinning their wage packets by about 25%. Lots of flexibility is built into shift patterns, explains Michael Janssen, a company spokesman—for example, extending shifts by 30 minutes, adding extra ones or rearranging lots of them at short notice. Parts of the factory can be run for 140 hours a week (Sunday work is illegal, so that is pretty much the lot).

At the same time, BMW has made liberal use of Zeitarbeiter. In all, 5,200 workers are on the site, of whom 2,500 are employed by BMW. Of the rest, about 1,300 are temps; soon there will be at least 300 fewer, as Zeitarbeiter used by a company contracted to assemble doors are taken on to the supplier's permanent staff.

You might imagine that the temporary workers, like the nurses employed by time & more, are called in when demand is high and sent away when it slackens. But according to Mr Janssen, this is not BMW's reasoning. Over the next ten to 15 years, the company will not need the same workforce as it does now. Rather than take people on and let them go—“it's always a mess in the future”—the company would rather not take them on at all. That could be interpreted as a reference to the Kündigungsschutz, the legal protection against dismissal that can make firing workers costly, but Mr Janssen puts it differently. “It's not BMWphilosophy to hire and fire,” he says. “Our philosophy is to guarantee jobs.”
Them and us

Perhaps predictably, the terms of Zeitarbeit have caused resentment among temporary workers and some controversy in the press. Largely, this is because pay is lower, even though (in true German fashion) temporary workers are subject to their own centrally negotiated wage contract between agencies and trade unions. Zeitarbeiter at BMW in Leipzig get around 75%, on average, of the pay of the factory's permanent employees. (The cost to the company is rather more than that, because it must pay the agency its cut, on top of the slice that goes to the workers.) But little things can bruise too. One former temporary worker at BMW recalls that whereas permanent staff get a €1 discount on meals in the canteen, Zeitarbeiter must pay full price. Not much of a slight, you may say, and when unemployment is still high surely any job is welcome; but such things can sting all the same, especially when a temp's wage is lower to start with.

This pressure on wages is, not surprisingly, reflected in a marked improvement in German industry's competitiveness. Unit labour costs in manufacturing, which soared in the early 1990s, are now back to around where they were at reunification (see chart 4). Since 2001 Germany's unit labour costs have fallen by around 20% relative to Italy's and Spain's.

Viewed another way, however, this is as much a reflection of an old German virtue as of a new one. In the days before monetary union, German business time and again sharpened its blade on the hard stone of a strong D-mark: to get France and Italy, in particular, out of trouble, devaluations of the franc and lira were dressed up as revaluations of the D-mark. In the euro zone, however, national currencies no longer exist, so nominal national exchange rates cannot change. Real rates can be devalued—but only through having a lower inflation rate than other members of the club. Since the euro was born, the Germans have proved themselves as competitive as they ever were. Unable to devalue, others have fared less well.

That said, it would be a mistake to ascribe all of Germany's renewed economic strength to export competitiveness created by wage restraint. For one thing, although exports kept the economy going when domestic demand was truly feeble and although foreign sales have carried on apace, investment and construction are now pulling more of the weight. For another, changes in relative prices within the euro zone explain only so much.

According to research by economists at the Bundesbank, the growth of overseas markets is more important in explaining the growth of Germany's exports than is price competitiveness—although prices play a bigger role in the euro area than they do outside it. By luck or by judgment, Germany is in the right businesses at the right time: China, India, Russia and other countries in central and eastern Europe are growing fast and wanting the goods in which Germany specialises. Indeed, exports to Russia and other European countries to Germany's east now exceed those to the United States.

Orders for machine tools, for instance, have been growing by more than 10% for the last three years and have been at their strongest for 30 years. In a study of 25 countries by economists at Goldman Sachs, the correlation between the imports of Brazil, Russia, India and China and Germany's comparative advantage (revealed in the structure of its exports) was bettered only by those for America and Finland. Southern and central European members of the European Union were worst placed. Dirk Schumacher, of Goldman's Frankfurt office, thinks that Germany is well placed to benefit from growing interest in environmentally friendly technology. With America, Germany is the leading exporter of goods of this type.

It is clear that Germany's economy is now whirring after years of idling. Given the shock (and cost) of unification—absorbing the former East Germany added 25% to population but precious little to output—that is quite an achievement. Yet it would be easy to become too starry-eyed over Germany's recovery.

The world economy has been exceptionally strong in recent years, and the euro area was due for a cyclical upturn. At some point the cycle will surely turn again. It is not hard, either, to make a strong case for further structural reform. The banking system remains fragmented, split among private, state-owned and co-operative institutions between which consolidation is difficult, if not impossible. The labour market, for all its improvements, still needs further reform. Like other European countries, Germany has loosened the periphery of its labour market but not the core. For example, the Kündigungsschutz—under which many dismissals end up in front of special labour courts—makes the costs of firing both high and uncertain, and thus deters hiring.

It would be as mistaken to get carried away by Germany's revival as it was to write the country off earlier in the decade. Some rebound was sure to happen and German business is looking in exceptionally good shape. But without further reform, some of the old obstacles to employment and growth could yet re-emerge.