Policy Overshooting in Trade: The Roots of Germany’s Contentious Export Surplus

• In Event: The Politics of Overshooting in Advanced Economies

Abstract

Major German tax and labor market reforms in Germany aimed to bring down unemployment from worrisome levels in the early 2000s. These included welfare state reforms that lowered the reservation wages for some unemployed workers while essentially forcing others into activity. Corporate taxes moved sharply lower. In the aggregate, these measures had the effect of substantially shifting German savings rates, as the income for consumption bottomed out in the lower ends of the German labor market. The winners in this distributional battle were Germany’s exporting firms, which rode buoyant early Eurozone markets and piled up substantial profits. Given lowered domestic consumption potential—a result of wage cuts and welfare state reforms but also of an aging population—firms generally retained these profits rather than reinvesting them. German labor markets did tighten dramatically, but income distribution skewed in the direction of much less equality (market income inequality in Germany is now equal to that in the US, although Germany subsequently redistributes much more).

Meanwhile, a complementary surge in savings (over consumption or investment) was occurring on the public side as well. Most importantly, Germany adopted a constitutional balanced budget that applied to both the federal and state levels (albeit on different time scales). With municipalities mostly prevented from issuing debt, this meant that all levels of government were soon running surpluses, adding to the strong surge in corporate savings. Necessarily, public infrastructure was starved, and these public savings joined with corporate savings and flowed abroad in portfolio flows and, to a lesser extent, FDI.

With consumption and investment both constrained, net trade assumed a larger role as a source of growth in Germany. German capital outflows facilitated higher demand in ‘peripheral Europe’ and, later, also outside Europe. This substantial overshooting soon boosted German exports to disruptive levels both inside and outside Europe, where they have stayed ever since.
A number of countries have criticized German policy choices, but the German government implausibly denies any macroeconomic basis for its large current account surplus, claiming it is only the result of ‘good products at good prices.’ The politics of restoring balance to trade and capital flows has proved as difficult in Germany as it is in Japan or China, countries that also subsidize exporting industries by sharply reducing household income shares.

By increasing economic insecurity at home and sending destabilizing capital flows abroad, German policy overshooting has played a contributing role in the rise of populism in advanced industrialized societies.

Author

• Wade Jacoby, Brigham Young University