Trade deficits and global imbalances

There’s great anxiety over the fact that the Germans have such a large current account surplus. Some believe that this occurs because German wages are suppressed, others that German Government’s finances are too tight (it runs a budget surplus!) and yet others think that business is underinvesting. Trump is very exercised by it as most likely is the new commerce secretary, Wilbur Ross.

These arguments end in the same way: German living standards are lower than they could be. But if you think about it, they are also all variants of the ‘Germans have all gone mad again’ theory – workers because they are suppressing their own wages (unions sit on German Boards remember), businesses because they are underinvesting despite having low wages and the Government because is raising too much in taxes.

I don’t buy any of it.

You see if German workers really were paid too little relative to productivity compared with the rest of the world then you’d expect German businesses’ profit share in GDP to be higher than in the rest of the world – and its not. And what’s more German workers have the highest real wages among big countries in the rich word and their living standards have been rising. Some suppression!

Then take a look at investment: it IS true that Germans are investing less than they once did – but, if they were underinvesting, German productivity would not be RISING relative to rest of the world. When you remember that German industry is more weighted towards manufacturing, rising productivity when there is underinvestment would be surprising, wouldn’t it?

I think the consensus on this subject is just wrong.

They key here is the ageing of the population and the dramatic fall in the working age population that is taking place. Businessmen are investing less than before because they expect that the population will decline and consumption and demand will fall in absolute terms. Germany’s famous long-termism ironically in this case means less investment. Productivity, however, is rising because the number of workers is falling faster than the fall in investment – so the capital stock per worker – that’s the key that drives productivity – is actually rising. And conservative taxation policies also make sense if you have pay-as-you-go healthcare and pensions systems and face a falling working age population and the likelihood (certainty?) of falling future tax receipts from domestic sources. How do you deal with that? Lend abroad to younger populations and to places where productivity is low but rising.

And that’s what they seem to be doing. Instead of investing at home (where returns on incremental investment are falling), Germans are investing abroad where they hope returns will be higher and these higher returns will pay their pensions in the future. And mostly they have been correct in thinking this, especially when you take into account currency movements.

The result of this preference for foreign over domestic assets drives a big capital account movement and means that Germany runs a current account surplus. This is not a consequence of its competitive manufacturing sector (German products are not cheap) but a consequence of its wish to save for the future. It’s the capital account that is driving its surplus.

Now Germany is not the only country that faces these ageing issues in Europe. Italy, Greece, Spain and Portugal also face similar issues although not to the same extent. And slowly all of these states have now come to have current account surpluses. Europe is in structural surplus because it is ageing. Only Japan is similar.

Take a look at the chart which shows the dramatic fall expected in the number of workers.