One of the weirder experiences for anyone who lives in the eurozone is a visit to a German supermarket. I had the pleasure the other day, and found the general price level there to be a little over half of what it is in Belgium, Italy or Spain. This, of course, is just an unscientific guess. I also found price differences of some 30 per cent when comparing certain categories of goods on various Ebay sites in the eurozone.These differences go some way to explaining the eurozone’s divergent economic performance, and give a pointer as to what to expect in the future. The really intriguing aspect of the divergences is not how they happened, but why they are not correcting themselves. We know how they happened: Germany entered the eurozone at an uncompetitive exchange rate and embarked on a long period of wage moderation. Macroeconomists would say Germany benefited from a real devaluation against other members. But while real exchange rates tend to move around, one would not normally expect extreme misalignments to be persistent. In this case, one would expect Spanish and Italian consumers to abandon their expensive retail stores and swamp German internet sites with mail order purchases, especially for durable goods. Eventually there would be some price realignment.
It is not happening.
You would also expect some pressure for realignment from the labour market. As the German export sector returns to full capacity, one would expect wage costs to rise by more than the eurozone average.
This is not happening either.
The reason for the lack of demand-side adjustment is that Europe’s internal market is not fully functioning, certainly not at the consumer level. I spoke to an executive of one of Germany’s mail order companies and asked him why people in Belgium, where I live, cannot buy his extremely cheap products. He told me that national tastes were so different as to preclude a European-wide mail order service. My response was that the Belgians, and the Italians, probably share the Germans’ taste for low prices, and would probably shop if only given an opportunity. Despite some recent improvements it remains surprisingly hard to shop cross-border.
While adjustment of the product side is prevented by an imperfect single market, adjustment on the labour market side is prevented by a complete absence of market integration. You would expect German workers to seek higher wages outside the country. But this is not happening, as the European labour market remains almost perfectly fragmented. That means German wage moderation can persist uncorrected for a long time. Nominal wages are effectively frozen, and are set to rise by only small percentages in the next few years.
Taken together, this means the intra-eurozone imbalances will not only persist, but probably increase. This will make the economic adjustment for Spain, Portugal or Greece even more difficult than it already is. Those persistent imbalances, much more than the build-up of debt, are my deep cause of concern about the long-term health of the eurozone.
But from a German perspective, this strategy boosts growth in the short term. It is, of course, a beggar-thy-neighbour strategy. The improvement in Germany’s economic growth is driven not by productivity gains but by real devaluation.
So while I expect the German economy to perform better than the eurozone average, it is important to keep some perspective and not draw false inferences from the 9 per cent annualised growth rate during the second quarter. If you look at the period since the beginning of the financial crisis, Germany’s economic performance has been dismal. If you compare levels of gross domestic product between Germany and the US since the crisis, you find the US significantly outperformed Germany during that period. That situation may still be reversed if the US were to go into a double-dip recession. But the best judgment we can make now is that of Christine Lagarde, the French finance minister, in her recent interview in the Financial Times: Germany is recovering faster this year because it contracted faster last year, when GDP fell by 5 per cent. So far, this looks like classic dead-cat bounce.
Given its export-dependence, the performance of the German economy will ultimately depend on the global economy. As the US is heading for another downturn, it is hard to see how Germany can maintain its recent rates of growth. To do so would require a sudden increase in domestic demand. But I cannot see where that would come from.
The bottom line is that Germany’s economic performance will almost certainly improve relative to the eurozone average in the years ahead, but also that the current wave of enthusiasm is much exaggerated.
The real danger – to the eurozone, but ultimately to Germany itself – is the strains stemming from the policy of a real devaluation. I cannot see how southern Europe can ever fully reverse the misalignments in the real exchange rate. Nor are there any signs that the reforms in the EU’s product and labour markets will be sufficient to ensure that economic adjustment mechanisms can kick in. In other words, Germany’s economic strength is likely to be persistent, toxic and quite possibly self-defeating in the long-run.