May 11, 2017    5 minute read

The German Trade Surplus: A Blessing or a Curse?

Piling Capital    May 11, 2017    5 minute read

The German Trade Surplus: A Blessing or a Curse?

Germany has consistently run a current account surplus (trade surplus), which is this year expected to run to 8.7% of GDP. Germany is also experiencing greater foreign exchange reserves, and its euro reserves have doubled since 2008.

Although the nation has among the highest wages in the developed world, it also has the most competitive and vibrant manufacturing sector. This is primarily because of its high savings rate as a percentage of GDP.

More saving means that there are more funds to be invested in innovation, R&D and capital accumulation, which in turn facilitates greater production and therefore explains the nation’s strong manufacturing sector.

Concerns over the Current-Account Surplus

The enormous capital accumulation has allowed Germany to lead the world in automobiles, electrical equipment, chemicals and other machinery. However, although Donald Trump is eager to promote an American trade surplus, many German economists are worried about their own country’s trade surplus.

The reason for their concern is that there is not enough demand to justify the high savings rates and German capital. Mario Draghi stated “there is simply not enough demand for capital elsewhere in the world to absorb that excess saving without declining returns”. Furthermore, the FT notes that “Germany has not retained a large trade surplus because of subsidies or currency manipulation. The problem is an excess of savings over investments”.

The IMF and ECB have thus proposed higher government spending and tax cuts to stimulate demand. However, it seems that Germany’s large trade surplus is typically viewed through a negative lens. In fact, there are significant reasons to consider it an overwhelmingly positive phenomenon.

Why The Trade Surplus Should Be Encouraged

One reason why the trade surplus is a cause for celebration is that Germany’s unemployment rate has fallen to just 3.8%. The German labour force has increased to over 44 million workers, and as a result, the German labour market is becoming much tighter. The trade surplus is caused primarily by high saving rates, which have led to high capital accumulation.

This has led to an increased demand for German workers and a consequent upward pressure on German wages even though the government has promoted labour market flexibility. Real wages and labour productivity increased by 1.8% in 2015, which was significantly higher than other EU countries. As a result, these higher wages, in turn, cause higher domestic spending, while also continuing the cycle of savings and capital investment.

Furthermore, although the IMF recommends expansionary fiscal policy to stimulate more demand (as the IMF does not think there is enough domestic demand), Germany should, in fact, let their trade surpluses, their foreign exchange reserves and budget surpluses accumulate.

This is because Germany’s population is rapidly ageing, meaning that the public pension and healthcare will be under yet greater pressure. Therefore, since the government will be forced to spend more on pensions in 20 years’ time, Germany can use its foreign reserves to spend on public pensions and healthcare. Therefore, the high savings and capital accumulation should be encouraged.

The Impact on the German Budget

This will enable Germany’s budgetary surpluses to quickly deteriorate as pensioners contribute little in taxes but require money from the government to sustain themselves. Furthermore, when people save money today, it means they have more money available to spend in the future.

Elsewhere, Saudi Arabia has suffered from a large fiscal deficit simply because oil prices are no longer $100/barrel. Oil prices, in recent times, hit as low as $30/barrel, and Saudi Arabia has had to burn through their foreign exchange reserves to sustain the government’s budget. In fact, since 2015 Saudi foreign exchange reserves have fallen by over 30%.

Overall, higher saving means more capital accumulation and thus greater output; it also leads to more available consumption in the future, so leads to sufficient demand for this increased output/capital stock. As a result, the new macroeconomic equilibrium will be at a higher level of output (GDP) and promote greater living standards.

The IMF’s Concerns

If the IMF is concerned that German imports are too low, then the nation could always expand economic integration. TTIP, for example, would have allowed the US to trade freely with the EU single market. As a result, Germany would have had access to American made products and boosted their import levels.

The IMF’s main worry is that there is not enough demand to meet Germany’s capital stock. To resolve this, Germany could increase integration with Asia and Latin America. These two regions have seen rising incomes and have a higher demand for imports of goods such as automobiles, which Germany can produce a great deal of, due to capital accumulation as a result of high savings rates.

Can Trump Learn from Germany?

Donald Trump has every right to be unhappy that America runs a large trade deficit, but his anger is sorely misplaced. China and Germany produce a lot because they are genuinely competitive. America can also be competitive.

Firstly, they need to save as much as Germany does. Given that Americans are richer than Germans, a saving rate as high as Germany’s is achievable. Secondly, Americans need to reform their education sector. Currently, the federal government commits more resources to university education, but it should instead divert resources to job training. This would allow for more productive American workers, who are able to compete with German efficiency on the global stage.

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