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Don't bash Germany for its trade surplus

By Hans Werner-Sinn, Special to CNN
  • Hans Werner-Sinn: Germany has not profited inordinately from the euro
  • Before the crisis, Germany's exports were stimulated as cheap credit fueled growth in countries like Greece and Portugal
  • But Germany's economy slumped as capital outflows kept the country from investing at home, he says
  • Sinn says now that risk has returned, long-delayed investments in Germany are being made, and domestic demand is returning

Editor's note: Hans-Werner Sinn is a professor of economics and public finance at the University of Munich and president of Germany's Ifo Institute for Economic Research. He has been a member of the Council of Economic Advisors to the German Ministry of Economics since 1989 and also runs the CESifo Research Network.

(CNN) -- Many politicians today criticize Germany for its large current account surplus, and insist that it be reduced. Germany, goes the argument, profited the most from the euro and should now stand by the troubled countries and give them more loans. Those who so argue show they haven't understood a thing. They blithely overlook the fact that both demands stand in contradiction to each other, because a country's current account surplus is by definition the same as its capital exports. It is impossible to reduce the current account surplus and lend more capital to other countries at the same time. They also ignore the effects wrought by the euro throughout Europe.

The very announcement of the euro caused a nearly total convergence in interest rates across today's euro zone countries from 1995 to 1997, from which the southern countries and Ireland profited handsomely. These countries' creditors believed themselves protected from the risks of inflation and depreciation and never imagined a sovereign insolvency could occur. With the exception of Italy, they reacted to lower interest rates by expanding their borrowing to finance consumption and real estate, and enlarged their public sectors. This fueled strong growth. But what started out so promising turned into overheated economies, real estate bubbles and a massive real depreciation that sucked many banks and even countries into the resulting maelstrom.

Before the crisis hit, the countries in Europe's southern and western periphery could live well above their means, thanks to abundant credit. They became huge capital importers, fueling their economies with foreign credit. Greece and Portugal consumed far more than their income. Their aggregate savings became negative long before the crisis, reaching -12% and -10% of GDP, respectively, in 2009. Spain, in turn, boasts that the euro bestowed upon it a "golden decade." In fact, however, these countries went through a period of "soft budget constraints." Much money flowed into consumption, and much was invested wrongly. Before the bubbles burst, capital inflows and rapidly rising incomes had led to a dramatic increase in imports. Concurrently, the overheating labor market, which substantial immigration flows could only partially counter, pushed wages up, undermining the competitiveness of exporters. The capital imports turned into current account deficits that ballooned out of proportion.

Germany, meanwhile, experienced a prolonged economic slump. Given the seemingly safe and profitable investment opportunities offered by other countries, German banks invested abroad their savings instead of at home. Germany became the world's second-largest capital exporter after China. The country's net investment rate fell to the lowest among the OECD countries. Property prices slumped, while massive unemployment goaded the government into ramming through painful social reforms. From 2002 to 2010, Germany accumulated €1.6 trillion ($2.2 trillion) in aggregate savings. This money was in principle available to finance the construction of factories, buildings, roads and other investments, but two-thirds of it flowed abroad instead. One-fifth of this capital export was foreign direct investment, while four-fifths were mere financial capital flows.

Capital exports are a blood transfusion to other countries that materializes through a current account surplus.
--Hans Werner-Sinn

Although Germany clawed its way back to the average growth rate of the euro zone during the 2006-2008 upswing, from 1995 until the financial crisis hit, it had Europe's second-lowest growth rate, and in the end people even began to emigrate. This poor performance put a brake on imports, while lack of demand in the labor market and domestic economy led to moderate price and wage hikes, making Germany's products, compared to those of its trading partners in the euro zone, 18% cheaper from 1995 to 2008, which in turn stimulated exports. The fleeing capital pushed the country into a slump, which led to a current account surplus. It's only thanks to the flexibility and efficiency of Germany's export industries that the capital exports did not translate into even larger growth losses. Capital exports are a blood transfusion to other countries that materializes through a current account surplus. It is absurd to interpret it as inordinate gains from the euro.

What is beyond doubt is that in 2010, Germany, with a 3.6% growth rate, thrust itself to the head of the European convoy, and the tide appears now to be turning. But that is because banks and insurance companies do not dare send their money abroad, seeking instead safe investments at home. The rapidly rising interest spreads show how far risk perceptions have shifted. In a way, the situation before introduction of the euro is being restored, and long-delayed investments in Germany are being made with remarkable zest. Foreign trade accounted for only around 30% of the surge in demand that lies behind last year's growth. Half the surge was attributable to growth in domestic demand for investment goods that surpassed all expectations. Germany can now look forward to the kind of upswing, albeit less exuberant, that countries in Europe's periphery experienced in the past 10 to 15 years. Only it will do it with its own savings, not with borrowed funds.

The opinions expressed in this commentary are solely those of Hans-Werner Sinn.