Germany is characterised by a high degree of international economic integration. This is a source of risk in view of the increasing concerns about the stability and durability of the post-WWI liberal international order (Jaeger 2020). The end of the Cold War and the integration of the Eastern European economies into the EU single market allowed corporate Germany to extend its supply chains and tap into former Communist countries’ low-cost but well-educated workforce. This not only helped lower the price of intermediate inputs in German exports. It also helped keep German labour costs down. Near-simultaneously, China’s investment-oriented growth and economic rise led to a sharp increase in demand for German capital goods exports. Last but not least, the creation of the euro locked Germany’s major trading partners into a fixed exchange rate regime and prevented the sort of competitive devaluations that had characterised Europe’s various post-Bretton Woods exchange rate regimes. Over the past 25 years, Germany’s trade openness has increased substantially and is today significantly higher than in all other major economies.
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| Source: World Bank |
At close to 60%, the EU-28 (or rather the EU-27 and the UK) absorb the bulk of German exports. Among the top-15 trade partners, each of which accounts for 2% or more of German exports, only three are not members of the EU or EFTA, namely, the US (9%), China (7%) and Russia (2%). In other worlds, leaving aside the US and China, export concentration is very limited. This is not to suggest that trade with the US, China and Russia are not economically and politically important. It would a great exaggeration, however, to claim that the German economy is “dependent” on any of the major non-EU markets. To put this into perspective: upward of 70% of both Canadian and Mexican exports go to the US.
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| Source: BMWi |
Total trade is a useful, but insufficient measure of trade dependence, let alone economic dependence, for it does not take into consideration the degree to which exports and imports add to economic growth, nor whether whether imports can be substituted. At 4/5, domestic value-added in German exports is about the same level as in Italy and France, but tangibly lower than in the US, Japan, Brazil and China (around 10%) as well as China and India (around 15%) (OECD 2020). The importance of trade to German prosperity is most starkly reflected in the fact that 28% of German jobs are directly or indirectly linked to trade. The respective figure for the manufacturing sector is a stunning 56% (BMWi 2019). Last but not least, the German economy, like many other economies, is dependent on critical commodity imports, including energy. This latter fact explain why the German government has historically been prepared to defy US diplomatic pressure over its import diversification strategy (incl. Nord Stream 2). All said, there is no doubt that the German economy is quite susceptible to external trade shocks given the high degree of trade openness. But its trade profile is more robust than it may at first appear thanks to the large share of EU (and euro area) trade and a fair degree of overall diversification and a slightly higher share of import content in its exports compared to several of its peers. Naturally, in the event of a major global shock, trade diversification is not of much use.
Germany’s de facto international financial integration is high and its net foreign claims have surged dramatically in the past few years on the back of very large trade surpluses. The net international investment position has risen to 70% of GDP compared to less than 5% of GDP a decade and a half ago. The German government usually argues that the trade surplus is not an economic-political issue because its size, shape and form is due to market forces. Whatever the merits of this argument, large gross and net external claims make the economy more susceptible to international financial volatility and losses (e.g. German Landesbank losses on CDOs in 2008). Moreover, the financial returns on foreign asset holdings are very low (IFWK 2019; Jaeger & Mayer 2013), suggesting (but not necessarily proving) that the huge surplus savings (aka current account surplus) would be better invested in the domestic economy rather than exported. To get a better grasp of how significant these financial risks are, a more detailed geographic and sectoral analysis would be required, which unfortunately is beyond the scope of this comment. Just for reference, FDI accounts for EUR 1.5 tr and and portfolio and other investment for roughly EUR 3.0 tr each, with financial derivatives and reserve assets accounting for the remainder of foreign asset holdings. German gross assets increased from just over EUR 2.0 tr (< 150% of GDP) in 2000 to EUR 8.5 (>250% of GDP) in 2018. (By Q3-2019, assets had surged to an all-time high of EUR 9.6 tr.) By comparison, US foreign assets amounted to less than 150% of GDP in 2019. The upshot is that Germany’s large foreign assets, often seen as virtuous, also create financial risks or at least sensitivities - maybe outright vulnerabilities.
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| Source; EuroStat |
In terms of outward FDI, the EU accounts for 1/3 of Germany’s outward FDI stock, followed by both the US and Asia with 1/4 each. Compared to trade, outward FDI is less heavily concentrated in the EU. Both the US and Asia are more important in terms of German outward FDI than in terms of German exports. It is worth noting that Germany trades with, and invests in, the US and China in comparable measure, at least as far FDI is concerned. Two decades ago, China was not even on the proverbial map. The longer-term implications of this trend are worth exploring in a separate comment, not least given that China’s share in German exports has almost quadrupled since 2000 and is set to increase further on current economic trends. German FDI in China increased similarly. Increased trade with, and investment in, China makes Germany structurally more reluctant to confront China by threatening to restrict trade, quite apart from the fact that generally such measures are WTO inconsistent. (The US fewer qualms given its more limited trade relationship with China.) Again German outward FDI is relatively well diversified, even though the non-EU share is much larger than the non-EU share of its exports.
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| Source: BNP |
The post-WWII international multilateral economic regime and ever-closer European economic integration have allowed Germany to reap the benefits of increased international trade and investment. De-globalisation would put these benefits at risk. Should the present multilateral economic order falter, the EU single market would provide Germany with a second line of defence. At this point, a complete and permanent breakdown of the WTO should probably be considered a tail event in spite of the current US administration’s attempts undermine it by not blocking the appointment of judges to the appellate body. A future US administration is likely to be less unilateralist and more keen to reform the WTO rather than weaken the WTO further. There is reason to be somewhat optimistic. While Germany, given its greater trade dependence, does have a greater stake in the maintaining a liberal and stable international order than the US, Berlin (and Tokyo and Ottawa and others) shares several of Washington’s concerns and grievances as far as China is concerned (e.g. IPR, industrial policy, China 2025, China market access). Berlin, not surprisingly, opposes the means by which these ends are being pursued by the current US administration. Resorting to economically damaging tariffs and invoking, rather dubiously, various types of exemptions under WTO rules risk undermining the WTO framework. This is not in Berlin's interest. Nevertheless, Berlin is concerned about the “competitive” threat China poses to key German industries and technological leadership. Berlin has already introduced tighter investment restrictions in sectors deemed "critical". The new inward investment regime will also allow for more thorough screening of non-EU investors in various high-tech sectors (Financial Times 2018). China’s state-capitalist system and practices are seen as a threat to German industrial leadership. No wonder Germany is one of the most vocal supporters of a EU-China BIT as well as the European Commission’s greater involvement in screening FDI from outside the EU. In short, Germany - like many other advanced economies -shares many of Washington's concerns and this should allow it to salvage the WTO regime from wreckage provided a mutually acceptable compromise with Beijing can be found.
Finding international agreement on how to reform the WTO will prove politically difficult and it will take time before a compromise on broader WTO reform is reached. In the meantime, Germany might be well-advised to put its trade and fiscal surpluses to work. Designing a long-term, productivity-enhancing investment programme focused on developing key future technologies might offer a temporary fix to cope with a skewed level playing field. Selling fiscal stimulus policies to the German government is difficult task (Jaeger 2019) given Germany’s experience with Keynesianism in the seventies (and given its ordo-liberal beliefs). But the German government has become less hostile towards increased spending in the context of an investment programme. As with all industrial policies, there is the question of whether and how to design a successful and efficient programme.
Undoubtedly Germany has significant fiscal space and faces no external financing constraint in terms of increasing government (or government-supported) investment by 1.0-1.5% of GDP annually. (Additional spending of that size would not violate the constitutional "debt brake" as of now. The challenge is rather how to design efficient spending plans and implement them effectively.) The fiscal position, including the structural fiscal deficit (surplus, in fact), is very strong and government debt is set to continue to fall for the foreseeable future. Germany’s trade and current account surpluses are huge and would not represent any obstacles whatsoever in terms of raising investment. In fact, reducing Germany’s net foreign claims might even help reduce the risks associated with too rapid an accumulation of foreign assets. Once again, the key question is whether boosting investment makes economic sense. Can investment projects be found whose economic (and social) returns exceed the cost of capital (currently negative in nominal terms)? Can the programme be designed in a way so that it does not contribute to domestic cyclical overheating and a build-up of financial risks?
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| Source: IMF |
In the security realm, post-WWII Germany relied on the US and NATO, while seeking to strike the right balance between its European and transatlantic interests in the context of its commitment to Westbindung (even during Willy Brandt’s Ostpolitik). As in the case of the international economic order, Germany is increasingly concerned about Washington’s longer-term commitment to the transatlantic security alliance. NATO and the US were indispensable in terms of security during the Cold War. GATT and European economic integration were indispensable in terms of economic prosperity. With US support for the multilateral economic order in doubt and with China emerging as a potential economic competitor, Germany will seek to strengthen the EU economically. With a US commitment to NATO that looks less solid than before, Germany will seek closer security cooperation with France. Ultimately, the US is unlikely to abandon NATO. After all the US had to intervene in Europe in two world wars and one cold war during the 20th century in order to prevent the continent from falling under the hegemony of a single country. (This observation will understandably do little to put the Germany security establishment at ease.) Rather than the emergence of great power competition between the world’s three major economic blocs, we are more likely to see North America and Western (and Central) Europe maintain a security community (Deutsch 1957) – at least for the foreseeable future. There is going to be a continued tussle over the distribution of the costs of maintaining the military alliance. But this is hardly a new phenomenon (Olson & Zeckhauser 1966; Zimmermann 2002). Germany, more than most other countries, has a keen interest in preserving both the multilateral liberal economic order and the Western multilateral military alliance. Cognisant of its structural vulnerabilities, Berlin will go a long way to seek to find a compromise with Washington that will help preserve the foundations of Germany's post-war economic stability and security.