IN a striking column in the Financial Times a few days ago, Wolfgang Munchau, the FT’s European affairs commentator, suggested that Britain’s economic ascendancy in Europe could be coming to an end. “What masquerades as an economic miracle in the UK may in fact be nothing other than an old-fashioned Keynesian spending boom,” he thundered. What we had seen under New Labour could simply be “the first part of a boom-and-bust cycle” — with a long bust to come.
While digesting these sentiments, I came across some striking evidence, from Lombard Street Research, about the speed with which German industry is making itself newly competitive. Hourly labour costs in Germany, which were 20% higher than in France as recently as 1997, are now only 5% higher, and the rate of progress shows no sign of abating. German business is sorting itself out.
Put these two observations together and we have an intriguing question. Could it be that over the next five to ten years, Britain and Germany could swap roles, with Germany becoming the economic powerhouse of Europe, while Britain is once again seen as a less efficient trading partner, suffering from its traditional weaknesses of skill shortages and inadequate investment? To answer this, we must ask why Britain has boomed, and what the sequence of events in Germany is likely to be as its industry becomes steadily more competitive.
The British side of the story is scarcely a secret. The principal driver of growth during the Labour years has been rampant consumer spending. Gordon Brown has presided over the most extended spending spree ever recorded, financed by an unprecedented increase in household debt. And in the last parliament, the economy received a huge additional boost as the government’s finances swung from a £15 billion surplus in 2000-1 to a deficit of about £35 billion now in order to pay for rapid growth in public spending. Throughout most of that time, investment continued to disappoint, and the balance of payments moved from near balance in 1997 to a deficit exceeding 4% of GDP now.
This looks pretty much like “an old-fashioned Keynesian spending boom” to me, albeit brilliantly disguised in presentational terms by constant reference to “prudence and caution”, and carried through under the protective cloak of the (economically irrelevant) “golden rule”.
Of course, the Thatcher reforms made the economy and particularly labour markets much more flexible. This made it possible to keep spending rising, and unemployment falling, for a good deal longer than could have been managed in the past without inflation being rekindled. But the party is now coming to an end — the latest figures show that the economy is growing at its slowest rate for 12 years.
It is not difficult to see why. Both the consumer and the government have run out of road. Debt payments as a proportion of household income are at record levels. Equally, government borrowing is now at the limits of acceptability, and taxes may have to rise to keep it within them, discouraging households further. With a weak international economy, it is hard to see where any new substantial demand might come from.
Moreover, it will take some years for consumers and government to get back to more sustainable levels of borrowing, which means that, although “bust” is too strong a word, Britain’s economic growth will be subdued for an extended period.
Contrast this with what has been happening in Germany. It has been the very reverse of the British experience. Germany’s progress has been disguised because of the tendency of structural reforms to make things worse before they get better. It is well known that costs are too high in Germany, social welfare too lavish, and labour markets too inflexible. Gerhard Schröder’s government, under its Agenda 2010 programme, has at least begun to tackle labour-market rigidities and excessive pension costs.
More to the point, German industry has been hard at work cutting costs and concluding agreements that have, for example, lengthened working hours for the same pay. The result has been the substantial improvement in Germany’s relative cost position. This advance is underpinned by a steady increase in the share of profits in the national income, from 36% at the start of this decade to 39% now. German business has taken its future into its own hands and is in steadily better shape.
So why has Germany’s growth been so dismal in recent years, with its economy struggling to expand at even half the rate of Britain’s? The story is the reverse of Britain’s — a reluctance to spend and borrow. The personal savings rate has risen rapidly since the late 1990s partly for demographic reasons — the baby-boom generation has moved to its late-career, savings phase. But the savings rate has also increased in response to the fear and insecurity caused by the structural reforms that were designed to make things better.
So as the supply side of the economy has improved, demand has stagnated, and has been further depressed by the government’s efforts to prevent a rise in the budget deficit. On top of everything else, Germany has had to contend with too high an interest rate, as a result of its membership of the euro.
However, as German competitiveness improves, a virtuous circle should gradually be created. As production rises and unemployment starts to fall, people will feel less insecure, so that domestic spending will start to recover. Improved economic performance will generate higher tax revenues, taking the pressure off government finances. And a somewhat higher inflation rate will make the euro interest rate less onerous. In short, consumer spending will start growing again.
What is more, as the baby-boom generation moves from employment into retirement, it will save less and consume more. And, not least, German and overseas banks will move to exploit rising consumer confidence by promoting the use of credit cards, which scarcely exist in Germany in a form we would recognise. This process is starting already.
In other words, as the structural reforms start to work, the scene will be set for Germany to embark on its own British-style consumer boom. Ours is over; theirs is still to come. And from a starting point of 12% unemployment, it is likely to last at least as long as ours has done.
In the long term, Germany’s growth prospects continue to look difficult as its population ages and its workforce declines, reflecting the country’s low birth rate. But in the next decade at least, attention is likely to be focused on a new Wirtschaftswunder. It could be difficult for Britain to keep up.
