Why Germany Is The Economic Powerhouse Of The Eurozone

By Brent Radcliffe | December 03, 2012 AAA

The eurozone experiment is on thin ice. This should come as no surprise to even the most casual follower of news, seeing as the debt troubles of Greece, Spain and a host of European countries have splashed across headlines for much of 2012. The argument over how to save the euro has oscillated between budget austerity measures and infusions of stimulus money, and the continent's two biggest players - Germany and France - have yet to see eye to eye. Pundits and analysts have even coined clever portmanteaus like "Grexit" and "Fixit" in an effort to explain who will bail out of the euro first. At the forefront of the hubbub sits Germany, widely considered the healthiest of eurozone economies. It has done so by emphasizing high value, high complexity manufacturing and exports, while lowering the bar to open a new business and keeping government debt low.

Economists have pointed to several reasons why the eurozone crisis started, but the general consensus is that the countries in the most dire straits - Greece, Ireland, Portugal, Spain and Italy - are not competitive. The main culprit is unit labor cost, which is the total amount of compensation that a worker receives compared to labor productivity. Between 1999 (when the euro launched) and 2010, unit labor costs increased 20% in Spain, 25% in Italy and a more modest 5% in France; Germany's barely budged at 0.6%. All Mediterranean economies currently have higher unit labor costs than Germany.

Exporting the Good Stuff
What sets Germany apart is the type of products that it manufactures. According to a 2011 working paper by Jesus Felipe and Utsav Kumar of the Asian Development Bank, Germany exports a large portion of the world's most complex products to manufacture. It holds a significant advantage over other eurozone countries that do not specialize in the production of these products, which may have contributed to Germany weathering the eurozone crisis better. The paper lists Germany as the second most complex economy, after Japan, with Ireland (ranked 12th) being the closest competitor. While Italy may export a more diverse product list than Germany, it is ranked 24th in complexity of products.

According to the World Bank, exports of goods and services as a percentage of GDP in the euro area grew from 32.9% in 1999 to 42.6% in 2011. The rate in Germany, however, shot up from 33.4% to above 50%. While this figure is not the highest in the eurozone (that distinction belongs to Luxembourg, at 164%), it is significantly higher than France (26.9%), Italy (28.8%) and Spain (30.1%). Being export driven does increase the possibility of being hard hit by recessions, as evidenced by a drop in 2009 exports, but the type of goods manufactured by Germany made it easier to bounce back as the world economy recovered.

In order to lower unit labor costs and stay competitive, a firm would have to enact a strategy that combines keeping wage growth in check and increasing productivity. In the case of the eurozone, it is not high labor costs in the non-German states that are preventing the countries' economies from growing, it is that they produce goods that are less complex and thus open to more global competition. Felipe and Kumar estimate that 7.93% of Germany's exports are in the hundred most complex products, and only 3.5% of its exports are in the least-complex group of products. This is strikingly different in Greece, which sees nearly a third of its exports fall in the least-complex group. Germany is in a class of its own.

Minding the Mittelstand
One striking difference between France and Germany is the way their central governments operate. Central government debt as a percentage of GDP has ballooned in the eurozone, increasing from 58.5% in 2000 to 74.4% in 2010. For Germany the 2010 rate was 56%, far lower than the rates of France (88%) and Italy (117%). Goods and services provided by the government ate up nearly 50% of France's GDP in 2010 and 42% of Italy's, compared to 32% in Germany. Government activity can distort how an economy operates and can set the wrong expectations.

The business environment in Germany was ranked 20th in the World Bank's Doing Business report, with France ranking 34th, Spain 44th and Italy 73rd. The lower rankings are linked to protections afforded to employees, with businesses facing potentially costly and protracted struggles if they want to fire anyone. While red tape around the labor market can be daunting, Germany does have a fairly low barrier to entry when it comes to starting a business. It also has a total tax rate a third lower than France and Italy.

According to the World Economic Forum's 2012-2013 Global Competitiveness Report, Germany ranks 5th in higher education and training, a factor leading to it manufacturing such complex products, and 3rd in infrastructure, part of what helps Germany move its exports to market so efficiently. It is ranked 3rd in business sophistication, which includes supplier quality and quantity, value chain and production process. This is most likely linked to one of Germany's best assets: the Mittelstand. The Mittelstand is a collection of small- and medium-sized businesses that tend to focus on exports. They excel in the development of innovative technologies and techniques - Germany is ranked 7th in innovation, according to the Competitiveness Report - and often partner with research facilities and universities.

The Bottom Line
Manufacturing and exports are decidedly un-sexy, and despite being known for its high-end sports cars, Germany is just fine with looking more like a curmudgeon than a flashy celebrity. GDP growth rarely tops 3% and has averaged 1.35% since 1999, 25% lower than the OECD high income average and a third lower than the United States (2.04%). Yet, despite the slow growth, Germany has stuck out as the fiscally prudent leader of the eurozone, although this has brought it at odds with fellow members that find its dour focus on austerity measures at odds with the stimulus that some analysts think Europe needs.

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