How Germany became the world’s best economy

German unions’ willingness to hold down wages led to lower production costs in Germany, allowing the country to export more

Let’s hope US policymakers have woken up to the fact that the country is in a period of sclerosis, where its economic institutions seem to be inefficient along a variety of fronts. When things aren’t working, one good idea is to look around and see which countries are doing better.

Right now, Japan is one such country. But in many ways, Germany looks like the most successful economy in the developed world.

This wasn’t always the case. It was a German economist who coined the term “Eurosclerosis” to describe the slow growth that plagued the country from the 1980s through the 1990s. In the late 2000s, even as the US economy boomed, Germany’s unemployment rate exceeded 10%.

But almost a decade after the global financial crisis, the country has found its legs. Unemployment is down. Labour force participation has risen steadily. Wages have gone up as well, outpacing the US since the 1990s and looking healthy in recent years.

This stellar performance comes even as Germany faces many of the same challenges as other rich countries.

Its fertility rate is low—just 1.38 children per woman, even lower than Japan. And its population is slowly shrinking. That means that a smaller and smaller base of German workers has to support a growing number of retirees.

Germany also hasn’t escaped the global productivity slowdown. Like other rich countries, it’s struggling to produce more from the same amount of resources.

And Germany has also been dealing with the challenge of automation, possibly even more than the US. Only Japan has substantially more industrial robots than Germany.

If, as some now claim, robots are a big threat to jobs and wages, German workers should be suffering; instead, their wages have been growing at a steady clip, even as employment has risen.

What is Germany doing right?

The country has a very large state sector, generous welfare spending and a trade unionization rate almost twice that of the US. Though the country did undertake a few free-market reforms in the early 2000s, there has been no major wave of deregulatory mania.

Nor did Germany escape the 2008 financial crisis or the Great Recession, both of which hit it hard. In fact, political and financial instability in the European Union probably was a drag on the country.

A new article by economists Christian Dustmann, Bernd Fitzenberger, Uta Schönberg and Alexandra Spitz-Oener proposes a theory for the German revival. Essentially, they say, it’s all about exports and unions.

The authors note that Germany’s exports have increased steadily. Though the country accounts for less than 5% of global output, it has about 9% of world exports. Sales to other countries account for about half of Germany’s gross domestic product—more than twice as much as for China.

Why is Germany such an export powerhouse?

Dustmann, et al. attribute it to the country’s wage competitiveness. In Germany, wages are set by collective bargaining at the industry and regional level, rather than at the company level as in the US.

According to the authors, German unions’ willingness to hold down wages led to lower production costs in Germany, allowing the country to export more.

And although it may seem counter-intuitive at first glance, limiting wage gains eventually led to faster wage growth.

Think about it. Companies deciding where to produce things have to base their decisions not just on today’s wage level, but on their expectations of future wage changes.

German unions’ willingness to contain or forgo raises in bad times could act as an insurance policy for companies in good times, making them feel safer about building expensive factories and making risky long-term investments in the country.

But there are also other, more troubling explanations for Germany’s performance.

The country’s exports have not been matched by imports—Germany runs a very large trade surplus.

Under normal conditions, economists believe that if a country runs a trade surplus, its exchange rate should rise to cancel out some of the imbalance.

But Germany is part of the euro- zone, most of which is in an economic slump. That slump holds down the euro’s exchange rate against that of many other countries, making German exports cheap.

Also, the unified currency doesn’t allow the exchange rates of slower-growing countries such as Greece or Spain to fall against Germany, meaning that Germany gets a boost to exports within Europe.

Some of Germany’s export competitiveness, then, might be coming at the expense of other countries. And some might depend on other European nations being in a slump. Those advantages would be either unhealthy or temporary.

But if Germany’s success really is due to its unique method of collective bargaining, other countries—especially those with large persistent manufacturing trade deficits, such as the US—should think about ways to emulate the German system’s advantages.