German Stimulus Won't Save Europe

Permanently increasing German government spending by one percentage point of GDP would raise output in Ireland and Greece by just 0.1%.

By AMIT KARA

The euro-zone economy is stagnating, and many argue that Germany is partly to blame. German households and corporations tend to save, and the country runs a large and persistent current-account surplus. That implies a deficit in other euro-zone countries. 

Many have argued that a reversal of Germany's current-account surplus is a prerequisite for sustainable economic growth in the euro area. But a unilateral adjustment along these lines would be unlikely due to domestic resistance within Germany. It would also be harmful to the economic prospects of the entire euro area.

Germany is the bulwark of the European monetary union. Not only is its economy the largest in Europe, but it has navigated the crisis better than any major European economy. Without its strength, the single-currency experiment would probably have already collapsed under the weight of its contradictions. 

Many international policy makers also believe that Germany could provide the euro zone with the resources to fix its own troubles. For them, the solution requires a unilateral German domestic demand boost and an erosion of its current-account surplus. Unless that happens, they see little scope for multilateral assistance. 

Getty Images

Chancellor Angela Merkel (left) and

Finance Minister Wolfgang Schäuble

But that analysis is too simplistic. Germany's current-account surplus can be eroded if domestic demand grows faster than the external demand for its products and services. This can occur if the German government spends more, or if its private sector—households or corporations—saves less.

Both options would be more costly than is usually presumed. Germany runs a small and manageable fiscal deficit of just 1%, but the stock of government debt is high at 80% of GDP. And with a potential GDP growth rate of just 1%, any initiative that raises the debt level of Europe's strongest economy may well bring into question the sustainability of both its own debt and that of the entire euro zone. Put differently, Germany does not boast the fiscal strength that many assume.

Even if Germany manages to increase domestic demand, there is no guarantee that the additional spending will find its way into the peripheral euro-zone economies. A simple macroeconomic simulation suggests that a permanent increase in German government consumption equivalent to one percentage point of GDP would raise output in Ireland and Greece by 0.1% at most, and in larger countries, such as Spain and Italy, by much less than that. 

That should come as no surprise. After all, exports to Germany account for just 2.5% of the combined GDP of Italy, Ireland, Portugal, Spain and Greece. In order to make a difference, Germany would therefore have to embark on a fiscal expansion that is too big even for the largest economy in Europe. 

What about households and companies? German household saving is relatively high at 11%, in theory providing some scope for additional private spending. Here, too, however, there are difficulties. Designing a fiscally neutral set of measures that encouraged spending would be challenging because German households have, on average, less net wealth than their counterparts in France or Italy. 

There is also the possibility of faster wage growth in Germany, which would undoubtedly help stimulate consumption. But only a small portion of that additional spending would be directed toward the troubled countries. And Finance Minister Wolfgang Schäuble, while acknowledging the likelihood of more rapid German wage growth, also warned that the economy should not lose its focus on competitiveness, implying that there is a limit to how much wage growth German authorities will tolerate. 

What if German corporations spent more? That would help, but it is not clear how the German government can help channel that spending to the peripheral economies. Investment decisions are influenced far more by the cost of capital, demand prospects and structural reforms in the troubled economies than they are by German government policy.

All in all, an expansion in German domestic demand would have, at best, a marginal impact on the economic growth prospects of the periphery. At worst, there is even a risk that markets would start to question the debt sustainability of the German sovereign if domestic demand were stimulated by government spending or lower taxes. 

It is worth noting that such an injection of funds does not obviate the need for the troubled economies to make the painful structural adjustments that are necessary to become more competitive. At best, it would help ease the pain of that adjustment. The other likely alternative is for the euro to depreciate, perhaps by enough to help lift the troubled economies, but in this case the German current account surplus will expand further and Germany will have to suffer much higher inflation. 

Germany and the euro area would be better off pursuing a multilateral effort that involves other fiscally strong countries inside and outside Europe to create a structural fund targeted toward the troubled economies. 

A multilateral rescue plan obviously comes with costs, and for that reason it will be resisted. But until that resistance is lifted, questions about the viability of the single-currency project will remain. 

—Mr. Kara is economist for the U.K. at UBS.
Fuente: THE WALL STREET JOURNAL