Has Germany's bubble finally burst?

German policymakers have long been complacent about the country's economic health, but it now appears their inaction will come back to haunt them.

As recent economic data shows, the German economy is dramatically slowing. Exports experienced their biggest fall for five years, growth forecasts for the next year have been downgraded by research institutes. It is quite possible that the country is already in recession.

These are not just cyclical developments. A much bigger swing is on the way, which will end all talk about the economic powerhouse in the heart of Europe. Instead we will need to get used to being seriously worried about the state of the continent’s largest economy.

Needless to say, a German slowdown has dramatic implications for the eurozone.

To understand how the Germans tick, it is instructive to watch their book market. About a decade ago, books spreading doom and gloom messages about Germany were topping the lists. Among the most influential was a weighty tome by Hans-Werner Sinn, head of Munich’s Ifo research institute, under the telling title: Can Germany still be saved?

The core argument of this and other doomsayers’ books was that the German economy was ill-prepared for the ageing of society; that public finances were in a sorry state; that the education system had fallen behind internationally; that the labour market was overregulated; and the welfare state way too generous.

The diagnosis of the German patient in the early 2000s was quite correct, and economic circumstances of the time reflected the malaise. For a short time in the winter of 2003, unemployment exceeded 5 million people, and Germany failed to comply with the Maastricht Treaty’s budget deficit rule.

What turned the economy around and lifted Germany out of its mess were two things. On the one hand, there was remarkable wage restraint across the economy. Trade unions, which in Germany enjoy great powers through industry-wide collective bargaining, understood the severity of the crisis and quietly played their part in allowing companies to claw back cost competitiveness. On the other hand, the government under Chancellor Gerhard Schröder implemented reforms which liberalised the labour market and cut back the welfare state.

Both these measures, wage restraint and economic reforms, helped to restore Germany’s growth potential. When the euro crisis then hit, Germany also enjoyed its status as a safe haven for inflowing capital and ultra-low interest rates. This triggered a boom while much of the rest of Europe was in crisis.

The book market again reflected this sentiment. Suddenly, book stores were dominated by titles such as Save our money!, in which former President of the Confederation German Industry, Hans-Olaf Henkel, warned against Germany being required to shoulder the debt burdens of southern Europe. The Germans were no longer as concerned about their own economy. But they were worried about being exploited through mutualisation of eurozone debt.

If the market for business books is anything to go by, Germany has now entered a new phase -- and it sounds remarkably similar to the beginning of the century. Business journalist Olaf Gersemann has called his new book The Germany bubble: The last hurrah of a great economic nation. Marcel Fratzscher, a prominent economist, titled his new book The Germany Illusion: Why we think too highly of our economy and why we need Europe.

As you can see, the Germans never do anything half-heartedly. They are either on top of the world or in the depths of despair.  There is nothing in between. Or, as Winston Churchill once put it, “The Hun is either at your throat or at your feet.” Germans don’t do nuances too well.

Books like the current, pessimistic ones remind the Germans that many of the issues they were discussing a decade ago have not been solved but actually become worse. Maybe the fixation on even more problematic countries such as Greece, France and Italy made Germany appear stronger and more virtuous for a while.

However, such sclerotic economies should have never been allowed to pass as benchmarks in the first place. At the very least, it is odd that any German government would be able to pass off growth forecasts of not even 2 percent as good news, as happened last year.

The truth is that Germany has never been as strong as it appeared to others and as the Germans would have liked to believe themselves. Over the past years, this column has repeatedly cautioned against too much optimism about Germany’s supposed economic strength. It is not just that Germany was never as well placed as some naïve commentators thought. Unfortunately, the belief in Germany’s economic power also created a sense of complacency among policymakers in Berlin.

Since Chancellor Angela Merkel began her second ‘Grand Coalition’ with the Social Democrats late last year, her government has been engaged in populist feel-good policies. Her government spent money as if it grew on trees. Little wonder, perhaps, since tax revenue was strong and finance minister Wolfgang Schäuble hardly needed to pay interest anymore on his borrowing.

Germany may have recommended to other European nations to implement economic reforms and pursue austerity policies. At home, however, the German government has been pursuing the very opposite. Introducing increased pensions for mothers, cutting back the retirement age to 63 years and establishing a national minimum wage were all steps in the wrong direction.

Unfortunately, Merkel’s government does not stop there. Next on the agenda are laws to mandate equal pay for men and women and an ‘anti-stress law’ that is meant to protect employees from working too hard. Both are likely to keep battalions of lawyers employed without contributing anything else to economic growth.

Maybe the Germans do not even want to grow much anymore? At least that is the impression one might get from looking at Berlin’s agenda. There is nothing in Merkel’s record that suggests she understands anything about economic policy. She was a lucky Chancellor who inherited a reformed and growing economy. She was even luckier when the rest of Europe crashed and that crash actually boosted Germany’s performance. But Merkel has yet to implement any kind of policy that would strengthen her own economy in the long run.

Germany’s bubble has probably burst. Whereas the world did not know how to deal with Germany’s supposed strength in recent years, we will soon look back to this time as the good old days. Dealing with an ailing, sluggish and self-doubting Germany will be even harder. And this Germany will not provide any positive leadership to Europe either.

Dr Oliver Marc Hartwich is the Executive Director of The New Zealand Initiative.