How A German Sovereign Wealth Fund Could Help To Rebalance The Eurozone

Kurt Huebner, German Sovereign Wealth Fund

Kurt Huebner

Germany is on the dock, big time. In its 2013 ‘Alert Mechanism Report’ the European Commission announced that Germany jointly with Luxembourg would have to undergo a thorough review of its potentially disturbing high current account surplus. The procedure is a legal necessity given that over the last three years Germany’s surplus has been above the critical level of 6% of its GDP. The Commission’s alert was preceded by a stern warning in a report to the US-Congress on international exchange rates in regards to the potentially deflationary impact of Germany’s current account surpluses.

Yet the messages are not unidirectional. Only a few days after the Commission’s alert its own DG ‘Economic and Financial Affairs’ published a downward revision of the growth projection for the Eurozone, mainly due to the fact that the German export sector experienced a slack in its growth dynamic, which was then reflected in a downward projection of overall German GDP-growth. All this sounds a bit odd. On the one side, Germany is getting blamed to beggar its Eurozone neighbors with its export strength and on the other side already a slight reduction in Germany’s export dynamic makes the Commission shiver that such a slide could drive the whole Eurozone closer towards its fragile crisis zone.

Moreover, given that a surplus in the current account represents a surplus of domestic savings over investment it is quite a conundrum that budget-wise Germany should potentially turn more frugal. More public savings, ceteris paribus, would increase the surplus in the current account. The more the German government sticks to its Eurozone crisis approach, the less domestic growth and the more exports are to be expected. Thus, rather then aiming to constrain Germany’s current account directly, one could argue, Germany should move towards an expansive fiscal policy, even by risking to violate the Stability and Growth Pact (SGP). This can be done in a rather heterodox way.

Where is the Surplus Coming From?

A long-term surplus of the current account of an economy signals that one or more of the regular adjustment mechanisms are not working properly. In a regular case adjustment is being achieved by changes in the exchange rate, i.e. an appreciation of the currency of the surplus economy, respectively a depreciation of the currency of the deficit economy. An appreciation would undermine the price competitiveness of exports and would make imports relatively cheaper. Cheaper imports increase the domestic competition pressure and may lead to downward pressure on costs of production.

As a result, the trade balance surplus and then the current account surplus would get reduced or even eliminated. A malfunctioning of adjustment mechanisms can have several reasons that range from market distortions to politically motivated exchange rate interventions. Due to the lack of an external devaluation mechanism in a currency union it is up to economic policies to kick-start an internal devaluation that eventually will create a downward pressure on wages. Such a mechanism is by far not as elegant as the exchange rate mechanism, and actually generates quite substantial political uproar in the crises economies. Moreover, the mechanism is economically as well as politically asymmetric in its very nature because both do not occur in the surplus economy but are contained to the deficit economy.

There is no doubt that the southern periphery had serious deficits vis-a-vis Germany until the outbreak of the sovereign debt crises. It is still under debate how exactly the divergence in competitiveness should be best understood. The dominant view suggests that Germany controlled its unit wage costs in superior ways, whereas the deficit economies during the same period experienced a strong increase of unit wage costs. The result was a widening cost gap that provided the ground for German’s success. Contrary to this mainstream view, I argue that the German superiority is less caused by the far-reaching labor and welfare state reforms then by differentials in the inflation rate, the accommodating nominal wage policies of trade unions, and in particular by the build-up of EU-wide value chains that put enormous pressure on wages in German industry.

Whatever the reasons for Germany’s competitive advantages are, it is obvious that the trade surpluses with other Eurozone economies came with implications – for the surplus as well as for the deficit economies. In the case of Germany, as I will argue below, the price is a substantial underperformance of economic growth. In the case of deficit economies it is the adjustment crises those economies had to undergo.

The constellation has changed. Germany’s current account surpluses with the southern periphery of the Eurozone have become significantly smaller. This change has not been caused by adjustments on the side of Germany but is due to the successful working of internal devaluation in the deficit economies. As data show, Germany’s surplus with Greece, Spain, Portugal and Italy drastically decreased since the onset of the sovereign debt crises. This is no surprise at all and only reflects the brutal destruction of effective demand due to the austerity policies those economies had to launch in order to get support from the newly established EU rescue funds.

Despite these processes of adjustment Germany’s overall current account surplus stood high and continued to increase. Now the source of the surplus is more and more outside the Eurozone. In 2012 its trade balance surplus amounted to 5.7% of GDP; the current account surplus showed a surplus of 6.3% of GDP (BMWT 2013). Even though Germany’s main trading partners were still in Europe (69% of German exports stay inside Europe, and 70% of its imports stem from European economies), this economic area is getting less important in regards to the origin of Germany’s trade balance surplus. If we look at the geographic distribution of Germany’s surplus in the trade balance (goods and services) we can see that the southern periphery actually plays no longer any important role as ‘overshooting’ entities. The share of Italy, Spain and Greece in Germany’s overall trade surplus adds just up to less then 10%. In 2012 Germany was even running a deficit with Ireland. Close to two third of the overall trade surplus of Germany in 2012 was made up by France, US, UK and Austria. In other words, the contribution of the periphery to Germany’s surplus is close to negligible.

Aggregate data confirm the impression that the Eurozone share in Germany’s trade balance surplus is decreasing, and so is the share of German exports to Eurozone economies (BMWT 2013). However, it is also true that close to two-thirds of the German surplus is with the EU-27[1], i.e. the EU’s role for German surpluses may have diminished but it is still its main source of origin. Data from 2012 indicate, though, that Germany’s overall external trade has become relatively diversified. In absolute terms the US and China rank in regards to exports 2 and 4; and in imports 3 and 2. More disaggregated data also shows that only Germany was benefitting greatly from the strong Chinese import demand for investment goods and high-end consumer goods but also that Chinese exports crowded out substantial segments of previous export markets of southern Eurozone economies.

The sources of the trade balance as well as current account surpluses of Germany changed significantly over the last couple of years. Unlike other economies, Germany successfully compensated for the loss in markets due to the Eurozone crises by extending its reach to growth poles in the global economy. Given the deeply entrenched austerity mechanisms in the Eurozone it is likely that this change will continue. Germany will remain an export model but a model that will be much more global in its scope and range than it used to be.

Inferior Growth and Superior Exports: A Modest Proposal to Overcome the Impasse

Despite its current reputation as an economic powerhouse in Europe empirical facts suggest otherwise. Rather then representing a coherent growth model, Germany is the rare case of a growth model that succeeds despite its flaws. The success is grounded in its well-oiled export machinery that drives the overall economy but simultaneously results in an imbalanced growth structure. Germany’s real GDP just grew by an annual average of one percent between 2000 and 2013 – not a rate that usually qualifies an economy to be a powerhouse. It is true, though, that this average camouflages relevant developments, in particular the relative strong recovery after the disastrous shrinking of its real GDP in 2009 by more than 5 percent. Moreover, recovery has been speedier as in many other OECD economies. Between 2010 and 2013 Germany’s real GDP went up by overall 9.3 percentage point, only followed by Canada with 9.1.percentage points and the US with 8.7 percentage points. France only grew by 3.9 percentage points in this period and the UK by 4.4 percentage points. Italy’s real GDP even shrank by 2.1 percentage points after the Great Recession (IMF 2013). Doing better than others is quite an achievement but still it is a far shot from being a strong growth economy.

Given the structural features of the German economy it comes as no surprise that the export sector contributes significantly to the growth of German GDP. Of course, this structural features works positively as well as negatively. When the Great Recession hit, German export sectors were strongly affected. The recovery of the global economy – not least pushed by enormous deficit spending programs of governments as well as the rescuing of the financial sectors with the help of large assistance programs and accommodating monetary policies – turned out to be the critical trigger for the German version of recovery. The well-positioned export sectors made up their market losses in the Eurozone by strengthening their focus on the growth poles of the global economy, and they did well. Already in 2010 the contribution of net exports to the growth of GDP was stronger then the contribution of any other component. In this respect it is true that Germany’s recovery was helped by the improvement of growth conditions in other parts of the world. Rather then improving its domestic sources of economic growth, Germany again relied on the strength of its export sectors.

The combination of steady and high trade as well as current account surpluses with relatively low growth rates of GDP refers to an underlying problem of the German model. Steady surpluses can be an annoyance for the rest of the world and in particular for economies that run the bulk of their deficits with Germany. As long as the surpluses are recycled in an orderly manner and the capital imports are used appropriately such a imbalance can work for quite a while. In the best of all worlds the import economies are using the external resources to modernize and catch up on all levels, and over time the imbalance starts to disappear.

The capital exporting economy, on the other side, is not giving away its goods and services for free but actually earns interest income that spurs its economy. Unfortunately, the world in general and the German economic world in particular is not as perfect as assumed in this line of argument. The catch–up processes turned out to be highly distorted, in particular in the southern periphery of the Eurozone. Rather than channeled into productivity-enhancing activities most of the capital inflows fuelled large real estate bubbles and actually undermined the growth models of those economies. The story did not go well for the creditor economy, either. Germany may not be unique but still is an excellent case of high savings, high current account surpluses and low private as well as public investments. Germany has one of the highest saving rates of all OECD economies that averages more then 20% since the late 1999s and reached new heights in the last years when it went up to 26%. At the same time, Germany has a seriously low investment share.

This is a potentially explosive mixture, especially if one adds the additional feature that German investments abroad did not pay off as well as investors may have expected. According to a recent study German investors actually experienced serious losses:

Since 1999, German investors have lost approximately 400 billion euros on their foreign assets, which corresponds to around 15 percent of the country’s GDP. In the period between 2006 and 2012 alone, the figure was even as high as 600 billion euros, or 22 percent of GDP’ (Bach et al 2013:10f.).

Losses of this magnitude are quite substantial and indicate that the management of current account surpluses and high savings was neither efficient nor in any case satisfying. Over the same period the German business sector experienced a slight improvement in regards to the gross profit share as well as to the gross rate of return. Those conditions, however, did not translate into buoyant private investment. The main reason can be found in the overall weak effective demand from the consumption side as well as from the public sector. The former is closely connected to the increasingly unequal distribution of income and wealth, the latter is the outcome of restrained public budgets due to the anticipation of the coming Schuldenbremse as well as of the guidelines of the Stability and Growth Pact.

It seems that Germany’s economic policy-making is trapped in a self-inflicted double bind. In economic terms it would be rational and also necessary to significantly increase public investment in crucial areas of modernization but this would conflict with the strict criteria of the Schuldenbremse and the SGP, both regulations that were spearheaded by both parties that make up the current coalition government.

Gros/Mayer (2013) recently suggested a seemingly elegant way out of this double bind by proposing the launch of a German Sovereign Wealth Fund. This proposal is based on the idea of ‘excess savings’ in Germany that are not absorbed by domestic investment and thus result in current account surpluses. As already shown this interpretation is valid in a bookkeeping manner. An official sovereign wealth fund would offer German savers a secure saving opportunity that comes with a guaranteed positive minimum real interest rate. In case of favorable macroeconomic circumstances this positive minimum rate would automatically increase. (Gros/Mayer 2013:5).

The Sovereign Wealth Fund would then recycle savings into long-term investments abroad, very much in the manner of already existing sovereign wealth funds like the ones established by Norway and Japan. Such a management of current account surpluses would offer relief for an overstretched private banking industry and also prevent that a mechanism like TARGET2 would be overused. Gros/Mayer also make the point that the more funds would be invested outside the Eurozone, the stronger would be a potential depreciation effect on the Euro exchange rate that then again would improve the price competitiveness of the southern periphery[2].

The project of a German Sovereign Wealth Fund seems to me a valuable one if it comes with distinct institutional features that deviate from the Gros/Mayer-proposal. First, in line with Gros/Mayer such a fund has to offer a positive real interest rate for private savings and more generally speaking an interest rate that is always above the market rate. Only such an incentive can ensure a critical inflow of funds. Such a fund provides an alternative to private financial institutions and corrects the suffering transformation of private savings into long-term public investments.

Second, the difference between market interest rate and wealth fund rate creates a structural deficit for the wealth fund that needs to be covered. This will be the task of a newly introduced wealth tax. As it has been, inter alia, proposed by Bach et al (2011):’ Since net wealth is strongly concentrated at the top of the distribution, a capital levy could raise substantial revenue, even if relatively high personal allowances are granted, thus restricting the number affected to a very small percentage of all taxpayers. Assuming a personal allowance of Euro 250,000 I estimate a tax base of Euro 2,950 billion amounting to 118 percent of GDP in 2010. A capital levy raising tax revenue in the amount of Euro 100 bn, or 4 percent of GDP, would thus require a tax rate of 3.4 percent. In other words, financing the interest rate differential with  a capital levy on net wealth not only provides financial means to cover the gap but also contributes to an improvement in wealth distribution.

Third, rather then investing the resources abroad the means of the wealth fund will dominantly be used for financing domestic public investments. Such an allocation will close the large public investment gap, prepare the German economy better for the challenges of today’s global economy, and provide the base for a much more balanced domestic growth model. Given the input-output structure of the German economy one can safely expect that such a predominantly domestic use of the means of the wealth fund would have strong spillover effects and thus increase the import demand of Germany. Neighboring economies, including the southern periphery, would benefit from this policy project enormously and Germany’s current account surplus would shrink drastically – without undermining in any way its export sectors.

The long version of the paper with all references is posted at

[1] The share of Eurozone economies in the German surplus represents 36.7% in 2012.

[2] Obviously the same holds for the German export sectors. Thus the launch of an sovereign wealth fund may rather strengthen then weaken its current account surpluses.