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German and Chinese growth models are outdated

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Economists are understandably focused on the uncertain near-term global outlook. But the medium and long-term outlook is daunting given demographics, US-China tensions, over-leverage, reshoring and often limited macro space. Sustainable growth rates are likely to continue their downward trend this decade.

The Chinese and German growth models emphasize this misery and are outdated and in need of revision. Whether this will happen is an open question. The two account for nearly a quarter of global gross domestic product.

China’s growth over the past two decades has been extraordinary. Before the 2008 financial crisis, it was fueled by exports and then by large-scale credit growth.

However, the quality of growth has been damaged by state-owned banks pumping excess liquidity into state-owned enterprises, housing speculation and local government inefficiency. Authorities are now trying to mitigate the high leverage and vulnerabilities of financial stability. This is holding back growth and hurting a weakened housing sector – which accounts for up to 30% of GDP by some estimates. Potential growth this decade was expected to drop to 5%, if not further. Some analysts claim: that if only high-quality productive investments were financed, potential growth could be closer to 3%.

Authorities have long debated shifting activity from investment-led growth to consumerism and services. But that transition is not happening at a satisfying pace anywhere. While China’s current account surplus – the gap between gross savings and investment – ​​narrowed significantly to GDP after the global crisis, very high savings continue to weigh on consumption (Figure 1).

Figure 1. China’s investment and savings as a percentage of GDP

(Source: International Monetary Fund, World Economic Outlook Database, October 2021)

Furthermore, investment remains high and more is needed to generate a percentage point of growth (Figure 2).

Figure 2. Chinese investment, percentage change in real GDP

(Source: International Monetary Fund, World Economic Outlook Database, October 2021)

Against this background, the authorities’ pursuit of common prosperity and double circulation makes a lot of sense at first glance. Addressing inequality on the basis of communal wealth means raising incomes for low- and middle-income workers, which would boost consumption. Boosting domestic demand through dual circulation is essential because China is over-priced global footprint, especially amid global geopolitical tensions, to rely significantly on the global economy for their livelihoods.

This policy is easier said than implemented. Without significant credit expansion and given monetary constraints, fiscal policy will need to be stepped up to support growth and reduce inequality. But while macro-policy will ease, the Chinese authorities are stressing stability. China’s private sector is more efficient than the public sector, but President Xi Jinping is tackling the former. Implementation also requires concrete plans, for example on climate, infrastructure, hukou and education reforms.

The German economy has long been export-oriented. Current account surpluses have hovered around 7% of GDP for years and the IMF predicts that this trend will continue. Domestic activity remains subdued, while Germany absorbs demand from Europe and abroad. Its export power is clearly visible in the rest of Europe and China. The automotive sector – some say nearly 10% of GDP and nearly 1 million workers – plays a special role.

Over the past two decades, Germany’s rising current account surpluses have manifested themselves in steady investment and soaring national savings (Figure 3).

Figure 3: Total savings and investments in Germany

(Source: International Monetary Fund, World Economic Outlook Database, October 2021)

Accordingly, private consumption remains quite low as a share of GDP for an advanced economy – on the order of 50%. Furthermore, wage discipline has held back unit labor cost growth, maintaining strong export competitiveness but hampering consumption (Figure 4).

Figure 4: Indicators for unit labor cost growth in Germany

(Source: Federal Reserve Bank of St. Louis, Organization for Economic Co-operation and Development)

However, global growth should slow down over the decade. Especially China – an important German export market – will do so. European growth will remain modest. More restrictive global trade conditions and reshoring in the coming years and tensions between the US and China could further complicate the external environment Germany faces. The German car industry faces a difficult transition.

It is against this background that the new government takes office. The welcome plans to use fiscal maneuvering to circumvent the ‘debt brake’ and boost climate and infrastructure spending offer the prospect of more investment and less government savings. That would boost domestic demand and reduce external dependence.

But given the leadership of the Free Democratic Party of the Ministry of Finance and the innate German conservatism, the new government will ultimately only cautiously circumvent the ‘debt brake’. Nor are unions demanding sufficiently large wage increases that would significantly increase labor’s share of income and, in turn, consumption.

There is therefore little reason to believe that Germany will make a fundamental change of course and refocus its growth model and become independent of expected external demand.

That said, one should not underestimate Germany’s adaptability. After reunification, Germany was seen as the ‘sick man’ of Europe. But by pushing down unit labor costs in the early 2000s, coupled with the impact of the ‘Hartz’ reforms under Schroeder’s SPD government, Germany returned to its role as Europe’s dominant force. Will the new Scholz government be able to turn the script around with investments in climate, digitization and infrastructure?

The challenges countries face after the pandemic growth models, especially for Germany and China, are certainly worth adding to the long list of risks and vulnerabilities facing the global economy of the 2020s.

Mark Sobel is the American chairman of OMFIF.