The teetotallers' hangover
Dec 4th 2008
From The Economist print edition
High saving and low private-sector debt have not shielded Germany and Japan from recession
PAUL KRUGMAN, the winner of this year’s Nobel prize in economics, put his finger on something in the 1990s when he identified, and then ridiculed, the notion that a slump is a “necessary punishment” for the excesses of the boom that went before it. The popular idea of recession as purgative—the hangover following an ill-judged binge—has a strong and enduring emotional appeal. It allows distressed consumers in America and Britain, countries with a shared weakness for untrammelled spending and reckless borrowing, to make sense of the unfolding crisis. Recession, they reason, must be a penance for past profligacy.
However, such logic is of little use in Germany and Japan, two big and rich countries that did not succumb to the boom’s vices, but are nevertheless facing nasty recessions. Each avoided the credit expansion, consumer frenzy, house-price bubbles and trade deficits indulged in by many of their peers. Both went into the downturn less burdened by private-sector debt and with hefty current-account surpluses (see left-hand chart). Yet prudence has not spared them: both economies contracted in the second and third quarters, and seem set for a further retreat in the current one. The OECD forecasts that Japan’s economy will grow by just 0.5% this year, and will shrink by 0.1% in 2009. It thinks GDP in Germany will fall by 0.8% next year.
The latest data support such a gloomy forecast. In November, Germany’s purchasing-managers index (PMI), a gauge of manufacturing’s vitality, slumped to a level scarcely higher than that of sinful Britain, which is also at a record low. A survey by Ifo, a research institute, shows companies are gloomier than ever about near-term prospects. Foreign orders for plant and machinery are down by almost a fifth from a year earlier, according to VDMA, an industry group. Retail sales plunged in October.
Japan’s economy is in the dumps too. Its manufacturing PMI fell for the ninth consecutive month in November, to a new and alarming low. Sales of vehicles, including cars, fell by more than a quarter from a year earlier. A slump in exports helped push the trade balance into a rare deficit in August and again in October. Bankruptcies are rising amid signs of a corporate credit crunch. Anxious about the supply of credit to firms, the Bank of Japan agreed on December 2nd to accept riskier corporate bonds as collateral when it lends to commercial banks.
How did these countries get dragged so deeply into the mire? While consumers and firms in debt-ridden America and Britain scramble for cash and cut spending to shore up their frail finances, prudent Germany and Japan should be well placed to survive a credit drought. Their companies in aggregate regularly run cash surpluses—they spend less than they earn—and so are in a better position to hang on to their employees through the downturn. Unemployment has been stable in Germany, even as it rises in France, Italy and Spain. Consumers are not the spent force they are elsewhere so there ought to be some pent-up demand. Weak consumption during the global upswing was down to low real-wage growth, as well as caution: falling inflation should lift real income and spending.
The trouble is, surplus countries have become used to living off the spending of others. They are credit-crunch victims, but at a remove—suffering because their overseas customers are cutting back. In the fat years for the world economy from 2003, Japan remained heavily reliant on exports and investment to drive prosperity, while Germany’s dependence on them steadily increased. German firms sold into the credit-fuelled consumer booms of America, Britain and Spain, supplying high-quality cars and other durable goods. The capital-goods industry in both countries benefited from infrastructure spending in fast-growing developing economies, such as China, and by cash-rich oil exporters. Since consumer spending accounts for a small—and, in Germany, declining—share of GDP by rich-country standards (see right-hand chart), investment at home was driven largely by hopes of foreign sales. But now that foreign orders have dried up, firms are trimming their own capital spending.
Save hard for a rainy day; save harder when it pours
There should be plenty of scope for more domestic demand, but the instinct for saving hardens in a downturn. Consumers are unlikely to spend more when wealth is shrinking and they worry that jobs may migrate to neighbours with lower wage costs. Firms are also big savers in Germany and Japan, and seem equally minded to cling to cash in uncertain times. Even wealth and solvency seem to be drawbacks. Creditor nations are havens for capital in a downturn, with some perverse consequences. Flows into Japan have pushed up the yen, squeezing profits on exports and making firms less likely to invest. Skittish investors are keen buyers of Germany’s government paper, too, driving bond yields down. But lower borrowing costs are of little use if politicians remain sceptical about the merits of fiscal pump-priming.
Countries that have lived beyond their means may feel a justifiable remorse as their booms turn to bust. Surplus countries are simply stupefied by their plight. They should not be. A persistent current-account surplus is a symptom of unbalanced growth, just as a big deficit is. Countries that save too little to cover their capital spending are at the mercy of foreign investors; countries that save too much are at the mercy of foreign demand. China gets barracked for its current-account surplus, which was $372 billion last year, according to the IMF. Yet the combined surpluses of Germany and Japan amounted to a vast $463 billion.
If the world economy is to adjust to higher saving in shopaholic deficit countries, such as America, it will require surplus nations to stimulate their domestic spending. Germany, unlike Japan, can at least benefit from lower interest rates: on December 4th the European Central Bank cut them by 0.75 percentage points to 2.5%. It can also afford a much bigger fiscal stimulus than it has announced so far. Japan is far more constrained by its huge public-sector debt. But both countries can start by shaking off the mindset that demand has to come from somewhere else.
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