World Champion in Exports – What's the Big Deal?

The "Magic Square" (Magisches Viereck) is a concept many Germans learn about in school. It describes the four cornerstones of Germany's economy, enshrined in the 1967 Act to Promote Economic Stability and Growth: price stability, low unemployment, stable economic growth and balanced trade. While the first three of these cornerstones are easy to grasp, the fourth has proven quite slippery. What counts as balanced trade?

For years now, voices inside Germany have vaunted its status as Exportweltmeister, world champion in exports. Is this at odds with the Act to Promote Economic Stability and Growth? And why did the EU Commission stipulate a trade surplus of more than six per cent of GDP as a warning signal in its macroeconomic imbalance procedure (MIP)? In 2016, Germany’s trade surplus was equivalent to just under nine per cent of GDP. Recently, the Trump administration has sharply criticized German trade policy (as the Obama administration did several years back). Is this criticism justified? A trade surplus, or more precisely a current account surplus, is not unqualifiedly positive for an economy, just as a current account deficit is not unqualifiedly negative, despite what the terms “surplus” and “deficit” imply. For instance, a current account surplus is automatically accompanied by a flow of capital abroad. The dollars received for automobile exports to the US can be used to buy American goods – thus balancing bilateral trade – or to invest in the US. Indeed, foreign investment is the other side of running a trade surplus. We see this in the EU: since the majority of German exports go to Europe, Germany was  the EU’s largest net creditor in 2015.

There are good reasons for a country to invest abroad. Just as households invest savings and reap the returns later, so too do nations, especially countries like Germany whose rapidly aging population will take a heavy economic toll in the future. And it only makes sense for part of their investment to be placed in economies abroad when they offer better rates of return.

But these are not the only factors that increase capital outflow and export surplus. Wages in Germany have risen less than in other European countries, which have made German products cheaper to buy in foreign markets. And the expansionary monetary policy of the European Central Bank has weakened the euro against the dollar, reducing the price of European goods and promoting exports. In 2016, the current account surplus in the euro area totalled 3.7 per cent of GDP – an appreciable, however not overly pronounced, amount.

Germany’s balanced trade policy was put into law at a time when the German mark was pegged to the dollar at a fixed exchange rate. Options for revaluating and devaluating currency to correct trade imbalances either did not exist or were severely limited. Though the situation is different today, it’s still wise to avoid excessive current account surpluses for the sake of European stability. Some of Germany’s current surplus will naturally decrease as wages stagnate in Southern Europe and climb in Germany, driving up the prices of German goods. Demographic shifts will further reduce the surplus but it will take a while before their effect is felt. One ZEW study projects that in the following decades Germany’s savings ratio will fall in response to its aging population and thereby lower the current account balance.

Irrespective of these developments, critics are not wrong when they admonish the German government to help balance trade. More investment in infrastructure and defence is needed to increase the inflow of capital. At the same time, German imports would increase if trade barriers were removed. Service-market liberalisation would make it easier for foreign providers to enter the German market. As any student knows, it is four cornerstones which make up the magic square of economic stability and growth.

This piece initially appeared on 23 March 2017 in the "Handelsblatt".