Trade Surplus Surplus of Envy

Donald Trump doesn’t like Germany’s trade surplus and has threatened punitive tariffs and protectionism. But the U.S. president is not alone – a growing chorus of experts in Germany itself say it’s high time to address the high €253 billion surplus.
Delivering a surplus: Cranes at Hamburg harbour, a major German port.

Wolfgang Schäuble is more than Germany's finance minister. He is an elder statesman and arguably one of the most powerful politicians in Europe's largest economy. He also never backs down from a fight - even if that fight is with the president of the United States.

After Donald Trump's trade advisor, Peter Navarro, accused Germany of continuing “to exploit other countries in the E.U. as well as the U.S.” with the weak euro. Mr. Schäuble couldn't resist firing back. Apparently, he said, someone needed to explain to Mr. Trump's advisers that Germany is not actually in charge of monetary policy in the euro zone.

The German finance ministry also followed up with a written defense of the country’s trade policies, which it said were the consequence of a healthy business environment fostered by sound fiscal policies and a skilled, flexible labor market.

“Blaming a country that has embraced these tasks and benefits from a strongly competitive corporate sector would be bizarre,” read the document.

The message was clear: Germany doesn’t owe anyone an explanation for its massive trade surplus.

Clearly the reason for this kind of trade surplus is about more than just the superiority of German-made goods.

Mr. Schäuble wasn’t alone in his defense of the fact that Germany exports far more than it imports. Ingo Kramer, the head of the Confederation of German Employers' Associations, said a big reason for Germany's considerable trade surplus was the high quality of German-manufactured goods.

"That fact should also be remembered from time to time," Mr. Kramer said.

Eric Schweitzer, the president of the Association of German Chambers of Commerce and Industry, agreed: "The German export surplus is a sign of the competitiveness of the local economy."

Basically the messages from the Germans amounted to this: We can’t help it if our products are better than everybody else’s and that everyone wants them.

But it is precisely that attitude that has led Germany's government and its economic associations to ignore the growing criticism of the country's ever-increasing trade imbalance, or current account surplus.

Of course, trade imbalances aren't always a bad thing. In Germany's case, the International Monetary Fund, or IMF, has calculated that a surplus of between 2.5 and 5.5 percent of its overall gross domestic product would be fine.

The European Union has mandated an upper limit of 6 percent, though Germany smashed that limit long ago. In 2016, the size of Germany's trade imbalance was equivalent to 9 percent of its GDP. That year, German exports reached another peak. The country’s statistics agency Destatis announced Thursday that German businesses had sold goods worth €1.2 billion overseas, which meant the country’s foreign trade balance boasted a record surplus of close to €253 billion.

Clearly the reason for this kind of surplus – and imbalance – is about more than just the superiority of German-made goods. Normally if a country were exporting that much more than it was importing, its currency would skyrocket, making it harder to sell its wares abroad. That sinking demand would, in turn, bring the export-import ratio closer to equilibrium.

But given the fact that Germany is part of the euro zone, there is no such self-correcting mechanism at work. First of all, there's no exchange rate that can fluctuate when Germany trades with other countries inside the euro zone, which absorb around 40 percent of its exports. They all use the same currency. Additionally, the euro exchange rate against the dollar cannot reflect the strength of the German economy properly because it also reflects the lack of competitiveness in many other countries of the euro zone.

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Germany’s trade surplus is then used to provide the financial aid to other nations in the euro zone that allow their citizens to keep buying German imports. Once again, there is no balancing out and this harms all those who take part in the cycle – apart from the German export sector. Up until now, critics of this cycle and of Germany were weak. Until now – because the attacks from the new U.S. administration have changed that.

In order to understand why Germany’s trade surplus bothers the U.S. so much and why Germany, along with China and Mexico, have aroused the ire of the Trump White House, one need only look at the U.S.' own trade imbalance. The world's largest economy imports goods from Germany worth nearly €100 billion. In absolute terms, the U.S. runs by far the world's largest trade deficit: A whopping €430 billion. Germany accounts for €45 billion of that.

And if Mr. Trump has demonstrated one thing in his first, turbulent weeks in office, it is that he's more than happy to act on his campaign promises. As White House spokesman, Sean Spicer, recently said, the Trump administration wants to raise taxes on imports from countries with which the U.S. has a foreign trade deficit.

There has been talk of a tariff of 20 percent on imports from big exporter countries like China and Germany. The new tax would be aimed at making imports from those countries more expensive, while at the same time exports from the U.S. would be lifted by tax incentives for companies that do that.

If the U.S. makes good on its promises, and if Germany sticks to its guns, then a trans-Atlantic trade war could erupt with new import barriers on one side and possible retaliatory measures on the other.

Right now, the German government does not have a unanimous opinion on how to deal with Mr. Trump’s America First policies, if it comes to that.

Brigitte Zypries, Germany’s new minister for economics and energy has suggested that the governors of individual U.S. states could be convinced to oppose Mr. Trump's protectionism.

"We will travel to the U.S. and get in touch with the state governments,” Ms. Zypries said. “The governor of South Carolina, for example, has no interest in seeing BMW cut jobs there.”

In recent years, BMW, Daimler and VW have all opened large factories in the U.S., creating jobs for more than 30,000 people, counteracting the decline of American auto industry. Add to that the number of jobs indirectly connected to the Germans' manufacturing plants, such as parts suppliers, then those 30,000 jobs quickly become closer to a quarter of a million livelihoods.

Still, according to the industry publication Automotive News, while VW manufactures more than 70,000 vehicles every year in the U.S., it sells more than half a million there. To make up the difference, it imports a large amount of vehicles from Mexico, where it produces as many as 390,000 units a year. VW also ships cars from Germany.

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That's why VW has gone on a charm offensive. The car maker commissioned a study by management consultancy EY to analyze the economic benefit that it brings to the U.S. economy. The result: VW contributes $25 billion to the U.S.’ GDP through production, suppliers and dealers and is responsible for the creation of some 120,000 jobs.

There's also the fact that some of the German car makers export some of what they produce in the U.S. to other countries. Take BMW, for instance: Last year, the Munich-based company assembled 400,000 vehicles in the U.S. but only sold 366,000 there. Its Spartanburg plant, where nearly all of its X Series units are made, is now the company's largest production facility anywhere in the world, including Germany.

If Mr. Trump were to impose a punitive tax on all imported cars from Mexico, the American economy would suffer as a consequence. Because it is not just complete vehicles that are coming across the border. American automotive manufacturers cash in on the lack of trade barriers when they're importing injection pumps, alternators or hydraulic systems from the U.S.' southern neighbor. The same is true for smaller German car parts companies.

The latest statistics – German exports to the U.S. up to November 2015 - show that auto manufacturers and auto parts suppliers account for the largest share of goods sold there, worth €37 billion a year. In second place, at €17 billion, are the machine builders with their gear boxes, blowers, pumps, compressors and screws - which they, too, often sell to the auto industry.

"They often provide indispensable components, such as the interior trim of a car that is produced in the U.S.," said Peter Fuss, a partner at EY. "Anyone who produces screws and exports to the US is unlikely to build a plant in America. The effort would be greater than the yield."

Of course there is concern in Germany about U.S. protectionism. But there is also reality.

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A good example of a German business owner’s attitude is provided by Martin Herrenknecht, who some would say personifies one aspect of Germany’s export boom. His namesake company in southern Germany, Herrenknecht, is the world leader in tunneling technology with annual sales of €1.3 billion. It makes drill heads for enormous machines used to dig giant tunnels through the Swiss Alps, underneath the Bosphorus and even underneath cities.

But Herrenknecht isn't only a shining example of German engineering. It is also responsible for a chunk of the country's trade imbalance, because it exports 95 percent of the machines it produces.

Those unique machines are pieced together at the company's headquarters in Schwanau, Germany and assembly takes between six and 14 months. Each one is unique, built to customer’s specifications, then taken apart and dispatched to another country, where it is reassembled and put to work.

When asked how he felt about Mr. Trump's threats to impose punitive taxes on imports, Mr. Herrenknecht just shrugged.

"Last year, the last American producer of large tunnel borers was sold to the Chinese. It's going to get rather difficult to buy American,” he said.

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Still, it must also be noted that criticism of Germany’s trade surplus is not just coming from the U.S. The country’s economics ministry, for instance, is more worried about Germany’s trade surplus than the finance ministry. And an unlikely coalition of outspoken critics has formed to oppose it. Their opposition has less to do with the fact that such a surplus is hurting other countries. Rather, they worry that having exports outweigh imports could be severely damaging to Germany in the long run.

After all, a trade imbalance cuts two ways: One might think that it’s great to have more exports than imports. Because that means more money is coming in than is going out, doesn’t it?

In fact, the opposite is true. A surplus in a country’s trade balance invariably comes with a relative outflow of capital. Sending a large amount of goods and capital abroad not only has the power to strengthen Germany, it can weaken it too.

Germany lends money to the countries to which it sells more goods than it receives. Every day that Germany maintains a trade imbalance, the amount of money owed to it by its trading partners grows. So does Germany's claim to an increasing share of the future output of the global economy.

That’s well and good - as long as those debts to Germany are honored. But that's exactly the problem, according to some economists. The former head of the Ifo Institute for Economic Research, Hans-Werner Sinn, has raised doubts.

"The surpluses are not in Germany's best interest since we keep getting more and more IOUs, which we will never be able to cash in," Mr. Sinn said, pointing to so-called Target balances, which is short for the Trans-European Automated Real-time Gross Settlement Express Transfer System. In January, the German Bundesbank’s Target balances reached a record level of almost €800 billion while Italy and Spain had liabilities of more than €300 billion each.

Central banks in the euro system use the Target system to calculate cross-border payments and now half of Germany's net external assets - the amount of money its trading partners owe it for goods received - is made up of these Target credits.

"It is unlikely that the Germans will ever be able to use this fortune," Mr. Sinn said. "Many of the automobiles and machine tools that we export have been simply given away."

Thomas Mayer, the director of research at the Flossbach von Storch Research Institute, quantified those potential losses. The sum of Germany's annual trade balance since 1999 exceeds the amount by which its net assets abroad have risen by 44 percent. In other words: "For every euro generated by the surplus, around 30 cents are lost," Mr. Mayer said.

That's capital that is needed at home. Losing it weighs on potential growth and thus the prosperity of all of Germany.

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Investment in infrastructure and other projects at home is seen as one way of curbing Germany’s trade surplus excesses, as are higher wages. Both of these things could bring about higher demand in Germany, suggests Marcel Fratzscher, who heads the Berlin-based economic research institute DIW Berlin and was formerly head of the international policy analysis at the European Central Bank. German workers will be able to afford more consumer goods and investment requires machinery, concrete and other equipment – all of which would demand more imports and even out Germany’s trade surplus.

There is even an earlier example that shows how this can work. In the 1990s Germany’s trade balance slipped into the negatives – the exporting nation became an importer – because of the amount of infrastructure investment required after the reunification of the country. It took major investment to update businesses in what was formerly East Germany and the east German consumers went on a spending spree, buying goods they had never been able to access before.

However it is important to remember that right now, the government cannot be certain of how much their citizens will want to spend on imports. Nor can they do a lot about investment not of their own making. Indeed, around 90 percent of investment in new projects in Germany comes from the private sector. And right now the private sector is extremely wary of new factories and plants. They complain about a lack of qualified labor and volatile charges for things like power, among other problems.

And that last part – making Germany more attractive for private investment again - is certainly a problem that politicians could start working to resolve. But will they? Especially given that any resulting successes will only be seen in several years’ time, and not in time for the next election campaign. One thing is clear though: The more the country’s troubling trade surplus is discussed, the more it becomes obvious that this is not just about being nice to other countries, or trade wars, or legendary German efficiency. This is a problem that Germany itself needs to face up to, and soon.

 

This story was written by Handelsblatt correspondents in Brussels, Germany and the U.S.: Ruth Berschens, Martin Buchenau, Dana Heide, Martin Greive, Thomas Jahn, Jens Münchrath, Christian Rickens, Ulf Sommer, Frank Specht and Klaus Stratmann. To contact the authors: [email protected], [email protected]