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10 May 2017

The Ger­man cur­rent ac­count in the con­text of US-Ger­man trade

Germany’s current account surplus has been garnering criticism for years. Taking on this criticism coming from home and abroad the Ministry of Finance and the Ministry of Economic Affairs published a joint position paper that explains the reasons behind Germany’s current account surplus and outlines the fiscal and economic policy options.

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Source:  fotolia / Photo: eyetronic

Summary

Germany is among the most important trade and investment partners for the US. Ten percent of all foreign direct investment into the US can be attributed to German firms. German companies employ around 672,000 people in the US. US companies benefit from high-quality German capital goods and intermediates that help to improve their efficiency and allow them to maintain and increase their competitiveness. This creates and sustainably secures a large number of jobs in both countries.

As a member of the European Union, Germany does not pursue independent trade policy: Trade policy falls within the competency of the EU. The German government’s policy is in line with all international trade agreements and treaties; in particular Germany policy complies with WTO requirements.

Germany is a member of the European Monetary Union. On a global scale, the euro area balance is the only valid reference for assessing the significance of current account developments. Monetary tightening in response to the economic recovery in euro area countries would contribute to a reduction of the German current account surplus due to exchange rate effects.

Having peaked at 8.6 percent of GDP in 2015, the German current account surplus has since narrowed slightly, falling to 8.3 percent. According to recent projections the surplus will shrink further, to roughly 7.½ percent this year, and approximately 7 percent next year.

Fiscal and economic policy in Germany aims at strenghening domestic growth and creating favourable conditions for acompetitive economy. Overall, this policy helps to limit the German current account surplus. Given the record level of employment and marked increases in real wages, domestic demand has been the main driver of German growth for several years now. The German government is taking a range of measures to further strengthen an already robust domestic demand, for example by improving conditions for private investment, expanding public investment, introducing a statutory minimum wage and offering income tax relief. With regard to domestic demand, the preconditions for a reduction of the German current account surplus are now in place.

However, the German current account surplus is mainly the result of market-based supply and demand decisions by companies and private consumers on global markets. The German surplus reflects a comprehensive range of economic activities of private households and companies arising from international integration of production, trade and services. Hence, the surplus depends not solely on economic developments and policies in Germany, but particularly on the competitiveness and economic performance of other countries. To a large extent, the German current account is driven by factors which German fiscal and economic policy have no direct influence on, such as temporary factors including the euro exchange rate or global commodity and energy prices. In addition, the German current account balance is also shaped by a range of structural long-term factors such as demographic trends, the competitiveness of German suppliers on the global markets, an advantageous goods structure, and its high net foreign asset position.

Trade with Germany benefits the US

  • Germany is one of the most important trading and investment partners for the US. Germany was the fifth largest trading partner for the US, and the third most important partner outside of NAFTA with US-German trade totalling $164bn in 2016. Germany exported goods worth $115bn to the US, and imported goods worth $49bn. German-American trade is driven mainly by motor vehicles, machines and other industrial products such as chemicals, pharmaceuticals, and electronics. More than half (55 percent) of German exports to the US constisted of capital goods and intermediates. The equivalent figure for US exports to Germany is around 48 percent. US-German trade in the service sector (including tourism) is also burgeoning, totalling nearly $64bn in 2016. The American market is the most important market for German exports; roughly a tenth of German exports are sold to the US.
  • The German current account surplus reflects investments made in the US. The current account balance mirrors international capital movements. Germany’s current account surplus is counterbalanced by net capital exports. In 2016, Germany invested more than $63bn in capital into the US. Of those $63bn, German investors put $34bn into US shares and additionally made direct investments worth over $14bn. Portfolio investments in the US by German investors are primarily determined by risk-return considerationsand an effort to diversify risk. The US is particularly attractive for foreign portfolio investments because of its economic and political importance for the global economy and because the US dollar is the international reserve currency. German portfolio investments in the US strengthen American capital markets, make it easier for companies to access equity and thus increase investments, which in turn boosts productivity. At the same time, German portfolio investments increase share values and thus raise the wealth of US investors.
  • Germany is the third largest foreign direct investor in the US. In total, German companies have invested approximately $319bn in the US (2015), and thus account for nearly 10 percent of all foreign direct investments in the US. At $133bn , or 42 percent, the greatest share of German direct investments went into the manufacturing sector, which breaks down into investments worth $45bn in the automotive industry, investments worth 36bn dollars in the machinery sector and investments worth $31bn in the chemicals sector. At $46bn, or 15 percent, the second largest share of German direct investments went into the finance and insurance sector. Foreign direct investments promote the international transfer of technology and knowledge and contribute to diversifying production structures. In addition, various studies show that these investments generate stronger growth in the host country than domestic investments do.
  • German investors are among the biggest foreign employers in the US. German investors hold direct investments in over 3,000 companies that generate a total annual turnover of $466bn and employ approximately 672,000 people, mostly in the automotive, machinery and the chemical industries. German affiliates in the US pay above-average salaries and contribute substantially to training skilled workers in the US.
  • Imports from Germany are important intermediates for US consumer and capital goods as well as exports. The analysis of value-added shares shows that Germany is the US’s most important European supplier of intermediates used for consumer goods, exports and gross fixed investments; overall, Germany is the fifth/sixth most important supplier for the US. Germany’s contribution to the value chain is above-average for the manufacturing sector, especially the automotive and electronics industry, and for the machinery and plant building sector. The producers of capital goods are highly specialised and provide goods for which it is very difficult to find substitutes. US companies benefit from these intermediates, as they help to improve efficiency and allow them to maintain and strengthen their competitiveness.

Germany cannot influence the exchange rate and does not use protectionist instruments

  • Within a monetary union, it is not possible to single out any one country. Rather, each country must be considered as a part of the monetary area as a whole. On a global scale, the only valid reference for assessing the significance of current account developments is the euro area balance. Furthermore, the value of the currency of a monetary union is determined by economic conditions in the union as a whole. Neither the member states of the euro area nor the European Commission can influence the euro area’s monetary policy. The euro area’s monetary policy is governed independently by the ECB, which aims at maintaining price stability and does not manage the exchange rate.
  • In the short run, the dollar-euro exchange rate is mainly determined by capital movements and interest rate expectations. Since summer 2014, the euro has devalued by approximately one fourth in relation to the dollar, mainly as a result of the divergence between the monetary policies of the two monetary areas. While the ECB is continuing its ultra-expansive monetary policy in order to support the euro area’s economic recovery, the Federal Reserve has already begun to increase interest rates. Net capital inflows to the US tend to strengthen the dollar, which in turn improves the US terms of trade, i.e. the relation between the price of imports and exports. Economic growth in the euro area and growing inflation may prompt the ECB to start normalising the monetary policy in the euro area. A stronger euro would automatically reduce the trade surplus.
  • With respect to its long term trend, the US dollar currently not noticeably overvalued compared with the euro. Since the introduction of the euro in 1999, the EUR/USD exchange rate has averaged 0.85. At 0.94, the current EUR/USD exchange rate is only approximately 10 percent above its long-term average. Moreover, a currency’s external value as a factor driving price competitiveness is only one of a number of elements influencing the current account balance.
  • Germany does not use any protectionist instruments. VAT with a input tax deduction in the EU, and thus in Germany, is in line with the international standard applied by nearly all OECD countries as well as the overwhelming majority of UN members. According to the principle of taxation in the country of comsumption, exports are generally exempt from VAT, while imports are subject to import VAT. VAT can then be applied to the goods in the country to which they are exported. This practice is clearly in line with WTO requirements. It serves to create fair competition on the respective final consumer market, i.e. to ensure that goods imported for final consumption are treated as equal to domestically produced goods. The VAT applied is therefore independent of whether the goods sold were produced at home or abroad. Thus, VAT does not have any discriminatory effects.
  • In an open economy, surpluses and deficits in the bilateral trade balance are the rule rather than the exception. Surpluses and deficits reflect the comparative advantages of the various economies and the attendant specialisations within global value chains. As a country with few natural resources of its own, Germany has to finance its commodity imports by exporting other goods in the long term. When conditions are normal, this form of free trade increases welfare for all countries involved.
  • The German government is closely monitoring macroeconomic developments, although the current account balance is not a policy variable. Nevertheless, the current account surplus may indicate structural weaknesses, also for domestic investments, which may in turn justify economic policy adjustments. In addition, capital in search of potential investment can contribute to credit booms and/or asset-price bubbles in other countries. Capital flows can thus amplify imbalances, which then require more severe adjustment measures in countries with current account deficits. This is where governments have a responsibility to implement fiscal and economic policies facilitating necessary adjustments.
  • Provided the attendant capital inflows are used for investment, current account deficits need not be problematic for a country such as the US. If capital inflows are used for investive purposes and increase the US economy’s growth potential in the medium to long term, they will create the right economic conditions to reduce external liabilities in the future (which are currently at 45 percent of GDP for the US). The deficit may be problematic, however, if foreign capital inflows are primarily chanelled towards consumption or unprodutive investments, such as property bubbles. The US budget has been in deficit since 2002 and has inflated US debt from 64 percent to 108 percent of GDP since 2000. Consequently, a large share of foreign capital inflows has been – and still is – used for financing the US budget. Hence, fiscal consolidation, as announced by the new US administration, would reduce the US current account deficit.

Germany’s current account surplus is narrowing

  • Germany’s current account surplus decreased in 2016. It narrowed from 8.6 percent of GDP in 2015 to 8.3 percent of GDP in 2016. In 2016, there was a significant decline over the course of the year: A surplus of 8¾ percent was posted in the first quarter (adjusted for working days and seasonal factors), which decreased to 7½ percent in the fourth quarter of 2016.
  • In particular, exchange rates and energy prices caused the current account surplus to rise in recent years. Germany’s current account surplus stood at 5.6 percent of GDP in 2008, its lowest point in the last ten years. It subsequently climbed to 6.7 percent in 2013 and reached 8.6 percent in 2015. Of those approximately two percentage points, about two thirds can be attributed to the decline in energy and commodity prices as well as the depreciation of the euro. Simulations using the Oxford Economic Model show that, if the low oil prices and the weak euro were factored out, the current account surplus would have stood at 5.6 percent in the fourth quarter of 2016 – below the European Commission’s 6 percent threshold. More recently, the rise in oil prices and the stabilisation of the euro exchange rate had a dampening effect on the current account surplus. Exchange rates and commodity prices had a similar impact on the balances of other member states within the euro area.
  • International partners benefit from a strong German economy. Germany is not only the world’s third largest exporter of goods, but also the third largest importer. Our trade partners benefit greatly from the strength of the German export industry, as German exports contain a large share (about 42 percent) of intermediates.
  • In its annual projection, the German government predicts that Germany’s current account surplus will continue to decline. This is in line with most of the forecasts of other national and international institutions as well as the Bundesbank. In its independent forecast, the German Council of Economic Experts projects a current account surplus of 7.5 percent this year and 7.1 percent next year.
  • Germany’s bilateral current account surplus with the USA most recently also narrowed. Having reached an all-time high of $76.8bn in 2015, it decreased by approximately $13bn to $63.6bn in 2016. This decline was roughly equivalent to that of the entire euro area’s current account surplus with the USA (which narrowed by $12.9bn to $24.2bn).
  • The current account surplus is a European issue, not a German one. The euro area posted a current account surplus of 3.6 percent of GDP in 2016. According to the European Commission’s winter forecast, it is set to decline to approximately 3¼ percent this year. Almost all euro area member states are contributing to this surplus.
  • From a global point of view, focusing on Germany’s current account balance is not particularly conclusive. Germany is a member of the European Monetary Union. Structural reforms implemented in recent years have sustainably reduced imbalances in the euro area. On a global scale, the only valid reference for assessing the significance of current account developments is the euro area balance. California’s current account balance with China is not a subject of debate, and nor should Germany’s current account balance with the US be.

The German government has taken a number of measures contributing to the reduction of the current account surplus

  • The German federal government has launched numerous measures to promote sustainable and inclusive growth and a more dynamic domestic economy. A general statutory minimum wage was introduced in 2015 and increased in 2017. In addition, the German government has enacted income tax cuts totalling more than €11bn per year in the current legislative term. These measures serve to further stimulate domestic demand, which has been the main driver of growth for several years now. In the medium term, these measures can make a contribution, albeit limited, to reducing the current account surplus.
  • The German federal government has taken further important steps to strengthen public investment. During the current legislative term, federal budget funds appropriated for investment have increased by nearly 45 percent. In addition, substantial relief has been provided to the Länder (states) and local authorities that will allow them to increasingly channel funds towards investment. In 2016, government gross fixed capital formation went up by 2.2 percent in real terms, following a 3.4 percent rise in 2015. Due to the relatively small value-added share of imported intermediates in public investment, however, this is likely to have only a limited impact on the current account.
  • The German federal government is taking steps to boost private investment. The government’s sound fiscal and economic policy is strengthening the confidence of individuals, companies and investors in the German business environment, thus boosting private consumption and investment. In addition, the federal government and the Länder have allocated a total of €4bn to expanding the broadband network, to cite just one example. In total, €17bn is being provided for energy efficiency measures until 2020. Revised grid regulation has significantly improved investment conditions for the expansion of the distribution network. The first and second Bureaucracy Reduction Acts (Bürokratieentlastungsgesetz) cut private sector bureaucracy costs by a total of €1bn. Recent changes in tax rules for carrying forward losses will especially benefit young and innovative companies, as will the top-ups of various project funding programmes. The federal government is also looking into ways of providing tax support for research and development alongside its project funding. The general investment rate is expected to increase slightly again this year, from 20.0 percent of GDP to 20.2 percent of GDP.
  • Real wages in Germany have increased at an above-average rate in the last three years. This is the first phase of real wage increases in the range of 2–2 ½ percent since German reunification. Extraordinarily positive labour market conditions, collectively agreed wage and salary rises (which, in Germany, are negotiated without the government’s involvement), the introduction of a general minimum wage, and low inflation rates have all contributed to a considerable increase in private consumption. This trend is poised to continue, further reducing the current account surplus.
  • Structural reforms in Germany can further boost the economy. Examples include increasing competitiveness in parts of the services sector; improving incentives to work for secondary earners, low-wage earners, and older workers; and enhancing tax efficiency. It should be noted, however, that, supply-side structural reforms and public infrastructure investments increase productivity and therefore competitiveness over the longer term, which could cause the current account surplus to rise again.

However, many factors affecting the current account surplus are beyond policy control

  • The current account is not an economic policy variable. The extent to which Germany’s current account surplus can be influenced by policy measures is limited.
  • The German current account surplus is the result of market-based supply and demand decisions by companies and private consumers on the global market. Alongside temporary factors such as commodity prices and exchange rates, it is largely a reflection of long-term structural conditions, which account for about half of Germany’s current account surplus. They include the high level of competitiveness of German suppliers on the global markets; the high-quality, complex and industrial structure of German goods; demographic trends; and a high net asset position abroad. The competitiveness and performance of other countries also plays an important role.
  • Germany has built up high net foreign asset positions through foreign investment in recent years. Capital exports are a result of German companies’ successful globalisation strategies. Businesses are tapping new markets and taking advantage of higher returns in economies that are experiencing dynamic growth. These foreign assets result in corresponding interest and investment income, which in itself accounts for almost a quarter of the German current account surplus.
  • German demography is a key structural factor behind Germany’s current account surplus. In an ageing society, relatively high savings are reasonable with a view to evening out consumption as more people retire. Different estimates put the demography-related share of the current account surplus somewhere between one and three percentage points. Once a greater percentage of the population has retired, as is to be expected, savings accumulated abroad will gradually be drawn down.
  • Falling unit labour costs improved price competitiveness, but have been rising significantly again since 2010. From the mid 1990s to the late 2000s, wage restraint in Germany slowed or even lowered (unit) labour costs and improved price competitiveness compared with countries that had higher wage increases. Wage restraint was a response to (a) the high wage adjustments in the wake of Germany’s reunification, (b) high levels of unemployment, and (c) the overvaluation of the German currency upon entry into monetary union. The direct effects of higher price competitiveness were, on the one hand, greater demand for German products, resulting in rising exports and employment levels, and, on the other hand, lower wages and, hence, private consumption as a result of wage restraint. In the past, these developments caused the current account surplus to increase by about 1½ to 2 percentage points. However, since 2010, unit labour costs have been rising significantly , by an average of more than 1½ percent per year.
Overview of factors explaining Germany’s current account surplus

Factors (largely) beyond economic policy control

Factors that can be influenced by economic policy

Temporary factors

Fundamental factors

Fundamental factorsDemographyPublic investment
Commodity pricesReturns on foreign investmentsConditions for private investment
WagesEconomic structure, specialisationStructural reforms
Global business cyclesInternational interdependency

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