Race to the bottom

The euro-area economy is mired in a deep recession. Germany has fallen hardest.

ANY economy that cannot stay ahead of credit-crunched Britain is in deep trouble. Figures released on Friday February 13th show that the euro-area’s GDP fell by 1.5% in the last three months of 2008. That was as steep a drop as in busted Britain and far worse than in America. The pain was felt right across the region but, of the four big economies, Germany shrank fastest. Its GDP fell by 2.1% in the fourth quarter, following drops (albeit less alarming ones) in the previous two quarters. GDP in Italy fell by 1.8% over the same period; in France by 1.2% and in Spain by 1%. All four countries are mired in deep recessions.

Any hopes that the euro area would be more resilient to the global credit crisis have been firmly dashed. That grim figure from Germany, in particular, turns conventional wisdom on its head. It is seemingly ill-suited for the role as Europe’s leading credit-crunch victim (Britain is the usual suspect). Germany has a huge current-account surplus and so is not dependent on flighty foreign capital to keep its companies primed. Its economy has a reassuringly tangible bent—big in manufacturing and light on financial services, where profitability has proved illusory. Germans did not get caught up in the housing and credit booms that consumed large parts of the rich world. They have high saving rates and low debt levels compared with their peers in Britain and America. There ought to be plenty of rainy-day funds to dip into now that times are tough.

Yet for all its apparent solidity, Germany’s economy has crashed harder than that of any other big rich country (with the possible exception of Japan, another high-saving, export-led economy). Its apparent strengths are now revealed as weaknesses. Prudence is not always a virtue: the instinct to save for a rainy day seems only to harden when the rains set in. Consumers who were careful spenders during the good times for the German economy become still more cautious during a downturn. That has left Germany overly dependent on foreign demand, which has evaporated (orders for German goods have fallen by a quarter in the past year). The response of German firms to collapsing foreign demand has been to slash their own investment, which has only added to the dearth in spending.

Germany’s tilt towards manufacturing is something it shares with France and Italy, the next largest euro-area economies. That bent has left them cumbersome rather than strong. It is goods-producers that suffer most during recessions. Consumers are unwilling to shell out on expensive items, such as cars and home appliances but are less prone to cut back on the frequent small purchases that keep many service industries ticking over. Just as consumers are making do with the cars and fridges they already own, firms are increasingly loth to splash out for new plant and machinery. In uncertain times, the instinct is to make equipment last a little longer. That strikes at the heart of Germany’s economy, which specialises in consumer durables and capital goods.

As bad as the euro area’s GDP figures are, many will point out that in other important respects it is hurting less. Unemployment is rising less quickly than in America or Britain. The black spots for jobs are Spain and Ireland, where lay-offs in the swollen construction industries have lengthened dole queues. Perhaps the tendency of European firms to hoard workers through recessions will stop the damage from spreading. Yet that is probably too hopeful. There are already signs now that the pace of job losses is picking up in France and Germany. When economies are shrinking this fast, big job losses are never far behind.

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