Germany still a lesson for periphery despite ratings agency action, says Alliance Bernstein

One day after Germany had the sustainability of its creditworthiness thrown into question, the senior European economist at Alliance Bernstein says there are still lessons Europe’s peripheral states can learn from its strong economic development over the last couple of decades.

Berlin has reacted angrily today to the demotion by Moody’s Investor Services of Germany’s credit outlook from stable to negative, even though the agency did not touch its top-notch Aaa rating.

Despite this blow, Alliance Bernstein’s Darren Williams (pictured) says Germany still offers some important lessons to its debt-ridden neighbours.

He points to its ability to keep wage increases low between 1999, when it first joined the euro, and 2007.

Average wage increases in the country during that period were 10.5%, and importantly were roughly equal to increases in the productivity of employees.

This helped Germany reduce its real exchange rate, which was overvalued against other EU members back in 1999, he says.

France and Italy, on the other hand, allowed wages per employee rise by 37.5% and 40.6%, respectively, driving down their competitiveness against both Germany and other more successful economies within and outside the Eurozone.

To regain their competitive advantages peripheral states must now address these underlying issues.

But Williams believes simply cutting wages is not a plausible answer. This would make the economies more competitive, but it would also put pressure on personal incomes and reduce tax revenues, which would be bad news for household and public debt ratios.

The solution, Williams says, is to shift the tax base away from labour, by lowering company social contributions, and toward consumption, by raising indirect taxes. This would allow for wage reductions, without harming tax revenues.

The relatively poor performance of some of its Eurozone neighbours has left Germany footing much of the bill for their support.

The prospect of further costs falling on its shoulders, plus those of the Netherlands and Luxembourg, if Spain and/or Italy need bailouts, led Moody’s yesterday to downgrade the outlook for their top-class ratings to ‘negative’ , from ‘stable’.

The euro has fallen 0.25% against the US dollar today, to $1.20, as the Eurozone crisis worsens.

Some practitioners argue Germany’s exporters have benefited disproportionately from the weak currency.

But Williams believes “the myth that the euro has been a massive ‘free lunch’ for Germany” is unjustified.

Its strong economic position has been nurtured more through smart economic policy – and peripheral states such as Italy and France would do well to learn from its experience, he says.

The euro’s recent decline to a 10-year low is good news in this respect, Williams adds.

A weaker euro is likely to boost the competitive advantage of peripheral states against countries outside the Eurozone, and allow Germany to push wages a little higher without destroying its strong global position.

But he thinks the shared currency will “probably have to fall farther to help the euro area out of its current predicament”.

 

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