Germany and Japan rather than China are the countries with problematic policies which earn them large trade surpluses without contributing to global growth.

In the debate on global stability and growth attention is often focussed exclusively on US-China rebalancing, to the neglect of the role that could be played by two other major economies, Germany and Japan.  These countries, like China, have been running large amounts of current account surplus which reached $250 billion in Germany and $210 billion in Japan before the onset of the crisis compared to $370 billion in China.

A major reason why inadequate attention is paid in global rebalancing to these two major countries is that their bilateral trade surplus with the US is much smaller than that of China; on the eve of the crisis it was some $50 billion in Japan and $75 billion in Germany against $270 billion in China.

However, the conventional measure of bilateral trade balance is highly misleading when countries’ exports to each other have widely different foreign value-added contents.  China’s exports to the US contain a lot more foreign value-added than exports of the US to China.   For instance, in conventional terms the trade surplus of China with the US was estimated to be some $172 billion in 2005, while in domestic value-added terms (that is, when foreign content of exports of both countries is excluded) this figure comes down to less than $40 billion. In the same year Japan’s surplus with the US was around $85 billion.

Since the foreign content of Japan’s exports is much lower than the foreign content of US exports, in value added terms Japan’s bilateral surplus with the US turns to be higher than the bilateral surplus of China with the US.  German exports also have higher foreign contents than US exports, but not as much as Chinese exports.  Therefore, even though China’s bilateral surplus with the US in value-added terms is higher than the bilateral surplus of Germany with the US, the difference is not as high as that indicated by the conventional measure.

More importantly, Japan and particularly Germany have been siphoning off global demand without adding much to global growth.  During 2002-07, exports grew 25 times faster than domestic demand in Germany and 8.5 times in Japan while this figure was less than 3 for China (See Table Below). As a result, in Germany GDP growth exceeded growth of domestic demand by a factor of 4.  Consumption virtually stagnated and its share in income fell while the share of exports increased.

More significantly, despite the widespread hype about dependence of Chinese growth on exports, in both Germany and Japan, the contribution of exports to growth was much higher than that in China during the years preceding the crisis.  In China about one third of GDP growth was due to exports compared to one-half in Japan.  More importantly, in Germany the contribution of exports to GDP growth was some 140 per cent, which implies that without export growth, German GDP would have fallen by some 1 per cent a year during 2002-07.

This lack of dynamism in domestic demand in general and consumption in particular is due to stagnant or falling real wages and slow employment growth.  In all major advanced economies, wages have been sluggish since the mid-1990s, and the share of wages in income fell as real wages lagged behind productivity growth.

In the US, despite the downward trend in the wage share, private consumption surged, sustained by asset bubbles, credit expansion and household debt.  This has not been the case in Japan and Germany. Consequently, in both countries, notably in Germany, the decline in the share of consumption followed the decline in the share of wages in GDP (See Figure Below). Unlike China, however, falling shares of wages and consumption in GDP have not been associated with strong growth in real wages, consumption and GDP.

In Germany, there are several reasons for high unemployment, slow growth of jobs and stagnant wages.  First, reflecting largely the German aversion to inflation, the European Central Bank has focussed almost exclusively on price stability to the neglect of economic growth and conditions in the labour market.  Second, the accession of several low-wage Central and Eastern European countries has led to significant outsourcing by German firms, which has not only intensified the pressure on the labour market in Germany but also served to restrain investment at home. Finally, orthodox labour market and welfare reforms have considerably weakened the bargaining power of the workers, particularly at the lower end, without creating many jobs.

Wage restraints in Germany have been part and parcel of an attempt to increase competitiveness of the economy by reducing production costs ? a policy described as “competitive disinflation”. Greater competitiveness has thus come at the expense of consumer demand.   This has amounted to a beggar-thy-neighbour policy for several European economies locked in the euro but unable to restrain wages to the same extent, notably Italy and France.  It has therefore threatened growth and stability in the eurozone as a whole, leading to strong exchanges between Germany and France in recent weeks.

In Japan, the gap between wage and productivity growth has been greater than most other advanced economies so that the share of wages in GDP fell faster. Increased competition from low-cost DEEs has led to outsourcing and exerted pressure on wages at home.  Labour market deregulation from the mid-1900s onwards allowed greater space for employers to move away from the traditional practice of long-term employment where wages tend to rise with the tenure, towards lower-wage, temporary employees.

Like China, an increased contribution of Japan and Germany to global demand calls for faster expansion of domestic consumption which, in turn, depends on faster growth of labour income than has been the case so far.  Unlike China, this is needed in Germany and Japan not so much to replace external sources of growth with domestic demand, but to raise the overall growth rate of the economy.  Even with an unchanged rate of expansion of exports, a more rapid growth of domestic demand in these countries would naturally lead to a faster growth of imports and hence reduced trade surplus, thereby increasing their contribution to global growth.