On The Shoulders Of Giants – How Spain Is Destined To Follow In Germany’s Footsteps

The current generation of policymakers seem to be like Captains of large ocean liners, out there on the high seas, bereft of either compass or adequate charts, trying hard to calm there worried passengers by telling them nothing is amiss. But the charts are there, if only they would look at them, and in the present Spanish case, unlike the old refrain, the future is ours to see, and it has a name: Germany.

For those willing and able to examine our present situation with a reasonably open mind, a comparison of the recent history of the Spanish and German economies can prove illuminating, especially since, as I will argue below, there are strong structural homologues to be observed in the evolution of the two.

This post will contain comparatively few words (what a blessing!) since I will try and let the charts themselves tell their own story, in the hope that concepts which seem to be difficult to convey verbally, may be easier to grasp visually.

Consumer Boom

The first myth I would like to debunk is that it simply is not true that the Germans are a group of “non consumers”, and inveterate savers. Back in the 1990s German private consumption enjoyed a huge boom, a boom which ground itself to a halt around the year 2000. It is only since 2000 that German private consumption growth has been lacklustre, and incapable of driving the economy. (I am using a Bloomberg chart here, since I don’t have a long enough time series to hand to make my own version).

Now if we look at the same chart for Spain, we can see that private consumption growth enjoyed the same kind of “blossoming” that German consumption did between roughly 1999 and 2007.


Driven By Borrowing

But more than the phenomenon of the consumption boom in and of itself, what is interesting is what was driving it. Unsurprisingly we find the “usual suspect” – rapid increases in credit. Again, the following charts belie the idea that Germans have always been a nation of meticulous savers.

And again, the Spanish charts for mortgage increases tell a very similar (if even more exaggerated) story.

And it wasn’t only households, corporates were busy at it too. Interestingly, corporate borrowing seems to have had a brief renaissance in Germany on the back of the current crisis.

Yet again, the only area in which Spain distinguishes itself is in the magnitude of the phenomenon. Spanish corporate indebtedness is a much, much more serious problem than German corporate indebtedness ever was.

When we come to look at the last set of loan charts, I would point of two features. In the first place, total private sector debt is not that different between the two countries, despite the fact that German GDP is around twice as large as Spanish GDP.

And in the second place, look at the long tail on German year-on-year borrowing, this is the point where those with eyes to see should be able to discern something of the future which awaits Spain. Interannual lending in Spain isn’t going to climb back up again, and we should expect it to trawl around the zero percent level for many years to come, as Spain’s private sector deleverages itself.

From Current Account Deficits To Current Account Surpluses

Which brings us to the next point, the association between lending booms and current account surpluses. As we can see in the chart below, Germany was no exception to the rule here, and all through the duration of the consumption boom the country ran small current account deficits. Deficits which then became surpluses after the huge structural adjustment the country went through in the transition from being a consumer driven to being an export driven economy.

And this is the path that Spain will now surely have to follow, but just note the massive difference in scale between the two. Spain’s adjustment will need to be enormous. And how could this have happened we might like to ask ourselves? Were all the relevant drivers fast asleep, lurched over their wheels? How come no one “saw this coming”?

Given the magnitude of the correction, it is not really surprising that the IMF seem to want to hope against hope that it really won’t be necessary. As the chart below illustrates, they seem to be hoping markets will sustain the current account deficits all the way through till 2015. As can be seen, Spain is the worst case offender, and the country where the structural transformation will need to be largest. So why do the IMF continue to believe in something which is scarcely credible? It could be that they simply accept the Spanish government’s own optimistic idea that private consumption will come back to the 2% growth level again, kick started by a surge in borrowing. But a study of what happened in Germany makes that highly unlikely. Spain’s banks are having trouble enough financing themselves as things stand, are people seriously suggesting the markets will now fund another bout of additional leveraging?

And if the private sector isn’t going to do the borrowing, then who is? Since simple book-keeping tells us that having a CA deficit on the one hand implies capital flows on the other to fund it. The only conclusion I can come to – and this is what I argue in this post - is that we are assuming the government is going to continue to run a sizeable deficit, or that there will be straight fiscal transfers from other parts of the Euro Area to Spain. Otherwise the numbers simply don’t add up.

Worm Into Butterfly?

What I have been arguing so far should be relatively uncontroversial for anyone with a sound grasp of applied macro. What comes next is more of a hypothesis. As we have seen, economies seem to transit from being consumption driven to export driven, so we might like to ask ourselves, is the process merely random, or are their underlying structural dynamics at work. As I am trying to argue in the German case, the shift doesn’t seem to be a cultural one, and if Spain follows Germany down the same road then we will certainly know it isn’t.

So what could be driving all this. Well, as Claus Vistesen and I have speculated, ageing populations and the demographic transition may well have something to tell us here. Using Modigliani’s life cycle saving and borrowing idea, and the Swedish demographer Bo Malmberg’s idea of population “ages” (child, young adult, middle aged and elderly), Claus has prepared the following chart in an attempt to illustrate the process.

Of course, all of this at the moment remains at the levl of hypothesis. I tend to use median population ages as a rough and ready measure of ageing, and (even though I wouldn’t want to claim any precision here) it is interesting to note that both Germany and Spain have started to transit off towards export dependence at around the 40 median age point.

Still, this is early days yet, and we will know a lot more in this regard when we see how the different countries all along Europe’s periphery perfom in the years to come. Will they, as the IMF and the EU Commission seem to assume, go back to being consumption driven, or will they be condemned to follow the German path? Certainly Hungary, to take just one example, seems to look more and more as if its economy which desparately trying – but so far unable – to transform itself into yet another Germany.

Real Devaluation

The worrying thing looking at the above inter-country comparison is how much larger Spain’s correction is going to need to be than Germany’s was. As Wolfgang Munchau pointed out in the FT yesterday, Germany entered the eurozone at an uncompetitive exchange rate and embarked on a long period of (quite painful) wage moderation and deep structural reform. In fact, Germany entered the Euro with an excahnge rate which was too high, give the new role exports were going to play in economic growth. The German adjustment can be clearly seen in the REER chart below, as can the very large adjustment that Spain will have to make in comparison with the German one.

When macro economists say this will be “painful” they don’t do so to be sadists, they say this since they know this is going to be hard, very hard. And doubly so when almost all those responsible for taking policy decisions at all the respective levels seem to deny that it is going to be necessary. I have advanced two suggestings (a systematic reduction of 20% in wages and prices in Spain, or a temporary exit of Germany from the Euro Zone). Since neither of these have gained any traction at all, it is reasonale to assume they are now not going to happen (at least in any orderly way). But the car is still heading full speed towards that brick wall. When it finally does crash, will the Queen of England once more say to Luis Garicano, “but tell me Luis, just why was it no one saw this coming?”.

This entry was posted in A Fistful Of Euros, Economics and demography, Economics: Country briefings by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

19 thoughts on “On The Shoulders Of Giants – How Spain Is Destined To Follow In Germany’s Footsteps

  1. The 90ies in Germany saw a lot of pent up demand in the eastern half unleashed. Are they comparable at all?

  2. Certainly the credit expansion in Germany in the 1990′s was intended to smooth the integration of East and West; particularly the large number of East Germans who couldn’t find employment readily.

  3. Hello Hugh,
    The real effective exchange rate is based on inflation, isn´t it?
    Don´t you think that the difference in GDP growth rate has something to do with this?

  4. Oliver – entry into Eurozone saw a lot of pent up demand unleashed in Spain, or if you prefer the means to revalue, endebt and buy were made available. Not so different, if at all. Spain was several yrs. behind northern European economic reality (and still is by the look of the charts and in terms of productivity outside of construction). Spain has and still does look to the EU as a solution to its direction, same East to West Germany. As for the REER, and I do not know its composit, it may possibly return to more normal as debt repayment soaks up Spanish liquidity . Funds and credit were certainly poured into Spain, I always wonder if to ‘enrich’ it, modernize/restructure it, take control of it etc. and I don’t think there is one simple answer, more like a combination. The Spanish were certainly aware of their choices, though some still expect both the milk and the butter (or in some cases they have watched others make off with the butter and they are wondering what on earth they are now being served up with – though from the outside it is the same thing maybe).

  5. Thanks for this very interesting paper, and also for the illuminating previous one re France vs Germany. There seems to be some disconnect between media perception and economic reality.

    Maybe the stagnation of private consumption in Germany after 2000 is the result of (a) demography, as you argue, (b) post-reunification issues, as commented above, and (c) delibarate policy of internal devaluation, based on salary compression, thus compressing demand.

    Thus the magnitude of the 2000 German switch could be the result of these 3 forces going in the same direction at the same time. Spain experiences (a), not (b), and not – yet – (c). But the Spanish (a) seems to be stronger than the German one, according to your medium age graph. The rapidity of Spain aging is quite remarkable.

  6. As soon as Spain has a unification too, we can talk. The theory that Germany prior to 2000 was a consumer driven economy is peculiar, to say the least. The early nineties and the unification boom were a short interlude in a decade old orientation on exports. Germany had a goods trade surplus since the fifties and usually a balanced current account or a small surplus.
    So whatever your demographic idee fixe tells you, nothing happened in 2000. The economy was just as export dependent as ever. That has been the case since at least the early eigthies in combination with mass unemployment and no wage growth. That – the stagnating, if not shrinking income of the employed has been the decisive factor causing stagnating consumer demand.

    So whatever will happen in Spain – and just a difference in scale is funny, quantity is quality in the end – you should not look to Germany.

  7. Hi Karl,

    “The real effective exchange rate is based on inflation, isn´t it? Don´t you think that the difference in GDP growth rate has something to do with this?”

    I’m not sure how you mean. If you mean that the credit boom over heated Spain’s economy, leading to inflation and with it a loss of competitiveness, then yes.

  8. Hi Scott,

    “Certainly the credit expansion in Germany in the 1990′s was intended to smooth the integration of East and West”

    Well certainly this would be true if we were talking about government spending, but I am not sure how the urge to smooth integration should lead to a dramatic surge in household borrowing.

    I think we are losing ourselves at bit in the “stereotype narratives” here, and not looking at the common structural characteristics.

    In the German case the “excuse” for the borrowing boom was unification, in Spain it was European integration, but it doesn’t matter what the pretext was, it is what happened that matters.

  9. IM,

    “The theory that Germany prior to 2000 was a consumer driven economy is peculiar, to say the least.”

    Well look at private consumption growth during the 90s. The facts are there.

    “So whatever your demographic idee fixe tells you”

    Now this is the funny thing, since this is far from the first time I have been told this. But what if it isn’t me who has the obsession, and I am only trying to understand the imbalances, and follow the facts. What if population ageing really does matter, and having fertility at the 1.3 level for over 30 years is courting disaster. It’s a hell of a gamble you are taking. I mean, if I am right, and no one does anything, then Germany will be really screwed. And since I am more a Germanophile than phobe, that does NOT make me happy. What is going on at the moment is a kind of Monte Carlo play, with all the eggs in one basket, and to hell with those who don’t agree.

    Come to think about it, this is more or less what the Spanish banks have persuaded their government to do, an all or nothing “play”. Personally, these gung-ho type mentalities make me very nervous.

  10. And once again you did not lose a word about wages. Funny that. According to you, Bangladesh – population 156 million, fertility rate 2.56 should be the next economic superpower. It ain’t necessarily so.

    You somehow seem to assume that the youth can consume without income just on the inherent properties of youth. If consuming and birth-rate is everything, why are the UK and especially Ireland in the same trouble as Spain? Shouldn’t you compare Spain to them or to Florida?

  11. Let me explain it. Consumer prices in Germany are higher than in Spain. During the last years, Spain has been approaching to the GDP per capita level of Germany. I think this led to price level convergence. Even more if we consider that we are using the same currency.

  12. Hi.

    Was it really necessary to distort the aging graphs so hard to have an argument to mention?

    At least one reader (preplexed in Montreal) got the impression that “The rapidity of Spain aging is quite remarkable.” when actually with the data you are using spaniard’s aging is two thirds slower than german’s. The graph seem steeper only because Edward uses a different scale on the vertical axis for each country.

    Edward, in another article someone said that you are an independent writer and you understood that you do not have to please no one. The case of your independence is more of a need for an editor. Please do not let your obsessions emerge again and again, have someone read your articles before you publish them and let him/her cross out your bias.

  13. I concluded from the median age graphs that it goes from 34 to 45 in Spain and from 37 to 46 on Germany over the time period considered. That said, similar y axis would be preferable (this also applies to some industrial production graphs that you had on previous posts).

  14. Perplex in Montreal,

    then I assume you didn´t look to the horizontal axis. Neither spain nor germany have gone to 45 nor 48 because if I look at my calendar I see that we are in 2010 not in 2022. That graph is either wishful thinking or utter bollocks. Choose one. Definitely not something to base an argument.

  15. More to the point:

    This argument forgets one thing called reality. The circumstances of each country are the ones that mark the changes of the graphs and circumstances are not things that repeat once and again. In those graphs are embeded local circumstances that are not mentioned in the discourse, like the unification of germany or the incorporation of spain to the EU; as well as global circumstances, which are not mentioned neither, like the introduction of the euro or the global crisis of 2008. Pretending that a curve can repeat itself with ten years of delay without the factors that made it is, to say the least, foolish.
    Statistics DO NOT PREDICT THE FUTURE. Statistics only paint a picture of the past. This is something that is always written for the lay man in any pension plan you buy: past performance does not guaranty future performance. It is a very simple concept but seems that self proclaimed gurus cannot grasp.