No way to escape imbalances in the Eurozone? Three sources for Germany’s export dependency: fiscal federalism, social insurance and industrial relations

Over the last two decades the German political economy has increasingly relied on export specialization as a strategy for economic recovery. This export-led development strategy turned out to be of a mixed blessing. While on the one hand, specialization in high quality manufactured goods has preserved Germany’s competitive edge vis-à-vis many other industrialized countries, it has on the other hand led to an increasing dependency on exports as the engine for growth. There has been no equally strong evolution of a domestic service economy beyond manufacturing related services. The issue of export dependency becomes increasingly important with the financial crisis and global imbalances vis-à-vis Greece and the Eurozone but also globally. Weak aggregate demand depresses both domestic employment and endangers Germany’s position on global markets. The paper argues that Germany finds itself in an export dependency trap due to imbalances between domestic services and export-driven manufacturing. It analyses three sources for weak domestic demand and weak employment in domestic services: firstly fiscal federalism, secondly social insurance financing of the welfare state and thirdly the industrial relations system. All three are fundamental pillars of the German political economy and locked into political coalitions that are not easily changed. In the first part, the paper characterizes Germany’s increasing export dependency and economic specialization. Then it discusses each factor in turn. In conclusion, the paper makes suggestions of how to overcome the factors depressing domestic demand.