Mark Carney Square

Germany Vs UK? Comparing economies is not a penalty shoot-out!

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ECONOMIC COMPARISONS are not penalty shoot-outs, but the moment male economists hear the words UK and Germany, they seem to lose the ability to step back and look at the bigger picture. Rather than comparing simple numerical performance, we should look at the two countries’ underlying economies.

There is no reason why the UK and German economies should be synchronised. They are very different: manufacturing contributed 23.4 per cent of German GVA  but only 10.1 per cent of the UK’s; while the service sector makes up 79.2 per cent of the UK’s GDP but only 68.7 per cent of Germany’s. To suggest only Brexit could possibly influence their relative economic performance, as the former Governor of the Bank of England, Mark Carney, implied in a Financial Times interview is at best amateurish and at worse deceitful.

It has been amusing to watch Jonathan Portes, Professor of Economics, Kings College London, hammering Carney, now head of ESG investing at Brookfield Asset Management, for his inaccurate remark. Portes showed that Carney was wrong in claiming the UK economy had contracted to 70 per cent of the German level. While it would be worth investigating how the UK managed to appoint a Bank of England Governor who doesn’t understand basic economics it is also worth looking into the politics behind Carney’s decision to exclusively compare the UK to Germany rather than to the whole of the EU, or the Eurozone or even to France – surely, Carney wasn’t cherry-picking his miscalculated data?  Why would he want to do that?

Carney could have compared the German economy with France and come to similar results, without needing to worry about the currency differential. According to the World Bank Website, since Germany and France joined the Euro, Germany has outperformed France in absolute GDP (PPP) and in GDP per capita, (PPP). (See chart below).But French economic underperformance compared to Germany has never been a concern of the UK media, even though France is still a member of the EU and the eurozone. So, a country’s economy can underperform Germany – without leaving the EU. Who knew?

Add the UK to the World Bank’s GDP per capita graph and we see that the UK is now neck and neck with France, but pre-2008, when the UK financial services industry was stronger, the UK GDP per capita was closer to Germany. But again, does it matter? All three lines are roughly going from bottom left to upper right on the graph, with a Covid kink at the end. (See chart below)

If I wanted to embarrass all three countries, I would add Switzerland to the chart and following Carney’s example, cite this as clear evidence that the EU doesn’t work, and all three countries should join EFTA instead. (See chart below)

The Bigger picture – International trade

Germany’s GDP per capita began to diverge from the UK’s in 2009 and not in 2016, as Carney claims. Germany avoided the worse of the Global Financial Crisis caused by the American subprime mortgage market collapse due to its relatively smaller financial service sector. But that may also be merely coincidental with other external factors outside the EU. For 2008 was the year when China began to make its presence felt, not just as a producer of low-cost goods but also as a consumer of Germany’s high-end manufacturing products. And although France and the UK also sell to China, German exports are an order of magnitude larger and have been for years as the chart below shows. But it is easier for Carney to Blame Brexit.

The dominance of different industries in the three economies is the cause of the divergence in GDP growth. Unlike the UK, Germany never abandoned its manufacturing base and sells China everything from vehicles to manufacturing equipment to electrical machinery to industrial chemicals. The French sell China luxury goods: cosmetics, perfume, and wine; and some aircraft, but at this stage of China’s development, they are in less demand. The British export some vehicles, some fuels, and some machinery to China – but are not in the same league as Germany. The UK’s services exports mainly go to countries that need insurance, have pension funds, use Common Law and the English language, but that doesn’t really apply to China, although we do export architectural and engineering services there and some Chinese companies have listed on UK stock exchanges.

Of course, all this is likely to change as China develops the capability to build its own machinery without involving Germany and when possibly more Chinese can afford to buy French wine or British insurance. Then Germany might sink back to the GDP per capita level of France and the UK.

The engine of enterprise – cheap, plentiful, consistent energy

But other things have benefited German manufacturing besides having a willing export market in China. Nord Stream I opened in 2012, providing Germany with even more cheap Russian gas. Russian gas was not new to Germany – even when the Berlin Wall came down Russia was supplying a third of West German gas. But it does appear that as Germany’s industry was expanding with ample Russian gas after 2012, the UK moved into its self-flagellation days. Instead of cutting the ‘Green Crap’ as Cameron had promised, the government expanded reliance on wind power, banned fracking and procrastinated about building new nuclear power stations.

So, while German energy became cheaper and more plentiful, UK energy became more expensive and less reliable. This is perhaps another cause of the differential between the two countries GDPs, and not Brexit. The UK’s conversion to Green power sources has been a large drain on the economy and has coincided with the UKs GDP divergence from Germany. According to the ONS, electricity generated from wind power in the UK has increased by 715 per cent from 2009 to 2020.

So yes, the German economy has outperformed the UK, just as Germany has outperformed France since 2009. But will this continue? The German Think Tank, IFO Institute thinks not. It is predicting German GDP to fall by E64b or 1.8 per cent due to high energy prices pushing manufacturing out of Germany. But the canny Germans are going back to coal, which is generally cheaper than gas, so they may yet still outperform the UK.

It seems unlikely the UK will ever rebalance its economy away from services and back to manufacturing, unless of course we find our own abundant source of cheap power. But unfortunately, instead of developing our own gas reserves our government has decided to rely on imported fracked gas from the US that has been liquefied, transported across the Atlantic and then converted back to gas, all at much greater cost, and a much greater carbon footprint, than using our own gas reserves.

Let’s hope Portes and Carney will soon debate which economy saw the greatest GDP contraction from its Net Zero commitments. Mr Carney is still the co-chair of Glasgow Financial Alliance for Net Zero – so that debate would be a humdinger.

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