Some commentators are questioning whether Germany’s economic recovery really has legs. But the financial sector should guarantee some cheer. July/August 2007 issue

Is Germany’s impressive economic recovery for real? And is the country’s financial sector really an impediment for future economic growth?

When a senior commentator in the international arena, such as Wolfgang Munchau, assistant editor of the Financial Times, questions the sustainability of Germany’s economic recovery in this way and, in particular, hits hard at the low growth contribution of Germany’s financial sector, he can be sure to get a lot of attention.

In his column, “Do not get too excited by Germany ’s recovery” Munchau lists five “observations”, why he thinks that Germany’s economy “is not nearly as good as it appears today”.

When arguing that Germany raised its international competitiveness through a real devaluation in the form of wage moderation, and that the weakened bargaining power of trade unions will not last forever, I think he has a point.

Especially when he warns that emerging industrial countries might challenge Germany in sectors such as electrical and mechanical engineering at which Germany currently excels.

He also might be on the right track when arguing that Germany might have problems regarding productivity growth in the medium and longer term.

I also share his reservations regarding the sustainability of recent export successes in the booming markets of oil exporters in the Middle East and Russia.

And Munchau is right on the mark when he points to major weaknesses in Germany’s education system, in particular, the chronic under-investment, the lack of reform and the poor integration of immigrants and their younger generation.

I would disagree with Munchau´s overall assessment of “the antiquated state and mutual banking sector” as “a system that relegates the private sector to a niche existence in the domestic banking market”.

He concludes: “Germany is still notoriously poor at financial innovation, and while the country is less prone to sub prime-mortgage-style crises, the lack of financial innovation is going to drag on long-term growth.”

Talking down Germany’s financial sector as an economic growth impediment is not borne out by the facts.

Not surprising, in a letter to the Financial Times, Mike Treanor of Siemens Financial Services sharply objects to Munchau´s thesis that “Germany is notoriously poor at financial innovation and this lack of innovation is a drag on long-term growth”.

He argues instead that “the country’s recovery of economic vibrancy has not been because of a consumer spending boom, but rather because of the growing strength of its industrial and business services markets at home and abroad.

This growing business-to-business strength is being supported by financial innovation.”

He continues: “Increasingly, vendors of business products have realised that offering the customer attractive financing options is as crucial to closing a sale as the functionality of the products itself.

The uses of asset finance in the public sector is also on the up. None of this would be revealed in the economic indicators that Munchau has been tracking.”

But let´s ask those who are considered financial sector experts, such as Achim Duebel, a former World Bank financial sector analyst, who now runs a consultancy from Berlin.

“From a pricing perspective, Germany is a highly competitive market,” says Duebel. “There is no lack of innovation in corporate finance and more innovation in the retain and small and medium-sized enterprises sectors is coming, pushed by broker orgination and securitisation.

"The market could benefit from greater regulatory flexibility and lower political barriers to consolidation.”

Dirk Schumacher, senior European economist at Goldman Sachs and who published major studies on Germany’s financial sector reform in recent years, thinks that Munchau is “way off the mark”.

The Frankfurt-based economist, who published studies including The Changing German Financial System or German Profits from Restructuring, thinks “that German bank customers get more for their money in terms of financial services than those in many other countries”.

He questions the notion that only financial centres with a high level of financial innovation prosper. “Where in today’s world financial innovation is created doesn’t matter, what matters is that financial innovations is used and that is the case in Germany’s financial sector.”

Schumacher suggests that Munchau gets his facts straight by looking at the ample empirical data of a useful study The German Banking Industry in International Comparison.

Its core findings are that “in Germany it is mainly bank customers who benefit from the productivity gains within the banking industry – in the form of falling prices for bank services”.

Such a “distinct transfer of the productivity gains to customers could not be observed in any of the other countries included in the comparison”, concludes the study.

The authors concede that “measured against earnings ratios such as interest margin, cost/income ratio or return on equity, in international comparison Germany’s banking and savings banks have had to take a back seat for years”.

Yet the findings show that “the German banking industry is indeed highly productive: in terms of labour productivity, the banks and savings banks surpass most other German economic sectors and, compared with the banking industry in other countries, even comes second, behind Japan.

Also, measured against the macroeconomic resources that are used, Germany is not “overbanked”, say the authors.

As in the other major economies, about two per cent of Germany’s workforce is employed in the banking industry ( USA 2, 1%, Japan 2%, UK 2, 4%). At 4.1 per cent, Germany’s banking industry is far above the average for the overall economy in terms of annual labour productivity growth (all industries: 1.7 per cent, only services industries: 1.1 per cent).

In international comparison solely, the annual productivity growth of the Japanese banking industry is slightly higher, whereas Germany’s banks surpass those in all other “old” European economies and those in the US by a wide margin.

Productivity per person employed in Germany is 4.1 per cent, in the US 2.7 per cent and in the UK 3.9 per cent.

Although this major study is not a new one, there is strong evidence that banking and financial sectors do not change radically in a few years.

This means that financial sector experts such as Duebel and Schumacher have a point when they warn: don’t talk down Germany´s financial sector.

Klaus C Engelen is contributing editor to Handelsblatt and The International Economy.