Germany fires back: and who does Adam Posen think he is, anyway?

• Author: Engelen, Klaus C.

For Germany's informed public--the political establishment, the media, and the business world--outside views carry a lot of weight, particularly if they are expressed by a leading international expert on Germany and Europe. Adam S. Posen is such an expert. He is deputy director and senior fellow with the Peterson Institute for International Economics, and TIE's Associate Editor and Chief Economic Commentator.

Returning from summer vacation, Berlin's political community and Frankfurt's business world could hardly avoid getting Posen's views on important current issues.

As losses on complex financial instruments backed by subprime mortgages in the U.S. housing market were sending shockwaves through financial markets around the world, German banks with a public-sector domestic orientation began to reel. IKB Deutsche Industriebank, the specialist lender to small- and medium-sized firms, and Sachsen LB, the Landesbank of the state of Saxony, were caught with huge exposures in the U.S. subprime mortgage market. They had to be rescued by large liquidity infusions ordered by the banking supervisors. In interviews with the German press, Posen tried to put the possible damage from the subprime mortgage crisis to Europe in perspective. On September 6, 2007, in the Borsen-Zeitung, he predicted: "In a few weeks the stormy seas will be calmer again." He also reminded investors in Germany and other parts of the world that, "by then speculators will have gotten rid of their financial poison and will have made their money."

On August 26, 2007, in the mass circulation Welt am Sonntag, Posen tried to calm tears in the hubbub of the current financial crisis by pointing to the central bankers as still-reliable guardians of financial stability and explaining why the eurozone's lead central banker "is gaining fans through his activism, while the Federal Reserve's chairman is showing restraint--contrary to stereotypes and to the two institutions' own self-proclaimed orientations." The reason: The responses of European Central Bank President Jean-Claude Trichet and Federal Reserve Chairman Ben S. Bernanke to the recent liquidity crisis were different. Posen's message: "The financial--and particularly the banking system-is still more vulnerable in continental Europe than in the United States, and the transmission of problems in the banking system to the real economy is greater in the eurozone than in the United States. Thus, the differences in central bank responses across the Atlantic are not caused by a difference in style or ideology."

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But before, with his piece "Taking the German Recovery Less Seriously" in the summer issue of TIE, Posen rived up to his reputation that he is good at taking away the champagne glass and spoiling the party.

His provocative message: "While the benefits of German economic recovery are real and welcome, no one should attribute much lasting meaning to today's German economic recovery." He derides Germany's famed six economic institutes who "have now started competing over who can raise their economic forecasts the most, instead of who can be the gloomiest." He recalls "that it seems a far cry from just two years ago, when books about Germany's economic malaise or decline or even crisis dominated the country's bestseller lists." He introduces the "Dirk Nowitzki fallacy" into modern economic theory. If people were to say, "Because Dirk Nowitzki of the Dallas Mavericks won the NBA's Most Valuable Player award, all German people are really good basketball players," we would dismiss that as silly, he explains. Germany's preoccupation with remaining the world export champion is misleading, goes his thesis. "Because there are a couple of little machine tool companies in Baden-Wurttemberg that happen to make some exports to China, advocates of the Mittelstand argue everything is OK. But this doesn't really mean anything about the corporate sector generally and there is no correlation between how much a developed economy exports over the long term and how fast it grows."

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Posen questions the long-term economic growth potential of Europe's largest economy for several reasons. German real potential growth has not risen and is still only 1.5 percent or less per capita. "It is failures in the German private sector allocation of and returns to capital that are at work and that are still waiting to be addressed by increased market discipline or enforced liberalization." And he argues: "As soon as the economy started to pick up, German companies had to add a lot of workers to generate a small increase in production, which is the very opposite of productivity growth."

"No! You are wrong," say most German economists.

"Contrary to Posen's observation, I see Germany's economic growth dynamics on a fundamentally sound footing, says Jens Weidmann, who heads the economics department in the German Chancellery. "The export sector is the classical leg of our highly innovative and competitive economy. Last year, for the fourth consecutive turn, Germany was the world's export champion and the only industrialized country able to increase its global market share in the face of growing competition from emerging market economies. Behind this achievement are not only--as Posen argues--a few 'Mittelstandler from Baden-Wurtemberg.' In our country, no less than 8.3 million jobs depend on exports, and exports now make up 45 percent of GDP. In the meantime, business investment has become the second engine pushing economic activity. Last year, business investment expanded 8.3 percent, a level not seen since 2000. Also during the first half of 2007, companies kept their investment levels high. With labor productivity increasing and real unit labor costs decreasing, Germany was able to further strengthen its international competitiveness."

Chancellor Angela Merkel's chief economic...