Lessons from Europe's Winners and Losers

Berlin had perfect weather last week, and there was no better place to watch the world go to pieces than Dressler’s open-air terrace on Unter den Linden. Berlin famously is one of the world’s coolest cities, an edgy outlet for young artists. But it is also the face of the economic future. German unemployment is down from 11% in 2006 to 6.8% this April, with barely a bump during the Great Recession of 2008. Back in 2006, by contrast, Spain’s unemployment rate was just 8%. Now it’s at 25%. Spain is likely to go bankrupt, right after Greece, and the Germans don’t really care. All of Germany’s export growth in the past ten years has gone to the east, not the south.

One really can’t talk about a European economy when key indicators are moving in opposite directions in different countries.


Germany will emerge from the European crisis intact. So far, Germany hasn’t even noticed that there is a crisis. Berlin real estate prices are soaring, I’m told, as Greeks and Italians turn up with suitcases full of cash to invest in one of the few property markets that showed no price appreciation during the bubble years. More important: the smartest Greeks and Spaniards are looking for work in Germany. Germany’s workforce has begun to shrink rapidly, but it will assimilate skilled workers and professionals from the feckless European south.

On paper, Germany’s economy should collapse between now and 2050, as the number of Germans between the ages of 15 and 59 falls to just 33 million from today’s 50 million. That’s almost as bad as the population decline during the Thirty Years’ War (1618-1648), which left wide swaths of German territory empty. The Great Elector, Friedrich Wilhelm I (1620-1688), solved the problem by inviting in French Protestants, who emigrated to Prussia in huge numbers after the revocation of the Edict of Nantes in 1685, as well as Slavs, Jews, and whomever else might be available. German was a minority language in the Berlin of Frederick the Great, and it will probably be a minority language again in twenty years.

Why should Germany thrive while Spain implodes? That’s like asking why Facebook is worth a lot and Myspace is worth nothing. It’s a winner-take-all world. Countries that do well have to do a few things extremely well. Germany makes the world’s best machine tools, some of the best heavy engineering equipment, not to mention autos. German manufacturing dominates innumerable key niches. The Spanish don’t do anything well. They haven’t done anything well since the Spanish Empire outsourced its manufacturing to Flanders in the 16th century. Germany has a score of marquee manufacturing brands, as well as hundreds of lesser-known quality manufacturers, of which my favorite is Howaldtswerke, a ThyssenKrupp subsidiary that makes the Dolphin class submarines for Israel. Name one world-class Spanish manufacturing brand. There aren’t any.

It’s not only in manufacturing. With its 82 million people, Germany has a cumulative total of 1,618 Olympic medals. Spain has 50 million people, but only 115 medals. On a per capita basis, that’s one eighth as many. Spaniards don’t wake up in the morning with the desire to go out and be the best in the world at something. There are hundreds of first-rate Italian firms, most of them small (intentionally so, to keep under the tax radar), and there are plenty of world-class French products. Spain is a bust, which is why it almost certainly will go bankrupt. It lived off the world’s most egregious real estate bubble for the past ten years, and now that the bubble’s popped, there isn’t that much else to the Spanish economy. There are plenty of smart Spaniards, to be sure. They are the ones who will end up working for Germans. There are also plenty of smart Turks, and as Turkey lurches further into Islamism, many of the best Turkish engineers will bail out and work in Germany as well.

In a winner-take-all world, you make a good living by being best at something, or a poor living by producing generic products cheaply. South Korea has chosen the first route to success. No people are more driven to excel. The national obsession with Olympic success and the wild enthusiasm for such athletes as figure-skater Kim Yu-na parallel Korean ascendance in such key niches as smart phones. There are enough things to be best in the world so that every country has a shot at being best at something. But you have to want to be the best. I’m not a Hispanophobe. Spain had the best poet of the 20th century (Federico Garcia Lorca) and, arguably, the best classical musician (Pablo Casals). But the sad fact is that if Spain fell into the Atlantic tomorrow, the world economy wouldn’t miss it.

There is another way to compete, and that is by producing mediocre products very cheaply. The trouble is that the feckless Greeks, Spaniards, and Italians used the euro system to borrow money to pay themselves more than they are worth. Notice that unit labor costs since 2000 are virtually unchanged in Germany. The German labor law reforms undertaken by the previous Social-Democratic government of Gerhard Schroeder reduced union power and eliminated incentives for Germans to stay on welfare indefinitely. Wages were restrained while productivity grew. Greek unit labor costs rose by nearly 40% during the same period, and by 30% in Italy and Spain. Wages cuts by those amounts would give Greece, Italy, and Spain a shot at competing with the Germans. But that’s a hard argument to sell.

Don’t believe the reports that a new Lehman-style financial crash is in the offing. What’s going to happen is much less dramatic. In 2008 no-one knew how to value Wall Street’s liabilities (for example, AIG’s famous guarantees on subprime securities). Now the full extent of the problem is known to everyone. It’s just a negotiation now over who gets knackered. And the answer, by one means or another, is the southern Europeans.

Spain probably has to spend the equivalent of 20% of GDP bailing out its bankrupt banks. It won’t quite bail them out: the $85 billion of subordinated debt of the banks — two-thirds of which is owned by individuals — will be vaporized, so Spaniards will lose a good deal of their savings. If Spain has to reduce debt payments to creditors like Greece, other European banks (mainly French) will get hung out to dry just like the Spanish banks. Their subordinated debt will vaporize, and the French will lose a large part of their savings. It’s easy to fix a financial crisis when you can put the damage back to individuals, insurance companies and pension funds. A lot of Europeans will get poor, fast. And the Chinese, or the Germans, or the Canadians, or someone with ready cash will come in and recapitalize the bankrupt banks. The Germans will be left with a lot of loans to the European Central Bank. They’ll live with it.

The worst possible thing would be to pour more public money into corrupt and inefficient economies and subsidize their failures, as President Obama proposed at last week’s Group of Eight summit. Reforms would help. Some of my conservative colleagues seem to think that if you sprinkle supply-side fairy dust on the Club Med economies they will roar back to growth. In fact, labor market reforms would work wonders in Italy, which has very low private debt, lots of public assets, and many pockets of strength. In general, though, these economies deserve the nasty wake-up call they are going to get. The trouble with the southern Europeans is that they insist on combining familial amoralism with state dependency: everyone views the state as an enemy when it comes to paying taxes, but insists on handouts and protection from the state. In the case of Spain, you can’t get there from here, as the Maine farmer told the tourist. (Portugal is an exception. The stoic Portuguese work had and pay their taxes, which gives that small country a better shot than Spain.)

Spain should serve as Schreckensbeispiel (a horrible example) to Americans. If we do not give Americans the opportunity to realize their dreams, be the best in the world, hit the ball out of the park, go for the gold, we will fail as a nation. In a winner-take-all world the devil takes the hindmost. If we penalize the winners, we guarantee that all of us will fail. Spain shows how quickly a seemingly prosperous country can come apart when its entrepreneurial engine stalls. If we don’t eject the most anti-business president in American history, we will look not like Europe, but like Spain.