down but not quite out

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FT editor Roula Khalaf selects her favorite stories in this weekly newsletter.

The writer is chief economist at German bank LBBW and former chief rating officer at S&P

Germany has not yet been downgraded by the capital markets in the sovereign rankings. Despite the country’s economic weakness, the Bund is still the undisputed benchmark for euro debt. Its AAA rating has a stable outlook with all major rating agencies. But that won’t last forever.

The simplistic view still shared by many German politicians is that high creditworthiness is a direct function of low debt. It is not. In fact, the public debt burden of high-rated advanced economies is substantially higher than that of lower-rated emerging markets. Other factors such as growth, productivity and innovation capacity also play a critical role. And here Germany is getting weaker and weaker.

There has been a disappointing pace in economic data in the country. All high-frequency indicators are pointing down again, from order books and industrial production to retail sales and confidence indicators. For two years now, the economy has been in and out of contraction. Even so, the economy is going nowhere.

Germany’s weakness led to stronger expectations for more rate cuts from the European Central Bank. The 10-year Bund yield, which briefly touched 2.6% in early July, has fallen quickly to around 2.25%. This is evidence of the crowding of economic pessimism that is forcing the ECB’s hand. The fact that other eurozone countries, such as France or Italy, have their own deepening challenges flatters Germany in relative terms and makes its benchmark status unassailable.

The main reasons for Germany’s structural stagnation partly reflect adverse megatrends beyond direct government control. The first factor is the end of globalization and the second is a daunting demographic profile. Added to this is the self-inflicted wound of continued underinvestment.

Germany has benefited, like few other countries, from China’s emergence into the world economy. When China joined the World Trade Organization in 2001, the country only needed the things German companies excel at: investment goods, cars, vehicles. Exports went through the roof. In 1999, slightly more than a quarter of all things produced in Germany were sent abroad. By 2008, this share reached 46% of GDP.

But since the financial crisis, world trade and German exports have largely gone sideways. China has gradually become a competitor rather than a customer. Protectionist tendencies have crept into the world trading system. As foreign demand flattened, Germany’s economy came to a screeching halt.

German consumers did not get their game. They have good reason to be thrifty: a rapidly aging society with an underfunded public pension system. The large cohorts born in the 1960s are beginning to retire. Over the next half decade, Germany will lose a net 1% of its workforce each year.

This trend is exacerbated by fewer and fewer hours worked. In no other OECD country are workers spending less time at work. With the labor force shrinking by about 1% per year, labor productivity would have to rise equally for the economy to stand still. Unfortunately, productivity gains per hour worked have been well below 1% in recent years. The country’s fundamental speed limit for growth could be below zero.

Slow productivity growth can also be attributed to decades of underinvestment in education and infrastructure. When European soccer fans arrived in Germany this summer, quite a few positive preconceptions about the country’s transportation system were shattered. That shouldn’t come as a surprise.

Since the turn of the millennium, Germany’s public sector has spent an average of just 2.3% of GDP on investment. In the euro area as a whole, it was almost 1 percentage point higher, in France even by 2 percentage points. The gap with peers has recently become smaller. But that just means that Germany continues to fall behind, just at a slower pace.

If the AAA crown were to be taken from Germany, it would not be because of too much debt. It would be because of prolonged economic paralysis and the lack of adequate measures to address it. As policymakers increasingly recognize the fundamental obstacles to growth, we can be confident that the fixation with balanced budgets trumping all else will be overcome. Don’t get rid of Germany yet!