Final Paper: Role of Trade in the Growth of the German Economy - Grade: B+ PDF

Preview

Summary

Final paper on the role of trade in the growth of the German economy, along with bibliography....

Description

Precious Molokwu Bozena Leven ECO 340: International Economics May 5th, 2016 Role of Trade in the Growth of German Economy Introduction

Why trade with another? Ideally, to help yourself and each other. When two parties exchange goods of relatively equal values, both parties are made better off in the end because they are gaining access, through the other, to something which may otherwise not have been available to them. At least that is, under the doctrine of mutually beneficial trade, what most economists hold to be true and a way of thinking that has shaped international trade policies for years to come. One's ability to trade, however, grows reliant on several factors including size of economy, goods offered, modes of transportation, insurance guarantees and distance between nations to name a few (Frank, 1968). Nonetheless, it goes to stand that no nation has an absolute advantage in all areas of industry, across all forms of commodities, and thus most nations stand to gain from exchanging goods or services with other nations whom excel in the areas they themselves do not. That is not to say that there are not any losers in this global engagement but, that international trade, for the most part, has made everyone better off because it creates increased competition which lowers prices and produces a greater variety of goods and services for consumers to choose from (Ibid.).

While nations would trade with neighbors, out of access and necessity, prior to the 1950s many countries held protectionist attitudes and focused more on saving than trading, pursuing import substitution models before opening up their economies (Frank, 1968). Since then, the potential benefits of trade have been globally recognized, underscored by several coalitions formed between nations since

advent of World War I. The formation of multilateral treaty agreements such as the General Agreement on Tariffs and Trade (better known as GATT) in 1947, and later on the World Trade Organization (also known as the WTO) in 1995, demonstrate that trade grew to be a global issue in more ways than one. Not only insofar that international trade affects all countries individually, on the account of trade balances and their impact on GDP, but also in the sense that nations recognize the shared profitability of global trade and organized themselves in a fashion which aimed at decreasing costs and barriers for the benefit of all through voting, regulations and conflict resolution processes (present in the WTO, but not GATT). In a world growing ever-connected, through communication and transportation, many nations realized standing alone was no longer as beneficial as it once used to be an abandoned the heavily protectionist, often import-limiting ideals of the past in pursuance of a more liberalized trade model.

Germany was no different. Trade, of course, is a vital part of a country's economy. But looking at import/export statistics, GDP growth rates and trade balances is, in itself, not enough when trying to determine the importance of trade to a nation. Going further, my paper aims to analyze the institutional changes and policy shifts undertaken and experienced by Germany since the Congress of Vienna in 1815. This approach allows me to understand the underlying factors which shaped German trade policy over the last two centuries. I chose this time frame for two reasons. Firstly, a narrative told over the course of more than 200 years provides a more whole argument with respect to change over time and tracking the impact of certain policies and global events. Secondly, German history is unique (comprised of a coalition of states then unified, split and re-unified again) and my timeframe allows me to look at how these historical changes in German identity correlated with trade practices over time and their impacts. To further understand this impact of trade, my paper examines the changes necessary in German history which allowed them to build the trading apparatus they did prior to World War II and thereafter as well as the impact it had on economy.

Zollverein

The formation of nations predicates the practice of trade. That is to say, the way in which a nation is formed, by way of populace and borders and resources, holds great impact on the trade abilities it possesses. Only unified in 1871, what is known as Germany today was primarily comprised of several nation-states asserting their own sovereignties, principally among them Prussia (Passant, 1959). Often at conflict with each other, these states created an environment unfavorable to crossborder trade practices during the late 1700s and [very] early 1800s.

However, following the Napoleonic wars, concluded in 1815, the borders of Europe were reorganized in line with the Congress of Vienna which favored Prussia and the German Confederation of states (much in part due to their opposition of Napoleon), granting them territory on the Rhine and Westphalia as well as in parts of Poland and Saxony (Kissinger, 1956). The following two decades were spent between individual nation states forming trade agreements amongst each other until, in 1834, the Zollverein was established as a formal coalition between many German states as a means of easing and optimizing trade practices. A principal achievement, duplicated in many later multilateral trade agreements, was the creation of a common tariff rate amongst members states (Ploeckl, 2015). The Zollverein, with Prussia is a motivating force, also laid the groundwork for standardizing the acceptance of multiple currencies across members states, harmonizing weights as well as measurements and simplifying trade across state boundaries (Ibid.).

While disputed, most scholarly works points to economic reasons as the basis behind the creation of the Zollverein. While unification (and full formation of the coalition) followed only four decades later, under the umbrella of an empire, the incentives felt by members were largely financial

ones. The policies instituted under this coalition provided, “huge fiscal saving due to economies of scale in customs administration”1, and points to financial gains as the prime motivator for membership. We know this to be true because pertinent information provided in 1830s shows that the ratio of state border to total area of the confederation match the ratio of cost and revenue for customs administration. That is to say, small state revenues were often on par or in excess of costs, making the current arrangement unprofitable and a viable coalition economically attractive (Ibid.). Cooperative game theory, as demonstrated by some states prior to unification, would posit that initial or potential member states would indeed break off on their own to form alternatives to coalitions such as free trade agreements (which may be more favorable to two or three individual states than a coalition would) between each other. Ultimately, economies of scale alone do not accurately capture why not all German states joined within the first few years of formation but they do explain why and how the coalition ultimately succeeded following unification. As members joined, total area of coalition increased and “borders” between members ceased, transportation and administrative costs also decreased while resulting in rising revenues for most members (excluding Prussia, which experienced losses during this time) and laying a foundation for political, as well as economic, unity (Ibid.).

Industrial Revolution

In time with the Zollverein, the industrial revolution began to grip Europe in the early 1800s and did not take long to reach across the continent towards the German states. Fortunately, as a result of the Congress of Vienna, Prussia (likely in response to their aid in combating Napoleon) was granted territories in the Rhineland and Saxony (See Figure 1). Unbeknownst to the participating parties, the Rhineland would turn out to have immense coal reserves which would in turn fuel much of the Industrial Revolution and as such were an invaluable asset to the growing German economy (Kissinger, 1

Ploeckl, Florian. "The Zollverein and the Sequence of a Customs Union." Australian Economic History Review 55.3 (2015): 277-300. Print.

1956).

Figure 1: Allocation of German Territories, 18152

Coupled with the early leadership of Otto von Bismarck (1st Chancellor of Germany), a unified Germany managed to exploit it's natural resources and establish an industrial infrastructure which would help it surpass it's neighbors. After Germans adopted British innovations during the mid- to late1800s, introducing steam engines and coke smelting, coal became a driving force behind the success of their manufacturing sector (Gutberlet, 2013). The development of a railroad system on the mainland in the second half of the 19th century created new and more efficient modes of transporting goods for German suppliers, effectively cutting transport costs, bolstering regional manufacturing hubs and feeding an increasing demand for heavy industry (Ibid.).

Furthermore, Bismarck enacted initially protectionist policies concerning the arrangement of his

2

Von Burgsdorff, Elias Kühn. "Zollverein and German Unification: To What Extent Did the Zollverein Promote a Sense of National Unity within the German Confederation Prior to German Unification in 1871?" McGill University (2011): 1-16. Graphite Publications. Web.

economy. Signing into law the Tariff Acts of 1879 an 1880, he aimed at protecting developing industries, namely the agriculture and manufacturing sectors. Entering into trade agreements with neighboring nations, Germany created a trade network which allowed it to ship goods to close-by countries at relatively cheap costs (Shafaeddin, 2005). Two iterations of the Tariff Act later, in 1891, the Germany economy was on their way to becoming one the largest industrial powers in the world [growing to be the third largest in 1913]. Introducing further infant industry protection policies, these new acts also included export bonuses, punitive actions and cost-exemptions on processing, repairs and re-exportation (Ibid.).

What truly connected everything in the German economy and let it surpass it's neighbors during the Industrial Revolution was the development of the universal banking sector and it's relationship to other sectors of industry. Just as the name suggests, universal banks are concerned with both commercial and investment banking, supplying firms with current account credit and organization over issuance of securities (Edwards and Ogilvie, 1996). The fundamental difference however, between German banks and the others, was that these banks were linked with joint-stock companies which were popularized due to their nature of limiting risk for individual investors. This had a direct relationship to industrialization by linkage of the railway system as many of the initial projects were directly financed by joint-stock companies and, therefore, the universal banking industry (Ibid.).

Following World War I, the Weimar Republic, which governed Germany until the early 1930s, experienced massive amounts of hyperinflation and subsequently decreased trade with outside territories as a means of saving on foreign exchange (Ritschl, 2001). Between 1929 and 1937, during the Great Depression, Germany's exports reduced from 13.6 billion Marks to 9.3 billion Marks, decreasing at a rate of 31.5 percent, as seen in Figure 2 (Robinson, 1944). Under the early parts of the Nazi regime Germany experienced stagnant foreign trade rates under protectionist policies, their trade

balance decreased by 33.7 percent to -443 million Marks in 1937 (Ibid.). Aiming at a war-time, statecapitalist regulated economy, Nazi Germany pursued autarky, instituted price controls and restricted imports of finished goods and foodstuffs while simultaneously increasing production of war materials yet decreasing exports of the same kind (Schweitzer, 1943). Making it a habit of trading with smaller countries [such as Romania, Bulgaria and Greece], Nazi Germany created a dependency relationship with their partners, disproportionately holding more negotiation power, exercising an exchange monopoly and exacting involuntary credit from partners (Ritschl, 2001). Nazi Germany pursued policies aimed at militaristically driven autarky [widely adopting import-substitution methods] during WWII, effectively “de-specializing” and abandoning previous trade practices while leaving most of the intra-industry trade infrastructure, built upon in the following decades, in place (Schweitzer, 1943).

Figure 2: Export Statistics, 1928-19373

Post-war Recovery Following World War II, Germany's general, not least economic, outlook was dire; property damage as result of war and occupation proliferated, industrial output decreased and so did labor force participation as many working age men had died in the war. Split into two countries at the time, my paper chiefly examines the effects of post-recovery efforts undertaken on the part of West Germany. Preventing a skills shortage, this part of the country opened it's borders to immigrants, often expellees 3

Robinson, Nehemiah. “German Foreign Trade and Industry After the First World War”. The Quarterly Journal of Economics 58.4 (1944): 615–636. Web.

and mostly refugees from East Germany and other Soviet-influenced or controlled territories, adding 3 million new members to the workforce [doubling in the next decade, adding 3 million more during the 1950s] (Payne, 2011). Figure 3 plots the relationship between expellees and the rise in non-agricultural non-primary sector (for example, secondary or tertiary sector) employment. While the primary sector of economy primary deals with the extraction of raw materials, the secondary sector deals with manufacturing and third with services. As country develop, they tend to move towards the secondary and tertiary sectors which have more room for specialization (Soubbotina and Sheram, 2000). The reason this immigration policy was so successful was mainly due to the fact that labor recruitment was centered around quality instead of quantity, bringing in skilled labor as a means of improving gains experienced by the economy.

Figure 3: Positive Relationship between Immigration and Employment4

4

Braun, Sebastian Till, and Michael Kvasnicka. "Immigration and Structural Change – Evidence from Post-War Germany." Kiel Institute for the World Economy: Working Paper No. 1778 (2012): 1-39. Web.

Under the guidance of Ludwig Erhard, Germany's Economics Minister, the country implemented several monetary reforms as a means of combating their dying currency and forming a social market economy, addressing the inflexibilities which lead to economic stagnation following post-war recovery (Karsten, 1985). Aiming at an, “integrated, non-fragmented approach, combining the advantages of competitions with concerns for justice and equity”5, Erhard had to craft policies which wove together two opposing schools of thought, one socialism and the other capitalism. These reforms abandoned price and rationing controls, effectively re-instituting money as an effective medium of purchasing power (Heller, 1950). This policy also coincided with the creation of the Deutsche Mark, replacing the Reichsmark and effectively reducing the volume of money by 90%6 (Emmer, 1955). A central banking system was re-established not long after, removing credit restrictions and lowering borrowing/lending rates (Ibid.). These changes all aimed at making money cheaper and more available while simultaneously shielding from potential hyperinflation.

Furthermore, Andreas Predöhl, a German economist, asserted that the country was already located in an industrial “core area” defined by an embrace of integrated factories amongst other characteristics.This is to mean that these factories do not use raw materials nor produce finished goods but rather deal with converting intermediate goods into highly fabricated intermediate goods (Grotewold, 1973). Locationally, this is true insofar that Germany was a regional hub of iron and steel production to it's neighbors during the reconstruction period (Ibid.). Yet, this increased production could not be met by domestic consumption and as such new markets needed to be created to sustain growth. Germany was restricted in expansion due to the currency realities of the day, most currencies were backed against the dollar and many of them were not freely convertible (Ibid.).

5 Karsten, Siegfried G.. “Eucken's 'social Market Economy' and Its Test in Post-war West Germany: The Economist as Social Philosopher Developed Ideas That Parallelled Progressive Thought in America”. The American Journal of Economics and Sociology 44.2 (1985): 169–183. Web. 6

1 DM = 10 Reichsmark

As such, they turned their attention inwards, focusing in re-establishing an intra-European trade network. Spearheaded by the United States, a push for European integration was on the way through the creation of Organization for European Economic Corporation (OEEC), to facilitate trade, and the European Payments Union (EPU) to deal with currency problems. With aid from the Marshall Plan and increased economic activity, by 1951, the German economy was already in a state of recovery (Ibid.). Entering into the European Economic Community (EEC) in 1957, Germany boosted trade competitiveness as a result of effectively lowering tariff rates below average of the norm of the time (Koopmann, 1998).

By nature of the economy's composition, Germany relied heavily on exports as a determinant of growth. Responsively, as global demand for specialized goods increased, investment and production increased as well to meet these new needs (Funk, 2012). Facing a growing European market, their increased competitiveness allowed Germany to rely on growing foreign trade as a major component of their economic success. The economic miracle experienced in the post-war period was reliant on the stabilization of currency, easing foreign trade, and the influx of refugee workers, reducing unemployment and boosting productivity (Ibid.).

Opening up to trade liberalization, Germany increased it's volume of exports between 1952 and 1968 by 466.2% [$2,576 million to $14,586 million]. Imports during the same time period increased by 309.9% [$2,477 million to $10.152 million] (Ibid.). While trading more, evidence suggests that Germany was still trading with a lot of the same partners, choosing the cheaper intra-European transaction costs over entering riskier (potentially costlier) markets. Re-armament (in response to Soviet presence) had an effect on the import share of war goods, decreasing their value from 60% to 22.7% between 1957 and 1969 (Payne, 2011). Coupled with the growth of exports experienced during the same time, the trade balance of the country greatly improved.

Modern Times

However, as a result of globalization and unification, an inflexible German economy was slow to catch up without reform. Considered the “Sick Man of Europe” for most of the 1990s and early 2000s, German economy was characterized by stagnant 1.2% per year on average growth between 1998 and 2005, a recession in 2003 and a rise in unemployment rates (See Figure 4) (Dustmann, Fitzenberger, Schönberg and Spitz-Oener, 2014). The integration of East Germany in the late part of the 20th century brought on massive unemployment and raised the financial burden (taxes rose, investment fell) on the West (Dornbusch, 1993). Retrospectively recognizing the problems which may lay ahead for the economy, and to address the inflexible nature of the economy, Germany decided it needed to reform and re-focus in order to turn around their poor performance over the previous decade and a half. Attributable in part to the Hartz reforms I-IV, characteristics of the labor market already in place, and its Mittelstand of mid-tier specialized firms, Germany was able to rise above it's European neighbors toward...