The German Turnaround: The reform story revisited, part II

(in cooperation with Sebastian Dullien)

Today, the German tabloid “Bild” ran a story that a number of top German employer federations have written a joint memorandum warning the government of rolling back even parts of the “Agenda 2010” reforms enacted by the Schröder government. According to them, the recent upswing in German can at least partly be credited to these reforms, much as Michael Burda has argued. Any change would thus endanger the recovery.

We have already written a post on Monday in which we question this wisdom, stating that such an interpretation of the origins of the German turnaround is not covered by developments into the German labour market.

However, we have not yet tackled an argument frequently brought forward by those seeing the Agenda reforms to be crucial for the German upswing: If it has not been the Agenda reform, why did the German stock prices hit their bottom in March 2003, only days before Gerhard Schröder’s Agenda 2010 speech in the German Bundestag and have increased by almost 250 percent since? (Michael Burda has made this argument repeatedly, both in his contribution to VOX EU as well as in his post on RGE Monitor.)

For the first question (why the stock prices staged their turnaround in March 2003), there is a simple explanation, as Sebastian’s colleague Thomas Fricke has pointed out in his column in FT Deutschland (those who read German might also want to take a look at FT Deutschland’s online debates on the origins of the upswing): The turnaround in the stock prices in March 2003 was a global event, not a idiosyncratic German one. From mid-2002 onwards, financial markets were quite weak due to growing uncertainty on whether the US would invade Iraq, whether Saddam Hussein would have chemical or nuclear weapons and whether there might be interruptions in the global oil supply. As soon as it became clear in March 2003 that the US-led invasion of Iraq was about to begin, markets globally turned around and started their increase since (figure 1 compares the German stock market in red, the US stock market in green and the French stockmarket in blue from early 2003 until the end of 2004).


So far for the timing. But what about the argument that German stock prices increased much more than prices in other countries? After all, the French stock prices only increased by a 120 percent since March 2003, while German stock prices soared by almost 250 perce nt (see figure 2 below – the red line is the German DAX 50 index, the blue line is the French CAC 40 index).


We would argue that you have to see the increase in German stock prices in the context of the above-average loss in German stock prices in the years before. When comparing stock indices across countries, you have to look at sector compositions and you have to check whether some of the sectors might have been harder hit by exogenous shocks than others. In the German DAX, the financial sector has a much higher weight than in the other continental European indices. The German banking system, however, was badly hit by the bursting of the New-Economy-Bubble. In the media bubble, German banks had quite freely lend to New Economy companies and they had an above-average share of non-performing loans in their balance sheets. In 2002 and 2003, there was even the debate about a possible fall of Germany into deflation and there was talk about a possible banking crisis. At the height of this scare, according to stock valuations, the German corporate sector was worth less than the tangible assets in their balance sheets even though German accounting standards allow for the easy formation of undisclosed assets and most German companies make ample use of this possibilities. These factors help explain why German stock prices fell much more than other European stock prices after 2001 and why they rose so much more strongly after 2003.

Against this argument, a look at the German stock price developments relative to those in France over the past 10 years is quite illustrative (figure 3 below): At a 10-year-horizon, stock prices increased almost exactly as much in Germany as they did in France. During this time, Germany introduced the Agenda 2010 reforms which supposedly have improved the profit outlook and the supply side of the economy significantly. France, on the other hand, over the same period did very little to please supply-side economists: The time span actually covers the time of the Jospin government in which the 35-hour-work-week was introduced which increased labour costs and which has repeatedly criticised of hurting competitiveness and growth.


Thus, if one really looks deeper into the development of stock prices, it is very hard to discern any Agenda effect there – just as it is difficult to see any Agenda effects in the details of the labour market.

Read next: How can one explain the German turnaround without referring to the Agenda-2010?

This post was co-posted at Eurozone Watch.

5 Responses to "The German Turnaround: The reform story revisited, part II"

  1. BJ   October 17, 2007 at 9:29 pm

    Could the increase in the profit share as a response to the labor market reforms also explain the DAX’s above average performance since 2003?

  2. David F. Milleker   October 18, 2007 at 12:03 am


    Thanks for this post. There is another point worth stressing when comparing stock market performance between Germany and France:

    The common quote for Dax30 is on a total return basis, while that for CAC40 is on a gross return basis. The difference is that Dax30 includes reinvested dividends while CAC40 does not. The really exceptional outperformace of Dax30 only appears if you do not adjust for the difference by either scaling back Dax30 to gross return or scaling CAC40 up to a total return basis.

    If you do that you find no significant outperformance on a gross return basis and a slightly better performance of Dax30 on a total return basis. the latter, of course, reflecting higher German profitability as a result of wage restraint.

    Unfortunately you’ve gone along with Burda’s flawed analysis with respect to using the indices

    Best regards

  3. Ulrich Fritsche   October 18, 2007 at 5:57 am

    Thank you David for pointing to this issue. It strengthens the argument. To BJ: The profit share increase is nothing new — in fact labor share falling for a decade. Wage moderation — as we argue in the first post might have helped over time to get rid off an possible overvaluation of the German Deutschmark when entering EMU. Maybe there was a trigger necessary to create the spill-over from an impressive increase in competitiveness accompanied by increased profitablity over the last decade to an investment boom going hand in hand with increasing stock valuation and falling unemployment. But the trigger was possibly a world factor, driving stocks upwards all over the globe — instead of minor reforms in legislation.

  4. Guest   October 18, 2007 at 11:56 am

    So how do you explain the sharp rise in equity prices in Germany? If it is not reforms what it is? Has the profit share in GDP increased in Germany and by how much?

  5. Ulrich Fritsche   October 20, 2007 at 3:42 am

    @ Guest: According to different metrics we get different estimates. However, one thing is clear: A accelerated fall in the wage share and a increased mark-up since 2001. See: