Fra Commerzbank:
For some, Germany is still the strong man of Europe. For others, the “Made in Germany” brand has been tainted by the car emissions scandal. In this note we assess where Germany really stands. Fuelled by low interest rates, the German economy could post reasonable growth rates for a few years more – like the French economy ten years ago.
But behind the glistening facade, many advantages of the German economy are being eroded on a broad front. Germany will not rise out of the next recession like the phoenix from the ashes. The pressure on the ECB will remain high in the coming years and the euro will likely lose rather than gain value. Fewer tailwinds from emerging markets Germany’s economic advantages are eroding on a broad front. For some time, growth in the emerging countries has been slowing.
This matters to Germany as they currently buy 40% of German exports. Tailwinds from the emerging countries are likely to diminish further. With US interest rates set to rise, a decade of easy money is also coming to end in the emerging markets. Businesses in EM economies are vulnerable because they have significantly increased their debt in recent years; in China for example, corporate debt has reached 161% of GDP.
The growth gap between the emerging and the developed countries should narrow further and in the foreseeable future will not return to the 4 to 6 percentage points range recorded between 2003 and 2010. Competitiveness within euro zone is eroding Another pillar of Germany‘s success in the past few years – its high degree of price competitiveness – is also starting to wobble. Since 2011, unit labour costs in Germany have risen at a sharper pace than the average for the other euro zone countries (Chart 1).
Germany has already lost almost a third of the competitive advantage it had built up in the first ten years following the inception of Monetary Union. This erosion of competitiveness within the euro zone is already having an effect. Since 2011, Germany has not performed better on global export markets than the other major euro zone countries (Chart 2). In the longer run, the stronger rise in unit labour costs will also put pressure on German corporate profit margins and curb their investment.
This is only being concealed at the moment by the recent depreciation of the euro, which has allowed sales prices to climb faster and therefore kept profit margins relatively stable.
Decaying infrastructure The competitiveness of German companies is also in danger because of low investment in transport infrastructure.1 In the past ten years, the rise in investment expenditure has not kept pace with the rise in road construction costs and real investment has hence fallen by around 20%. With private and state investment in infrastructure at around 0.6% of GDP, Germany is well behind in comparison with other industrial countries.
Recently announced additional investment is unlikely to be enough to preserve the current state of the existing transport infrastructure, never mind create necessary additional capacity. This is a growing problem for businesses in Germany. Almost a quarter of the companies participating in the survey by the “Institut der deutschen Wirtschaft” stated that their business operations were “significantly hampered” by poor roads and bridges.
Demographic problems despite mass immigration A significant damper for the German economy in the years ahead will also be the fall in population and the aging of society. Without immigration, the number of people aged between 16 and 64 will drop by over 400,000 or 0.8% per year in the next five years. Germany is experiencing huge immigration at present. This year, over a million more people are set to enter the country than leave, compared to a net immigration of 500,000 last year.
However, it is doubtful whether immigration can fully compensate for the economic consequences of the demographic trend. For one thing, Germany would need more than half a million people a year up to 2020 to keep the labour force stable – and it is questionable whether voters would accept immigration of this scale in the longer term. Secondly, it is unclear whether immigrants will be sufficiently integrated into the labour market and achieve the same productivity as those leaving the labour market.
All in all, immigration will, at most, ease Germany’s demographic problems in the long term but not fully compensate for the demographic-related lack of skilled workers. Consequently, the potential growth of the German economy is more likely to be below 1%, rather than above, on average in the coming five years. And this is based on the optimistic assumption that labour productivity will increase by more than 1% per year, after rising by only 0.8% a year on average over the past ten years.
Economic policy: Instead of promoting growth, more redistribution Precisely against the backdrop of a declining labour force, further structural reforms are an urgent necessity. However, since the decision to raise the retirement age to 67 in early 2007 there have been no additional measures that might cushion the effects of this demographic trend. In actual fact, Chancellor Merkel’s government even offered many employees the possibility to retire early at the age of 63.
Furthermore, the newly introduced minimum wage is also likely to reduce the number of profitably employable workers. Moreover, like other additional social benefits, this will make Germany a more expensive location, either directly through higher social security contributions or in the medium-term through higher taxes. Not much has happened in other areas either in recent years.
According to the World Bank’s Ease-of-Doing-Business Index, Germany is the one country whose location quality has fallen the most compared to all other EU countries since the start of the sovereign debt crisis (Chart 3, page 4).2 Germany has rested on its laurels, while other EU countries have constantly worked to improve their attractiveness for businesses. The notion of Germany as a model for reform has not applied for a long time.
Zero-interest rates gloss over problems All these factors indicate that the advantages enjoyed by Germany’s economy have been eroding on a broad front for quite a while. Even so, the German economy could show reasonable growth for a few years yet. Consumption in Germany should continue to rise strongly, after climbing by 2% this year. Employment and wages are increasing considerably, which, with an inflation rate close to zero, has allowed a sharp rise in real income. The strong domestic economy is creating more jobs again and this is driving consumption.
This wheel can continue to 1 See also “Potholes in Germany”, Economic Insight, 7 September 2015 2 See “Doing Business – The German eagle is losing its strength”; Week in Focus, 31 October 2014. 4 2 October 2015 Economic Research | Week in Focus turn for some years yet, provided higher ECB key interest rates do not halt the process, which we do not expect.
Ten years ago, France was a good example of how a strong consumption economy can gloss over the competitive weakness of an economy for years.3 The gradual introduction of the 35- hour week from January 2000 significantly increased French labour costs – especially as the unions enforced strong wage increases. French businesses responded to the lower competitiveness by barely increasing investment for six straight years after the stock market bubble burst in 2000 (Chart 4).
The fact that France’s GDP still expanded quite strongly until the outbreak of the financial market turmoil in 2007 was due to the strength of private consumption, which rose by over 2% per year on average during this period. French competitiveness problems only became apparent when the economy showed a slow pace of recovery following the recession in 2008/9.
The situation could be similar in Germany, which will not rise from the next recession like a phoenix from the ashes as it did in the years after 2009, especially as interest rates which are too low for Germany carry the risk of house price bubbles in the years to come. ECB remains trapped, more euro weakness While the ECB is tackling the consequences of the bursting debt bubble in the periphery countries via loose monetary policy, this policy is encouraging undesirable trends in a still strongly expanding Germany, which carry within themselves the seeds for the next crisis. The pressure on the central bank remains high to permanently follow a loose monetary policy, which will allow the euro to depreciate rather than appreciate in the longer term.
