Economic Clouds

The End of German Self-Confidence

Arbeitspause in Autowerkstatt
More time for coffee breaks in Germany?
  • Why it matters

    Why it matters

    With a string of weak data, the European Union’s biggest and strongest economy is looking vulnerable.

  • Facts

    Facts

    • German industrial production in August was down 4 percent. New industrial orders were down 6 percent.
    • The German economy contracted in the last quarter.
    • More than half of German exports go to European neighbors. Only 6 percent goes to China.
  • Audio

    Audio

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The prevailing narrative on the euro crisis goes like this: The recovery in southern European countries is progressing – slowly, but steadily. One reason is monetary policy, which is bringing relief to heavily indebted nations and giving their governments time to carry out necessary reforms. Another reason is Germany’s astounding economic power, which can carry along the continent’s feeble periphery.

But this is proving to be a fairy tale. First, there is no genuine recovery in most southern European countries. The two largest economies, Italy and France, are shrinking or stagnating. In most other nations things don’t look much better. Second, the supposed powerhouse at the center of Europe’s economy is itself losing strength.

For months now, almost all German economic data has been disappointing. Industrial production in August was down 4 percent. New industrial orders were down almost 6 percent.

Yes, these are only monthly figures. But they are alarming, especially as the downward trend has developed an ominous momentum over the course of the year. The first quarter was still strong. In the second, the economy contracted by 0.2 percent. Now a few economists no longer rule out the possibility that the economy will also shrink in the third quarter. Two quarters of negative growth in a row – that is called a “technical recession.”

Uncertainty is spreading in the German business community, not least because of geopolitical risks. The International Monetary Fund warned this week that conflict with Russia and war against the self-proclaimed Islamic State are weakening the world growth prospects.

This in turn dampens the mood of companies in Germany, which has just seen a fifth straight decline in the Ifo Index, a barometer of the German business climate. Firms are holding back from investing, and who can blame them? A sanctions spiral with Russia, a Russian gas boycott, or possible military escalation in Iraq – any of these could pull the rug out from under the best-laid business plans.

Germany’s solid government finances and the continuing strength of its labor market cannot hide the fact that Europe’s largest economy is vulnerable. It was always an illusion to believe Germany could detach itself from the rest of Europe. More than half of German exports go to its European neighbors. Only 6 percent goes to the much-hyped Chinese market. And let’s not forget that German economic performance is only slightly better than it was seven years ago, before the crisis. To be sure, Germany is in no longer the “sick man of Europe,” as was claimed shortly before the turn of the millennium. But it is far from being the universally acknowledged powerhouse of Europe.

The crucial question is: What can be done politically to overcome this period of weakness? It is not a matter of spending on large economic stimulus programs. And it is not a matter of abandoning the balanced budgets, which the German finance minister, Wolfgang Schäuble, has pursued as a top priority. At the most, the government could explore whatever room for maneuver it has to promote business investment, for example by allowing companies to write off machinery and other capital equipment more quickly.

It was always an illusion to believe Germany could detach itself from the rest of Europe.

But the German government could respond decisively in another way. Economics is 50 percent psychology, said Ludwig Erhard, the former chancellor who is considered the architect of West Germany’s post-war economic miracle. He was wrong: Now, 50 years later, one could argue that it is more than 50 percent.

What Germany requires more than ever is a sign of an upswing. The country needs structural reforms: more flexibility in labor markets, especially in the service sector; less bureaucracy; more money for education and investment, less for consumption.

Up to now, Chancellor Angela Merkel has done much to redistribute prosperity, but almost nothing to increase it. A minimum wage; retirement at age 63; pension eligibility for child-raising years. It can be debated whether these measures are justified in terms of pursuing a policy of fairer distribution of wealth. But it is undeniable that they do nothing to improve the investment climate.

The chancellor’s claim to exercise decisive influence on policy in Europe is based primarily on the relative strength of the German economy. But that strength is no longer a given. The reform dividends of her predecessor, Gerhard Schröder, have been used up.  Look no further than Germany’s increasingly weak economic data for proof. 

 

Jens Münchrath heads Handelsblatt’s economics and monetary policy desk. To contact the author: muenchrath@handeslblatt.com.

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