Lurking Problems

Germany’s Boom Under Threat

Germany logo superman Source Picture Press imago Montage 45441492
Germany is currently Europe's strong man.
  • Why it matters

    Why it matters

    Germany current economic boom is endangered by long term threats, such as a low birth rate, reform fatigue and wealth inequality.

  • Facts

    Facts

    • German unemployment in May fell to its lowest level since the post-unification boom in 1991.
    • The German economy could grow by 2.5 percent this year, according to the Kiel Economics research institute.
    • Germany has the lowest birth rate in the world, which poses a major obstacle to its long-term growth outlook.
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    Audio

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These are tough times for the world economy. The Greek debt crisis has Europe on tenterhooks, China is cooling off and even U.S. growth slumped in the first three months of this year.

Only Germany, Europe’s largest and the world’s fourth biggest economy, keeps on expanding. Its jobless total fell to 2.7 million in May, the lowest level since 1991, when Germany was on a high after unification.

At the time, confidence abounded that the unified economy would be able to keep up the boom that West German industry had been enjoying. Years of disappointment followed, and consistent anaemic growth combined with runaway welfare costs earned Germany the title of sick man of Europe in the early 2000s.

Reforms and cutbacks followed, and things look very different today. Germany’s current economic expansion is regarded as robust. Like a pacemaker in a marathon, the Germans have consistently been running ahead of their European partners. In the last five years, German GDP growth has outpaced the euro-zone average by more than a full percentage point.

“People used to be too quick to say that German industry is often only strong in niche areas, but today many of these niches have turned into world markets.”

Michael Grömling, Senior economist, Cologne Institute for Economic Research

To be sure, German first-quarter growth was a disappointing 0.3 percent, but economists nonetheless expect another good year.

Carsten-Patrick Meier of the Kiel Economics research institute believes Germany’s economy could even achieve 2.5 percent, up from 1.6 percent in 2014. The optimism is founded on the country’s industrial sector.

“People used to be too quick to say that German industry is often only strong in niche areas,” said Michael Grömling, senior economist at the Cologne Institute for Economic Research. “But today many of these niches have turned into world markets.”

No other nation apart from the United States has been as good at combining the Internet with the industrial sector, he said.

Germany’s export industry faces risks from a decline in demand in all the major emerging economies apart from India. But that’s being offset by growth, at last, in the euro zone.

Growth may could continue the next few years. The International Monetary Fund expects German economic growth to be around 1.3 percent annually by 2020.

A number of strengths underpin Germany’s current position, but they are threatened by other, long-term problems.

 

Digital industry made in Germany. Source: DPA
Digital industry made in Germany. Source: DPA

 

Looking at the positives first: Products made in Germany are in demand worldwide.

At the end of the 1990s, students were being taught that the world was on the brink of a gigantic shift from industry to services. Producing goods in factories was regarded as an outmoded business model. But then came the global financial and economic crisis, and suddenly all the theories were cast aside.

Germany, which had defiantly clung to its manufacturing sector, recovered from the recession better than all the other big economies. It’s become clear that an economy can’t succeed without a strong industrial core because a large part of the much-vaunted service economy is directly or indirectly connected to industry.

Without the big factories, many of the IT consultants, recruitment agencies, security and cleaning firms and financial service providers wouldn’t have any customers. Industrial firms like to complain about Germany’s high wage and energy costs, but these high costs force them to become more efficient. That helped Germany to lead the way in optimizing manufacturing.

German industry accounts for almost a third of the economy, well ahead of Japan, the United States, the United Kingdom and France.

Germany will be in surplus in 2015 for the fourth year in a row. The government has enough money in its coffers to make necessary investments.

A second positive factor is Germany’s robust job market, which is keeping domestic demand strong.

“Even though growth has weakened slightly recently, the labor market continues to develop favorably,” said Frank-Jürgen Weise, the head of the German Federal Employment Agency, which calculates jobless statistics, finds work for unemployment people and pays out benefits.

Adjusted for calendar effects, there were 6,000 fewer people unemployed in May than in April, and 55,000 fewer than at the start of the year. Seasonally-adjusted unemployment at just under 2.8 million is at its lowest level since 1992 when the current calculation method was adopted.

With employment at record levels, people’s bank accounts are brimming. Employers paid €1.2 trillion, or $1.34 trillion, in gross wages and salaries in 2014, almost four percent more than in 2013, 20 percent up from recession-hit 2009 and almost a third more than in 2005, when Germany was suffering from mass unemployment.

As a result, consumer demand is rising. The consumer climate index calculated by market research company GfK is higher than at any time since just before the 9/11 terror attacks.

And there’s no end in sight to the job miracle. Companies in many parts of Germany are desperately seeking skilled workers. The number of vacancies is at a record, but many applicants lack the required qualifications.

A third strength of Germany is its budget surplus, which gives room for maneuver. Germany will be in surplus in 2015 for the fourth year in a row. The government has enough money in its coffers to make necessary investments.

It has three people to thank for this: the current finance minister, Wolfgang Schäuble, former German Chancellor Gerhard Schröder and the European Central Bank president, Mario Draghi.

Mr. Schäuble’s trademark is budget consolidation and he has steadfastly opposed any major spending programs. Mr Schröder’s “Agenda 2010” welfare cuts and labor market reforms implemented in 2003 and 2004 are widely regarded as having laid the foundations for Germany’s job miracle. The measures relieved the government budget by lowering unemployment benefit payouts and boosting tax revenues. In 2014, the state collected almost €1.3 trillion in taxes, an average of €16,000 per inhabitant.

And then came Mr. Draghi, whose policy of keeping interest euro zone rates low is due to save Mr. Schäuble some €20 billion in interest payments this year, according to an estimate by the Kiel Institute for the World Economy.

 

old elderly people couple hand in hand Source DPA 37571589
An ageing population and a low birth rate are are expected to hurt economic growth. Source: DPA

 

A number of weaknesses lurk in the form of demographic change and reform fatigue, whichcould off-set the country’s strengths and hurt growth.

First, Germany will be hit harder by demographic change than most other economies, and policymakers have yet to come up with a convincing long-term strategy to tackle it.

In 1964, 1.357 million babies were born in Germany. It’s only half as many now. According to a study by the Hamburg Institute of International Economics, Germany’s birth rate in the last five years averaged 8.3 children per 1,000 inhabitants. That’s even less than Japan, which previously had the lowest birth rate.

Among European Union countries only Portugal and Italy are almost as bad with rates of 8.9 and 9.2 respectively. Other major E.U. countries have significantly higher birth rates. France and the United Kingdom have rates of 12.7 births per 1,000 citizens.

Germany’s declining population is the biggest long-term obstacle to growth. Some economists attribute the higher growth potential in industrial states like the United States and Britain solely to the higher population growth in those countries.

The London-based Centre for Economics and Business Research expects that Britain will oust Germany as Europe’s biggest economy by 2030.

Apart from Belgium and the United States, no other country has implemented so few reform proposals made by the OECD in the last eight years.

A second weakness is Germany’s reform fatigue. Despite its impressive growth, Germany has plenty of areas that need reform.

For example, founding a company here is unnecessarily complicated, according to the World Bank’s “Ease of Doing Business” ranking. It’s easier to set up a business in more than 100 other countries.

The service sector in particular is still quite over-regulated, a study by the Organisation for Economic Co-operation and Development (OECD) showed. Germany’s higher education system is also losing ground. Two years ago, economists at the Davos World Economic Forum still ranked it as the fifth-best in the world. Since then it’s slipped to 16th place. The transport infrastructure has fallen from third to seventh-best as a result of years of spending restraint.

An analysis by the OECD shows the extent to which Germany has been resting on its laurels: Apart from Belgium and the United States, no other country has implemented so few reform proposals made by the OECD in the last eight years.

A third problems it the growing gap between rich and poor regions. State development bank KfW estimates that German local authorities have amassed an infrastructure investment shortfall totalling €132 billion. Given that they only invested €23 billion in 2014, the cities and municipalities need to double the volume for at least five years to tackle all the necessary bridge, road and building repairs.

The lack of spending may seem surprising given that the municipalities have been consistently chalking up budget surpluses in the last four years. There shouldn’t be a shortage of money.

The problem is that the money is distributed extremely unevenly. Every third municipality is pessimistic about its past and its future finances. They’re in a downward spiral.

Due to weak tax revenues they’ve opted to save money by not investing in infrastructure. This will only create more problems in the long run. The weak municipalities will fall ever further behind, and the inequality will rise.

 

Hans Christian Müller-Dröge is an editor for Handelsblatt, covering economics and monetary policy. Axel Schrinner writes about tax and finance policy for Handelsblatt. To contact the authors. h.mueller@handelsblatt.com and schrinner@handelsblatt.com

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