Germany: Recession hits the EU’s “steam engine” – What the figures show –

With … Teutonic understatement, German Economy Minister Robert Habeck noted on October 9 that economic conditions for Germany are not “satisfactory”. His intervention was made immediately after the revision of the official forecasts for growth in the current year, which fell from 0.3% to a recession of 0.2%.

It is noted that it was preceded by a decrease in production by 0.3% last year, which means that Germany is facing its first two-year recession in more than two decades, as highlighted in an analysis by the Economist.

In fact, Europe’s largest economy had barely moved forward after Covid-19 hit, lagging behind the rest of the rich world (see chart 1). The European Central Bank’s Isabel Schnabel noted that growth in the euro zone excluding Germany is “extremely resilient” from 2021 and faster than that of many other major economies. But talking about the eurozone economy without Germany is like talking about the US economy without California and Texas. The country, once a driver of European growth, has become a burden on the EU.

It’s hard to imagine a worse set of conditions for the export- and manufacturing-heavy German economy than it has faced since 2021. Rising energy prices followed Russia’s invasion of Ukraine. Now China’s excess industrial capacity is wreaking havoc abroad. As comforting as it is to blame external factors for this economic weakness, Germany’s problems run deeper, many of them endemic. Moreover, a fractured tripartite government coalition prevents the formulation of a unified policy response.

Industrial production has struggled in recent years. Energy-intensive industries such as chemicals, metallurgy and papermaking have been particularly hard hit (see figure 2).

These sectors account for just 16% of German industrial production, but consume nearly 80% of industrial energy. Many businesses have responded to higher energy costs by shutting down production.

Changing global demand patterns are a bigger problem for most businesses. As Pictet Wealth Management noted, Germany’s economic relationship with China has changed. In the 2010s, the two countries’ growth was complementary: Germany sold cars, chemicals and machinery to China and in turn bought consumer goods and intermediate inputs such as batteries and electronic components. China is now able to produce for itself much of what it once imported and, in some cases, has become a serious competitor for export markets, particularly in Germany’s old classic domain of dominance, the automobile.

However, the gloom over German industry may be overstated, as the Economist points out.

The good news for Germany and its economy

Although manufacturing output in Germany has declined since 2020, its gross value added is remarkably stable. Manufacturing companies, in many cases, were able to shift to producing higher value products even as they lost market share. And last year, as the overall economy contracted, trade continued to contribute to growth, something that looks set to repeat this year.

Higher real household incomes, as inflation eases, have been slow to lead to greater demand, but will eventually show up in consumer spending. The worst of the industry’s energy squeeze is also a thing of the past. Most observers expect growth to pick up next year. The government has forecast growth of 1.1% in 2025 and 1.6% in 2026, based on the assumption that private consumption will start to recover. In some scepticism, ministers speculate that this will happen in part because of their own pro-growth policies.

But a delayed rise would not mean an escape from long-term structural problems. In fact, the economic weakness seen in Germany predates recent geopolitical and economic shocks. As Ms. Schnabel noted this month, German GDP at the end of 2021 was just 1% above its level four years ago, compared with 5% growth in the euro zone – excluding Germany – and more than 10% in America.

German success in the 2010s reflected the country’s competitive advantage over the rest of Europe. At the turn of the century, Germany was struggling with the aftermath of reunification. Its price level was higher than in the rest of single currency Europe (see chart 3).

Then, in the early 2000s, the Hartz reforms, which included sweeping labor market liberalization, put a cap on costs by weakening workers’ bargaining power. At the same time, rapid growth fueled by the debt boom in southern Europe has pushed the price level higher in the euro area as a whole.

The period after the 2010 debt crisis

Over time, however, this competitive advantage has been eroded. Following the sovereign debt crisis of the early 2010s, regional European economies embarked on their own structural reforms. Since 2015, after a decade of moderation, German wage costs have started to rise at a faster pace. By 2019 the price gap between Germany and the rest of the euro area had narrowed. The energy crisis, however, widened the gap again because Germany was more dependent on Russian gas than its neighbors. For the first time in more than two decades, Germany has no cost advantage over its eurozone peers.

As Germany deals with this loss of competitiveness, it must also deal with demographic changes. In recent years the country’s aging population has been balanced by high levels of immigration. But immigrants no longer arrive in huge numbers, leaving companies short of workers. Overall, the IMF expects Germany’s working-age population to shrink by 0.5% a year for the next five years, the steepest decline of any major economy.

IMF officials have warned that if productivity does not improve sharply, German economic growth is likely to settle at 0.7% a year, about half the pre-pandemic level. More government spending could provide a boost, but ministers are constrained by self-imposed fiscal rules. Annual net public investment has fallen from around 1% of GDP in the early 1990s to zero. Although criticism of the so-called debt “cutter”, which limits the federal structural deficit to just 0.35% of GDP annually, has become more frequent, few observers expect any change before next year’s federal election.

Germany’s recession is painful both for the Germans themselves and for the wider eurozone. An economic recovery over time, driven by lower inflation and lower energy costs, will not alleviate the structural problems. Germany’s economy was showing signs of strain long before the pandemic hit, Russia invaded Ukraine and China started pouring money into struggling industries. It will continue to show signs of strain for some time to come…

SOURCE: ot.gr