At the start of the last decade, German football was on its knees. Its national team limped feebly out of the European Championship in 2000, and the following year it suffered the indignity of being thrashed on home soil by England.
The rejuvenation of German football since the Munich humiliation of 2001 has been breathtaking. Bayern Munich is now regarded as the best club team in the world, while Germany itself is the bookmakers’ favourite to be Europe’s most successful representatives at this summer’s FIFA World Cup in Brazil.
As with football, so with the economy. At the end of the 1990s, with growth stalling and unemployment on the up, Germany was labelled as the sick man of Europe, which was an astonishingly wounding stigmatisation for the Wirtschaftswunder of the 1950s. Gerhard Schröder, whose chancellorship lasted from 1998 to 2005, responded with a decisive package of structural reforms that turned a cosseted, über-regulated and over-expensive workforce into Europe’s most competitive.
The legacy of Schröder’s Agenda 2010 programme is an economy that stands head and shoulders above its European competitors. Unemployment, for example, was in double-digits a little over a decade ago, with gloomy economists forecasting a jobless recovery. Today, it has dipped below 7% — a number that some European economies can only dream of.
Continued job creation supports the Ministry of Economy’s forecast that GDP will rise by 1.8% in 2014, which is more than four times 2013’s growth, rising to 2% in 2015. Although that is way above what is expected in most eurozone countries, private sector economists believe that even this may err on the side of conservatism. Stefan Bielmeier, chief economist at DZ Bank in Frankfurt, is projecting above-consensus growth of 2.3% in 2014.
His counterpart at Commerzbank in Frankfurt, Jörg Krämer, revised his forecast for GDP growth in early March from 1.7% to 2%. This upward revision, he says, is based principally on a persuasive combination of better than expected GDP figures for the last quarter of 2013, and the latest IFO business climate index and PMI indications, which also surprised on the upside.
Relaxed over Russia
It is notable that neither Bielmeier nor Krämer believe that their upbeat forecasts need to factor in the potential impact of sanctions against Russia, with Krämer arguing that Russia’s share in Germany’s overall trade is modest. “Russia is no longer a fast-growing country and it accounts for only about 3% of Germany’s exports,” he says. “By contrast, the US accounts for 8%.”
That may be. But Russia’s strategic importance as a trading partner to Germany should not be underestimated. It’s not just that there are reported to be some 6,000 German companies active in Russia today, many of them from the Mittelstand. More significant, as far as the broader German economy is concerned, is that about 40% of the country’s natural gas comes from Russia. With energy costs already having risen sharply since the German government’s hasty volte-face on nuclear power, in the aftermath of the Fukushima disaster, the last thing German industry needs today is sanctions blocking Russian exports to the EU.
Bielmeier says he is relaxed about the prospect of sanctions precisely because of the importance of Russian-EU trade, especially in energy, disruption to which would be extremely harmful to both sides. In any event, he says it is far too soon to jump to any conclusions about the possible fallout from the turmoil in Ukraine and Crimea.
In the meantime, Bielmeier argues that the German economy will continue to outperform the rest of its eurozone partners, for two reasons. The first is strengthening domestic demand, buttressed by rising wages and a declining savings rate underpinned by low interest rates. A number of recent surveys provide empirical evidence of the increasing confidence of the German consumer. In March, for example, the GfK Group’s consumer climate index hit a seven year high.
Domestic demand catching up
The second driver of Germany’s economic outperformance, says Bielmeier, will be the continued success of its exports, supported by an acceleration in the global recovery. The clearest indication of Germany’s exporting prowess is its current account surplus, which has risen to well over 7% and is likely to stay elevated over the foreseeable future. “Domestic demand may bring some more imports into the game, but this is a story for 2015,” says Bielmeier.
Others agree that domestic demand is likely to be an increasingly important component of sustained German growth. “Boom is probably too strong a word, but we are already seeing signs of improved domestic demand, with house prices strengthening and consumption rising,” says Dan McCormack, UK and European economist at Macquarie in London. “But the German consumer is a conservative creature and that psyche won’t be broken overnight.”
McCormack adds that more broadly, increased global confidence will support domestic investment in Germany. “In the last five years, corporates have been underspending massively, because credit has been tight and confidence low.” He says. “The corporate sector has plenty of catching up to do, and as they are leaders in high-end capital goods, German companies can be expected to benefit substantially from this trend of rising corporate capex spend over the next few years.”
Unsurprisingly, German policymakers are defensive about the politically sensitive issue of the country’s bloated current account surplus, insisting that it will decline gently as domestic demand kicks in. “Higher investments in equipment will — in view of their high import content of over 40% of GDP — also stimulate the level of German imports,” says the Ministry of Economy in its outlook for 2014. “Imports will rise faster than exports this year. This will reduce the German current account surplus.”
The government is also quick to point out that its current account surplus with other euro area countries has fallen by half in 2007, and that its surplus is now being generated predominantly by countries outside the eurozone, reflecting rising exports to emerging markets.
Regardless of its sources, Germany’s current account surplus inevitably leaves its economy vulnerable to external shocks. “In terms of the sustainability of growth, the biggest risk is a slowdown in demand in Germany’s major export markets, notably China and the EU,” says Mark Dowding, partner and co-head of investment grade at Bluebay Asset Management in London.
As Dowding says, while there is little if anything that Germany can do about what happens in China, it is strongly positioned to influence the European policy agenda. “We would argue that Berlin’s opposition to additional monetary stimulus in Europe probably does not serve Germany’s long term economic interests,” says Dowding. “If the periphery is unable to generate growth and risks moving into a deflationary phase, fears will resurface about debt sustainability in Europe, triggering renewed concerns about monetary union. In those circumstances, you could argue that it is in Germany’s interest to accept slightly higher inflation in return for long term stability in the eurozone.”
Payback time
Germany’s powerful economic recovery has brought its fair share of headaches for policymakers in Berlin, some of which will intensify over the coming few years. This is because for many Germans, it is payback time. Following the collective belt-tightening of recent years, Germans are asking for a little more pampering, which will roll back some of the reforms made under Schröder’s Agenda 2010.
This is why Commerzbank’s Krämer cautions against viewing the German economy through rose-tinted spectacles. “Just as it was wrong to call Germany the sick man of Europe 10 years ago, it is also inaccurate to regard Germany as Europe’s economic superpower today,” he says. “We need to be aware of the erosion of Germany’s price competitiveness that will start to become a more serious problem beginning in 2015.”
That competitiveness is under threat from a range of labour reforms, which will reduce the retirement age for many workers from 65 to 63. They will also phase in a statutory hourly minimum wage of €8.50, which Krämer says will have a far-reaching impact on Germany’s corporate sector. “The minimum wage will affect roughly 20% of the workforce,” he says. “We assume that in 2015 alone the phased-in introduction of the new minimum will lead to wages growth of 1.2% on top of an underlying growth rate of 3%.”
The good news is that this largesse need not come at the expense of Germany’s commitment to achieving a headline balanced budget in 2015. As Fitch explains in its most recent update, the cost of increased pensions and early retirement for some will be financed through social security funds and will not call for any new borrowing.
The bad news is that corporate confidence already seems to have been shaken by the reforms. Krämer points out that one recent survey found that 39% of German exporters have identified rising labour costs as the main obstacle to economic development.
Macquarie’s McCormack says he is relaxed about the outlook for inflation, for a number of reasons. “Spare capacity and increasing competition from emerging markets will help to reduce the unions’ bargaining power, and the increasingly rapid pace of technological innovation is another structural factor that will restrain inflationary pressures,” he says.
Anatoli Annenkov, senior European economist at Société Générale in London, is not so sure. He expects mounting pressure on wages to bring with it the threat of rising inflation, which remains anathema to a Bundesbank that is powerless to use monetary policy to counter upward pressure on prices. “Most countries in Europe are more worried about deflation than inflation at the moment, but it is reasonable to argue that interest rate levels today are below optimal levels for the German economy,” he says.
“I was surprised to see wage growth moderating from 3% to 2.5% in the second half of 2013,” he adds. “But given the tightness in labour market, we think there will be renewed pressure on wages, which may lead to higher inflation numbers in Germany. It would take many years for this to lead to Germany losing the added competitiveness it has gained in the last decade, but this may be an argument for Germany to be more careful on the fiscal side. Otherwise the risk in five years’ time is that it will have lost more competitiveness than it expected.”
This threat, says Annenkov, will coincide with another longer term challenge for the German economy, which is its disquieting demographic profile. Some forecasts suggest that as the population ages, some 200,000 workers will fall out of the labour force annually from 2016. That, says Annenkov, may mean that potential growth of around 1.5% is increasingly beyond Germany’s reach. That in turn means that the country will need to explore a range of initiatives — in areas such as immigration, for example — to underpin its longer term prosperity.
