Moribund Germany faces years of stagnation
Engine of the eurozone’s economy is now beset by problems but you would be wrong to write them off
We all know that the UK economy is in a pickle. Having said that, there are some signs that things are looking a little bit better, with inflation falling fast and interest rates set to be reduced in the summer.
While we obsessed about our many shortcomings, less attention was paid to what is happening to the biggest economy in Europe, namely Germany.
Despite last week’s rise in the influential German Ifo survey, it looks as though GDP will contract this quarter, meaning that Germany will be in technical recession. And the future prospects do not look good. Whatever happened to the German economy?
German economic weakness is nothing new. Of course, all countries in the developed world suffered during the Covid period and have had difficulties in recovering since.
Yet German growth stalled in 2017, three years before the pandemic, while industrial production has been in a pretty steep decline ever since.
From the third quarter of 2017 to the third quarter of 2023, the German economy has grown by only slightly more than 1pc, compared with 4pc for France and Italy, over 6pc for Spain, and, despite Brexit, 4.6pc for the UK.
Some of the causes of this German economic weakness could turn out to be temporary. It suffered seriously from the gas price shock, which had a dramatic effect on both consumers and its heavily energy dependent manufacturing sector.
Germany has also been hard hit by the rise in eurozone interest rates, with its construction industry seriously weak. There will be some relief on this soon, however, as eurozone interest rates start to fall.
But Germany has also suffered from a slowdown among its main trading partners, especially China. There doesn’t seem to be much hope of imminent relief on that front.
German price competitiveness has been falling back recently as wage increases have picked up. Meanwhile, although its export prowess continues, the years when it was able to benefit from a boom in China, which then had a high propensity to import exactly the heavy engineering goods, both capital and consumer, in which Germany specialises, are well and truly over.
Over and above this, there has been a self-inflicted wound – namely German fiscal policy.
Even though, at 64pc last year, the ratio of government debt to GDP is extremely low in comparison with most other countries, by law the German government is obliged to aim at something close to a balanced budget.
The result is that there has been considerable fiscal tightening.
Moreover, as weak economic growth worsens the overall position, the German government will be obliged to do more fiscal tightening. So, even if the other factors mentioned above prove to be temporary, the growth of aggregate demand in Germany is likely to remain weak.
One possible way out would involve a major rebalancing of the economy. Germany still runs a huge current account surplus of about 7pc of GDP.
This needs to be reduced not by weakening exports but rather by stronger growth in consumer spending. Yet German consumers remain as cautious as ever and continue to squirrel away large amounts of their income.
In any case, weak aggregate demand is not the real problem. There are some more deep-seated factors which give serious cause for concern. For a start, the working age population is falling.
In the past, this was mitigated by a substantial drop in unemployment and an increase in the participation rate of women. With unemployment now standing at about 3pc, there isn’t much scope for this to go any further. Female labour force participation is probably also at about its peak.
Of course, as with other European countries including ourselves, it would be possible to overcome this issue by importing workers from abroad. But politically this does not look palatable, especially given the rise of the Right-wing AFD party. Demographics are not everything and it is possible to imagine a surge in productivity growth making up for a contraction of the workforce. But this doesn’t look likely either.
In this country we are used to admiring the structure of the German economy with its wonderful success in export markets and heavy concentration on manufacturing, which still accounts for about 20pc of GDP compared with only 9pc in Britain.
Its prowess was emphasised in the years immediately after the formation of the euro in 1999 when it was widely feared that Germany might have a competitiveness problem against the other euro members.
In the event, exactly the opposite transpired. Germany engaged in an internal devaluation with domestic costs driven down by widespread wage restraint. The result was an enormous trade surplus with Germany’s fellow euro members and the rest of the world.
For all the wonders of the German corporate sector, Germany is far from being the most dynamic or entrepreneurial of economies. It is weak in all matters digital and it has only a small artificial intelligence industry. Moreover, as the benefits of AI wash over all economies in the years to come, it seems likely that Germany will not be one of those best placed to take advantage.
It would be wrong to write Germany off. It has too many underlying strengths to justify such a verdict. And we have been here before.
After reunification, Germany was widely derided as the sick man of Europe. Yet it soon bounced back. A repeat of such a resurgence, though, does not seem at all likely.
This has consequences, both economic and political. I reckon that over the rest of this decade, German economic growth is likely to be not much more than about 0.5pc per annum. Weak economic growth in Germany will make things more difficult for its trading partners.
More importantly, on the political front, its underlying economic difficulties are likely to make Germany reluctant to take a leadership role in Europe or to support closer integration of the European Union.
‘Consumers remain as cautious as ever and continue to squirrel away large amounts of income’