Published: May 02, 2012
While hard hit by the global recession, the German economy recovered strongly during 2009. With GDP growth of 3.7% in 2010 and 3.0% in 2011, respectively, Germany recorded not only the highest growth rates among the G7 countries, but was also one of the top performers among all industrialised economies. This stellar performance can be attributed to several factors. Firstly, Germany benefited from labour market reforms – in combination with wage restraint and increased flexibility in industrial relations – implemented during the last 10 years. Secondly, Germany pursued a policy of fiscal consolidation targeting the social security system in particular. But thirdly, and above all, the German corporate sector assumed an active role in the new wave of globalisation, which combined the innovative power of corporate Germany with the cost-saving potential of global value-creation chains. This helped German companies to take advantage of the increasing demand from emerging markets, while at the same time fending off increasing competition from those regions.
Given that 40% of German exports go into EMU and about 60% into the EU, the consolidation measures implemented as a consequence of the European government debt crisis, however, have left their imprint. The negative impulses were initially transmitted via the confidence channel, as evidenced by the sharp drop in confidence surveys such as the Ifo index or the PMI in the second half of last year. But recently, the negative demand effects have become more apparent. Take, for example, the 11% year-on-year decline in orders from EMU countries in January/February. Sluggish external demand is not confined to the peripheral problem countries, which account for about only 10% of German exports and imports. In the whole of EMU ex-Germany the structural deficit – measuring the discretionary fiscal policy impulse – will shrink by 1.9% of GDP after falling 1.2% in 2011, while GDP in EMU ex-Germany will decline by 0.5% in 2012.
There is a general assumption that the required rebalancing of the peripheral countries’ current accounts, read ’elimination of the deficits’, which stood at a combined EUR 121bn in 2011 (Italy, Spain, Portugal and Greece), will be mirrored in a 1-to-1 shrinkage of the German current account surplus (EUR 148bn in 2011). However, this assumption is much too mechanistic. Our analysis shows that, while bilateral current account deficits are indeed narrowing mainly because of lower import demand in the problem countries, Germany has so far been able to partly compensate with higher exports elsewhere. We therefore expect the German current account surplus to shrink relatively modestly, from 5.7% of GDP in 2011 to 4.9% in 2012.
Given the limited direct trade exposure of Germany to the problem countries, requests that Germany should boost domestic demand in order to support the adjustment in the peripheral countries are not very convincing. In an analysis, Germany’s Bundesbank (the country’s central bank) showed that the impact of German domestic demand on the peripheral countries’ current accounts is very small.
Taking a more holistic, rather than a purely bilateral perspective also eases some of the concerns that in the EMU surplus countries – Germany, to be more specific – inflation has to increase substantially in order to help erode the deficit countries’ competitive disadvantage via internal appreciation in Germany. Here again, the intra-EMU unit labour cost differential vis-à-vis Germany accumulated since 2000 and giving a range between 25% and 35% exaggerates the actual loss in peripheral countries’ competitiveness, which is more appropriately measured by the change in the specific countries’ real effective exchange rates. These have risen by between 10% (Italy, Portugal) and some 20% (Greece, Ireland). This metric shows not only a smaller necessary adjustment, but also indicates that the adjustment will have to take place vis-à-vis all the important trading partners and not just with regard to Germany.[[[PAGE]]]
Concerns that German inflation might shift into higher gear are also fanned by the currently very loose stance of European Central Bank (ECB) policy in combination with the stellar labour market performance. Indeed, after a 1.3% increase last year, employment might expand again by almost 1% in 2012. The unemployment rate has been on a declining path since 2009 (annual average of 8.1%) and will probably average at around 6.75% this year, which is clearly below any available estimate for the non-accelerating inflation rate of unemployment (NAIRU), the level of unemployment which will, if undercut by the actual unemployment rate, trigger a rise in inflation. However, NAIRU estimates usually fail to take into account recent structural changes. In the case of Germany, labour market reforms as well as changes in industrial relations should have pushed this threshold quite a bit lower. In addition, capacity utilisation has been falling to stand at 84.2% in Q1, not much above its long-term average of 83.5%. Wage settlements so far this year have been at around 3% (annual basis). The upcoming rounds in the metal and chemical sectors might yield settlements between 3.5% to 4%, which should not result – given the above-average productivity growth in these sectors – in a substantial increase in unit labour costs. In addition, despite the strong employment gains and relatively healthy consumer confidence, actual spending has remained subdued so far. Retail sales – although notoriously volatile and prone to revisions – declined in January and February. Car sales were up in Q1 by a meagre 1% year-on-year. All this supports our cautious private consumption forecast of around 0.5% for 2012, but also means that, except for energy, the potential to pass on higher costs to consumers should be relatively limited. Still, with real short-term rates strongly negative and even real 10-year yields slightly negative, ECB policy is very loose for Germany. But to some extent, this is offset by very soft global export growth, which is currently running at around 2.5% year-on-year. Given Germany’s large export exposure, this puts a lid on investment spending and hence credit growth. In January/February, German bank lending to the private sector was up just 1% year-on-year, indicating that the ECB’s expansionary policy has at least so far not reached the real economy. We expect the inflation rate to average about 2% in the current year, falling towards 1.5% in 2013.
While fiscal policy in the rest of EMU has become a delicate balancing act, Germany’s Ministry of Finance is enjoying major tailwinds from the robust economy, in particular the strong labour market. The budget deficit fell to 1% in 2011 and should remain in that range in the current year. Nevertheless, Germany’s debt-to-GDP ratio reached 81.2% in 2011. This, however, was driven by the government support for bad banks (+11.5 pp) and European support measures (0.8 pp). Given the generally favourable situation, we expect fiscal policy to be more or less neutral in 2012.
Although our forecast of 0.5% GDP growth for this year, rising to 1% in 2013, does not look very impressive at first glance, it is actually remarkable when compared to the rest of Europe and given Germany’s potential growth rate of around 1.25%. Furthermore, it has become more evident that Germany’s performance in the past decade, which looked pretty dismal at the time when compared to the credit-driven booms in the peripheral economies, was mainly the result of reforms which have really started to pay off in recent years.
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