Can Germany fix its economy?

Can Germany fix its economy?

Gloom has replaced relief as the overriding sentiment about Germany among economists. Experts are warning of another downturn in Europe’s largest economy, despite it emerging from last winter’s energy crisis in better shape than initially feared.

The longstanding structural problems, from an ageing population to crumbling infrastructure, have been aggravated by the war in Ukraine, rising interest rates and faltering global trade.

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The IMF and OECD both expect Germany to be the worst-performing leading economy in the world this year. The country’s top-selling tabloid newspaper Bild Zeitung recently raised the alarm, declaring: “Help, our economy is crashing” as it appealed for chancellor Olaf Scholz to take action.

Why is Germany doing so badly?

The world’s fourth-largest economy stagnated in the three months to June, after shrinking in the previous two quarters — underperforming all its large rivals. 

A big reason is the global downturn in manufacturing, which hits Germany disproportionately hard as the sector contributes a fifth of its overall output — a similar level to Japan, but almost double that of the US, France and the UK. 

Oliver Holtemöller, head of macroeconomics at the Halle Institute for Economic Research, said the higher energy prices and trade tensions triggered by Russia’s full-scale invasion have had an acute impact on the sector. The higher cost of capital and shortage of skilled workers has also put it “under severe pressure”, he added.

German gas and electricity prices have retreated since last year. But they remain higher than in many non-European countries and production in Germany’s energy-intensive industrial sectors, such as chemicals, glass and paper, is down 17 per cent since the start of last year, suggesting permanent losses.

“The outlook for German industry is bleak,” said Franziska Palmas, senior economist at consultants Capital Economics.

Adding to the country’s worries, its traditional strength in carmaking is under threat, as its big brands are losing market share to cheaper Chinese rivals in the fast-growing electric vehicle sector. “The country’s major export goods — cars — are increasingly contested,” said Martin Wolburg, senior economist at Generali Investments Europe.

Analysts surveyed this month by Consensus Economics forecast German gross domestic product will shrink 0.35 per cent this year — a reversal from the slight growth they predicted three months ago. They also cut their 2024 growth forecast to 0.86 per cent, down from the 1.4 per cent they expected at the start of the year.

How long has it been underperforming?

Germany rebounded faster from the 2008 financial crisis than the rest of the eurozone, as global trade grew and southern members of the bloc grappled with banking and sovereign debt crises.

But the leader has since become the laggard. German GDP only snuck above pre-pandemic levels in June, while the eurozone was 2.6 per cent above that level.

“If you take the coronavirus crisis out, the underperformance started in 2017, so the structural issues have been there for a while now,” said Jörg Krämer, chief economist at German lender Commerzbank.

The country’s competitiveness has been steadily eroded by rising labour costs, high taxes, stifling bureaucracy and lack of digitisation in public services, experts said. This is highlighted by Germany’s slide down the IMD business school’s competitiveness rankings to 22nd out of 64 major countries — from being in the top 10 a decade ago.

“The advantage Germany built in the first 10 years of the euro has largely eroded as German unit labour costs rose faster than in the rest of the euro area and labour costs in Germany’s eastern European supply chains have converged with the west,” said Christian Schulz, deputy chief European economist at US bank Citi.

The ZEW Institute recently branded Germany “a high-tax country for investment”, pointing out its effective tax rate on company profits of 28.8 per cent was well above the EU average of 18.8 per cent last year. Source

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