According to the recent annual report of the German Council of Economic Experts, the global economy has slowed significantly, and Germany is also facing headwinds. The two main sectors of the German economy remain cyclically divergent: the manufacturing sector is in recession, but the service sector is robust. New orders in manufacturing indicate that the economy will not rebound quickly. And despite the low interest rate environment, political and economic risks have been applying the brakes to investment.
ZEW’s Indicator of Economic Sentiment also delivers a pessimistic assessment of the German economy. In the October survey of financial market experts, sentiment about the current economic situation fell to its lowest level since April 2010. Regarding expectations for the future, pessimism was also on the rise, but the September to October change was smaller. Compared to the summer, the surveyed experts now see a lower risk of impending economic slump – due to, for example, an escalating trade war.
Fortunately, the labour market is robust. The unemployment rate was at 4.8 per cent in October, its lowest level since reunification. Employment has reached record levels, even if recent gains have been moderate compared to past years. Even if economic growth falters, there is little reason to expect unemployment to rise dramatically. One reason is that since the 2009 crisis, unemployment is no longer necessarily correlated with the business cycle.
2019 will not be a crisis year
So how bad will it get? The German government and the Council of Economic Experts predict 0.5 per cent growth in the current year. In 2020, the German government forecasts growth of one per cent, and the Council of Economic Experts 0.9 per cent. These are hardly impressive numbers, but it should be kept in mind that in the crisis year of 2009, the economy contracted by 5.7 per cent. The current economic slowdown must be placed in relation to past recessions. Since 1949, the Federal Republic of Germany has contracted in seven individual years: after the economic miracle in 1967; in 1975 and 1982 as a result of the oil crises; in 1993 after the reunification boom; in 2002 and 2003 after the internet bubble burst; and finally during the global economic crisis of 2009. Germany may currently be in a technical recession, but 2019 will not be in the same category as these recessionary years because growth will probably still be positive for the year as a whole. That means that the contractionary forces are not extreme.
But two worrying developments have accompanied the economic slowdown, making it difficult to predict when robust growth will return. These developments are structural changes in the automotive sector, and declining growth in productivity. Automobile makers and their suppliers are facing enormous challenges. These include the inevitable decline in demand for combustion engines, the transition to electric and hybrid vehicles, and IT advances, such as autonomous vehicles. These structural changes have come at a time when productivity growth in Germany is in decline. The economy grew by an average of 2.6 per cent between 1980 and 1990, but it only grew by 0.9 per cent between 2000 and 2010. Unlike large corporations, it is no surprise then that investments in innovation among small and medium-sized companies have been stagnant for years.
Structural challenges require investment
The government should intervene, but only where appropriate. The primary problem is not the business cycle. As a result, stimulus packages are not the right step at the moment. The economic situation also does not justify raising the debt ceiling. That is because unlike a balanced-budget amendment, the debt ceiling written into the constitution explicitly permits the debt to be increased to combat recession.
But measures must be introduced to meet structural change challenges in two areas: specifically, the energy transition and digital transformation. So those calling for increased investment in infrastructure are correct. But they should also keep their expectations realistic. Public construction expenditures were already increased by 10.2 per cent in 2018 compared to the previous year. The construction sector is therefore busy, meaning popular projects like expanding broadband networks, renovating schools, and repairing roads will initially result in higher costs. Road construction costs have already risen by 5.5 per cent compared to last year.
The German federal government’s climate protection package includes measures that will help ease structural change, such as adding charging stations and supporting hydrogen sector research. In addition, tax incentives for research and development currently in the works will stimulate innovation among small and medium-sized enterprises. That will in turn bring productivity hopefully up again. So concern about the economic slowdown should not distract policymakers. A range of measures of a very different kind are required to strengthen Germany’s economic base. Structural challenges are the real problem for Germany. Addressing that problem is the only way to ensure that a current technical recession does not turn into long-term economic frailty.
This article was originally published in German in the daily Süddeutsche Zeitung on 11 November 2019.