Germany has in recent years been another word for economic strength, as the country has enjoyed record high employment rates, unprecedented trade surpluses, government budget surpluses and been the economic anchor of Europe for the better part of the last decade.
Now, however, the party appears over and the country faces a potential recession later in 2019. This has important implications for the rest of European Union, and given the weight of the entire European economy, also for the U.S. and global economies. Deep supply chains stretch from Germany into its neighboring countries, ensuring that a German slowdown will quickly be felt across the continent, putting further downward pressure on growth and exchange rates.
This is bad news also for U.S. exporters to Europe, and perhaps more importantly the many U.S. businesses with sizable investments and operations located in Europe. A German slowdown will cut into their sales and profits across the European continent.
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There are several reasons for this change in Germany’s economic fortunes. Germany is first and foremost a very trade dependent economy. It retains the largest manufacturing share of GDP of any major industrialized country, and trade in industrial goods reached almost 40 percent of German GDP in 2018.
Consequently, Germany is highly exposed to any decline in the global growth levels or any increase in trade protectionism around the world. With the accelerating trade tensions between the United States and China, the Trump administration’s frequent threats against German car exports and copy-cat protectionism emerging in many other countries around the world, German exporters have recently faced many headwinds and the country’s recent downturn has been concentrated in the most trade dependent sectors. Germany’s traditional strength in many capital goods sectors moreover turns into a weakness, when businesses around the world scale back fixed and equipment investments, fearful over further deteriorations in the global trade and economic outlook. Demand for German goods exports falls disproportionally when global growth declines, as it has in 2019.
Secondly, the German economy has for several years been operating at full economic capacity, and numerous bottlenecks are beginning to emerge in the form of worker shortages and rising wages and house prices.
In some ways, Germany is therefore a country in which a cyclical recession is overdue following a very long economic expansion. This is particularly the case, as Germany – in contrast to the United States and many other industrialized economies – suffered only a very brief recession in 2008, after which economic growth and job creation quickly returned.
A combination of effective domestic stimulus in 2009 and booming export demand from China and other emerging markets meant that German employment never really fell during the Great Recession and the country, in contrast to the United States, didn’t have a huge economic and jobs hole to climb out of. So Germany has experienced good domestic economic circumstances since the early 2000s. The length of this period of economic progress in Germany has further been extended by the fact that German monetary policy is set by the European Central Bank (ECB), taking into account the far worse economic circumstances of many other euro area members.
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This continues to keep German short-term interest rates lower than they would have been had Germany’s national central bank set them according to only domestic economic circumstances.
Thirdly, as Germany is now approaching the edges of its economic growth opportunities, it is becoming increasingly clear that the country’s potential growth rate has been reduced by a government failure in recent years to invest adequately in public infrastructure, education and telecommunications network to continuously support German domestic economic growth opportunities.
Germany’s rigid balanced budget constitutional amendment (introduced in 2009), requiring virtually any public expenditure to be fully offset by new revenue if the government budget is not at or very close to balance, is at least partly responsible for the recent shift in Germany’s economic fortunes. Ironically, failure by the government to invest to avoid a recession now means it faces the prospects of having to loosen its purse strings if Germany soon falls into one.
Fortunately for Germany, the rest of Europe and the United States, few countries are in a better fiscal position to hypothetically afford a large fiscal stimulus to drag the economy out of a recession later in 2019. Here it is helpful that the German finance minister, Olaf Scholz, is now actively campaigning to take over the leadership of his Social Democratic Party (SPD) later this year. He now has a personal political interest in pushing for a sizeable German fiscal stimulus in the coming months.
With German social trust funds currently running sizeable cash surpluses, it would even be possible to expand Germany’s traditionally strong automatic stabilizers and merely run down these surpluses, rather than relying on new debt issuance to finance much of a countercyclical fiscal stimulus in Germany. Recalling, however, that the German government is now de facto able to issue debt and get paid to do so through zero coupons and negative interest rates, it would be financially illiterate of the German government not to issue new debt to finance a new stimulus.
Any potential German recession is likely to be relatively shallow – GDP might indeed only decline by 0.1 percent in both Q2 and Q3 for the shallowest recession possible – and it will not pose any real challenge for the German government to end it with a dose of fiscal stimulus. The real challenge for Germany going forward, however, is not ending a potential recession, but restoring economic growth rates much above zero.
Successful labor market and pension reforms and high levels of inward migration has in the recent decade muted the effect of Germany’s accelerating population ageing, as employment has reached record highs in early 2019. With political constraints likely blocking further increases in immigration and youth and older worker employment rates already among the highest in the OECD and far exceeding the United States, Germany’s employed population is likely to begin to decline in the coming years.
Japan illustrates the challenges such demographic decline poses for a country’s sustained nominal economic growth. Moreover, even if Donald Trump
Donald John TrumpGraham: America must ‘accept the pain that comes in standing up to China’ Weld ‘thrilled’ more Republicans are challenging Trump New data challenges Trump’s economic narrative MORE’s protectionist policies are ultimately not copied in the rest of the world and the United States itself eventually changes course, Germany’s trade dependent economy will continue to face challenges in an increasingly services dominated global economy in which openness and global supply chains may have peaked.
Germany’s true future economic challenge is therefore to continue to raise productivity growth and rely on domestic sources of continued economic growth.
Jacob Kirkegaard is a senior fellow at the Peterson Institute for International Economics.