|June 30, 2017
Last week, two influential German economic institutes – the Ifo institute and the German Institute for Economic Research, or DIW – published their midyear economic forecasts. They were released after the German central bank, the Bundesbank, published its own forecast, saying that the German economy’s “solid upswing” will continue. Ifo and DIW found similar results, asserting that the German economy will continue its “steady growth.” Overall, there were few differences between the two reports. DIW is more cautious when dealing with export growth, noting it is still “uncertain” the global economy’s recovery will continue. Both reports underlined that, unlike other periods of recent German history, the first-quarter economic results were based on domestic performance more than they were influenced by export growth.
Our 2017 forecast says German exports will fall in 2017, weakening Berlin’s trade position and, ultimately, slowing economic growth. The latest reports coming from Germany challenge this forecast on two fronts. First, the German reports say that exports will continue to rise. Second, the German reports insist that while exports have grown, it is the domestic drivers that have made German growth stable. These domestic drivers, they argue, remain key to maintaining growth. The following report will look at what accounted for German growth during the first half of the year, analyzing whether Germany underwent structural changes we may have missed in our forecast. It will also revisit Germany’s trade relations and look into Germany’s trade dependence on the United States.
The Basis for Growth
The economic recession registered in most European countries after 2008 meant that the most important German export market, the EU, was shrinking. Since then, Germany has struggled to increase exports to other markets, and the government has continued to increase public spending. In 2009 and 2010, public spending was almost 48 percent of gross domestic product. Until now, public spending has remained above 44 percent. The German economy experienced a steady decline for several years but, in 2014, the country began to experience positive economic growth once more.
Several notable elements characterize Germany’s recent comeback. In 2009, Germany experienced the most significant economic drop since the end of World War II – a 5.6 percent decrease of GDP – highlighting its dependence on international markets and, in particular, the eurozone, with total exports dropping by 23 percent. After the crisis hit, the German unemployment rate continued to register at historic lows. Furthermore, the rate of economic expansion was visibly slower than it was during previous phases of economic recovery. Before the crisis, exports grew at a rate of 6.3 percent. That growth significantly dropped in 2009, and only in 2015 did the export growth rate climb back to 5.2 percent. That year, exports accounted for 46.8 percent of Germany’s GDP, and the United States replaced France as Germany’s top export market.
Germany’s economy has strengthened, registering 0.6 percent growth in the first quarter of 2017 compared to the last quarter of 2016, and an annual growth rate of 1.7 percent. The positive net export result, determined by the growth in both exports and imports, was the main source of growth, contributing 0.4 percentage points. But growth in investment in construction and machinery, as well as increases in state spending and private consumption, have also contributed to the economy’s upward trend.
The export sector share of GDP grew from 46.8 percent in 2015 to 47.3 percent in 2016. The EU is the most important trade partner for Germany. Before the crisis, more than 60 percent of all German exports were EU-bound. After dipping to 56 percent in 2012, exports to the EU returned to 58 percent in 2016. Since 2011, however, Germany has shifted its attention toward markets outside of the EU, increasing exports to the U.S. and China. German exports have grown over the past five years, but considering Germany’s ongoing high dependence on the EU, this growth has been modest.
The European Market
In the past three quarters, overall growth in the eurozone and the EU has brought confidence back to the region. The 0.5 percent GDP growth for the EU and the eurozone in the first quarter of 2017 has been positive for Germany, given how closely the German economy is tied to the economic performance of the EU. But the EU has hardly returned to growth, and regional economic disparities continue.
Brexit poses a new problem to Germany, as Berlin now needs to plan for the possibility that London will increase protectionism. For the time being, the U.K. is still part of the EU – which means that German trade to the U.K. market benefits from free trade rules, as it does to other EU member states. Geopolitical Futures forecasts that the German-British trade relationship will continue to grow in the long term, considering the two countries’ dependence on each other. Brexit negotiations during the next two years, however, are likely to change the rules of the game as both the U.K. and the EU seek to protect their markets. This could hurt German-British trade in the short term.
France is another key country for Germany. The May 2017 French election results were good for Germany, giving the sense that Paris will continue coordinating with Berlin on European affairs instead of seeking to withdraw from existing agreements. But the election outcomes have not washed away France’s economic problems. France is struggling with high unemployment rates and regional disparities, making for stagnant economic growth. German exports to France have been falling since 2012 and, in the first quarter of 2017, they registered only 2.8 percent quarter-to-quarter growth. The prospects for German exports to France depend on the evolution of the French economy. And this is true for most of the other European countries where Germany exports goods.
In March, Germany registered its highest monthly growth in exports in the last five years, which was over 15 percent. This was due to an increase in demand for German goods in markets beyond the EU – specifically, in the U.S. and China. Sales in the U.S. and China increased by 25 percent, while those in the U.K. grew by just 12 percent. Germany registered 11.3 percent growth in exports to EU countries in March and a total quarterly growth of 4.9 percent for the first three months of 2017. This growth varied from country to country, considering the existing disparities between economies. German exports to France and Italy grew by 2.9 percent, while exports to the Netherlands decreased by 2.5 percent. What helped Germany achieve such performance during the first quarter was the euro depreciation against the U.S. dollar and the Chinese yuan during the final months of 2016 and the first of 2017.
Markets Beyond Europe
German strategy during the past decade has focused on increasing exports to non-European markets in order to reduce Germany’s vulnerability to European economic problems. Germany played China against the U.S. in 2015 when it compensated for a decrease in Chinese demand by substantially increasing its exports to the U.S. and the U.K. In each of these countries, Germany sells similar types of goods – industrial machinery items – making it relatively easy for exporters to switch between the three markets.
Chinese demand for German exports is expected to grow in 2017, but it will be difficult to secure in years to come. 2017 is of special political importance for Chinese President Xi Jinping, who aims to solidify control over the government during the next Communist Party congress, which will take place in the fall. This means Beijing will increase economic stimulus to maintain political stability no matter the costs, which, in turn, translates into growth for Chinese imports. Considering the Chinese economy, as well as political imperatives for the government in Beijing, a steady demand for German exports is not certain beyond 2017.
As for the U.S., there is nothing that indicates a decline in demand for German exports in 2017. Most of the goods Germany sells to the U.S. are affected by market cycles, since they depend on private consumption, which we will discuss further in section two. With no sign of economic decline in sight, American consumption has continued on an upward trend. But considering natural cycles of expansion and contraction that occur in the U.S. every eight years or so, signs of recession may start to appear by the end of the year. When that happens, German exports to the U.S. will decrease.
Thus, there are limits to how much Germany can increase its exports outside of Europe.
The German Domestic Market
In addition to seeking new markets for German exports, Berlin looked to increase domestic consumption and investment to maintain German economic health. This has proved to be difficult for a country with historically high personal savings ratios, since consumers that save more spend less. And low interest rates haven’t increased German companies’ appetite for domestic investment so far. Construction and machinery have experienced investment growth, but this is more connected to the increase in government spending and social security policies from Berlin than it is to private initiative.
In 2016, German domestic consumption increased, resulting in an increase of imports. This was the first year in which net exports (the difference between total exports and total imports) negatively contributed to GDP growth. This occurred even though total exports continued to grow at a rather low annual rate of 2.5 percent. Such an evolution was supported by the fact that both public and private consumption grew at higher annual rates than they did during pre-crisis times. Public consumption grew in 2016 at an annual rate of 4.2 percent compared to the year before, while prior to the crisis, the average annual growth rate stood at just 1.2 percent. The private consumption growth rate was lower, at 2.4 percent, but even this was significantly higher than the 0.9 percent average annual growth rate registered before the crisis. As a result, domestic demand positively contributed to GDP growth. This increased optimism about the stability of the German growth rate, suggesting that Germany has become less vulnerable to the international market.
The German government has declared the refugee crisis to be both a challenge and an opportunity and, since 2015, Berlin has implemented special policies to address it. One change is the establishment of an investment fund for municipalities. Another is increasing states’ budgets dedicated to the integration of refugees into German society, a program that includes the construction of housing and infrastructure specifically intended to accommodate the refugees. This program has worked as a stimulus for the construction business and, coupled with low interest rates that facilitate cheap real estate, credit has produced a boost for the sector, rising sharply since state funds became available in 2016. Investment in machinery grew, but only in 2017. The European Commission notes in its forecast for the German economy that while it remained subdued for 2016, it will grow this year because “replacement needs become more pressing due to the rising rate of capacity utilization.”
At the same time, while the unemployment rate has decreased, wages have remained at the same levels since 2012. This was partly due to the comparatively weak collective wage agreements, with some unions prioritizing other benefits, like retirement schemes, and partly because of low employment rates in other European countries, making people seek work opportunities in Germany. Growth in employment has not benefited investment, but it has stimulated private consumption. Ifo and DIW point out in their analyses released last week that the employment rate is likely to continue to grow while wage levels remain low, considering the cheap labor available from the refugees. But it is unknown how much Berlin has to spend for the refugees to become skilled workers who benefit the German economy. In 2016, the government spent 20 billion euros ($22.9 billion), about seven percent of government spending, on refugee programs. Merkel has openly said that Berlin intends to continue addressing the refugee crisis and has thus increased the budget for 2017, adding an extra 8 billion euros for integration projects at the state level. Though such programs create new jobs for Germans working directly with the refugees, it is unclear whether the skilled labor produced through such processes will be cheaper than what can be found now on the labor market.
Based on the positive figures of the last quarter, most respondents in recent business surveys are optimistic about business activity in the coming months. A survey carried out by the Association of German Chambers of Commerce and Industry points out that these positive expectations are due to the fact that German exporters have benefited from a revival of trade with both Europe and the world at the beginning of the year. About 58 percent of respondents said concerns about falling demand are declining, considering the increase in exports in the eurozone and the U.S during the first months of 2017. They perceive the lack of skilled labor for their operations – which is somewhat limited – as a major risk. All of this points to growing optimism for the business environment, due to the fact that exports’ performance remains key for the business community. If this optimism is sustained, higher business confidence will eventually lead to greater investment levels, which, in turn, will further increase domestic consumption.
Therefore, the current basis for growth in Germany relies on two elements. First is export performance, which remains a key indicator of the country’s overall economic performance. Second is the increase in government spending and the investment associated with it. Current growth in domestic investment is tied to government policies that relate to the refugee crisis and the resulting need for a build-up of infrastructure. In turn, private consumption is triggered by the stable labor market, which is characterized by low unemployment rates and stable wages. While the refugee programs give a boost to the construction sector and public investment drives the replacement of old machinery, such growth stimulus can work only in the short term.
Germany remains heavily dependent on international markets, considering its export sector share of GDP. Berlin can anticipate how its exports will perform by looking at the economies of EU member states, the U.S. and China. EU growth is still fragile, and exports to the U.K. will be affected in the short term by Brexit negotiations. China is stable for 2017. But the U.S. market is the most important to the German economy because it influences the way the world market evolves.
Germany’s Trade With the U.S.
More than 30 percent of German exports are sent to four countries: the U.S., France, the U.K. and China. The U.S. has been Germany’s most important export market since 2015. Last year, the American market accounted for 8.8 percent of Germany’s total exports and 3.4 percent of its GDP. (As a comparison, France accounted for 8.3 percent of total exports, the U.K 7.14 percent and China 6.2 percent.)
Effects of a U.S. Recession
In March, the total of German exports grew by 15 percent. In the following month, however, exports dropped by 14 percent, with exports to the U.S. dropping by more than 26 percent. This was not an isolated event – exports to China dropped by 22 percent, and those to the U.K. by 18 percent. The U.S. sets the tone of the global market; a decline in the American buying appetite negatively affects countries that trade with the U.S. With the U.S. among their most important export destinations, France, the U.K and China fall into that category. The correlation between the four countries’ trade dynamics made for a drop in German exports to all four countries in April. For this reason, but also because the U.S. is the most important export destination for Germany, understanding the degree of dependency of Germany and its export growth on the U.S. becomes key to analyzing the dynamics of the German economy.
Of all sectors, Germany’s automotive industry has been the most successful in exporting to the U.S. market in the past decade, accounting for more than 32 percent of total American imports from Germany in 2016. Automobiles alone make up approximately 20 percent of German exports to the United States. Industrial machinery is the second-most successful sector, accounting for 29.9 percent of total U.S. imports. Pharmaceuticals are third, accounting for about 12.05 percent of total U.S. imports from Germany. Pharmaceuticals are especially important because they are recession resistant; as the economy drops, people will continue to get sick, and the need to buy medicine will remain. On the contrary, car sales and, to a lesser extent, industrial machinery sales sync with market cycles. Car sales grow only when disposable income grows. The same goes for most industrial equipment – companies will invest less in new technology when dealing with a shrinking domestic market. As a result, a recession in the U.S. will harm both of these sectors, which account for more than half of German exports to the United States.
After the U.K., the U.S. is the second-largest market for the German car industry. The economic crisis has lasted longer in the EU than it has in the U.S., and once the U.S. economy picked up steam, German car imports increased. At the same time, the German automotive industry is not the same as the automotive industry in Germany, considering that German automotive industry production in foreign countries has outpaced production at home since 2009. This means that the German automotive sector is more resilient to change, considering the ability to switch production from a less-efficient site to one that is more cost-efficient. But it also means that, through the production chain, other countries’ economies are made vulnerable by the potential of a U.S. recession. The same is true for industrial machinery exports, making it difficult to precisely calculate the risk for the German economy when it comes to these sectors.
Trade is supported by investment links. Annually, more than 10 percent of direct foreign investments in the U.S. comes from Germany. The German BMW, Daimler-Benz and Volkswagen manufacturers produced more than 800,000 automobiles in 2015 in the United States alone. German companies are the third-largest foreign employer in the United States, with over 670,000 workers, nearly half of whom are employed in manufacturing. A recession does not necessarily mean that these companies’ activity will cease; it simply means that people will buy less. For the automobile and machinery industry, it means that people will spend less on purchasing new cars and spend more on repairs. A drop in exports could equal an increase in services provided by local affiliates of German companies in the United States. Concerns that protectionism will grow may combine with worries that a new recession may hit the U.S. soon. Considering the importance of the U.S. market, German automakers may increase investment in their American operations instead of those in their home country. Increased production in American affiliates of German companies could balance against potential losses that could occur due to an increase in import tariffs. Investment also reveals a limit in trade statistics. U.S. affiliates in Germany and German affiliates in the U.S. are clearly developing their own trade patterns, which are hidden in the companies’ books. While those relations make it difficult to fully calculate the impact of a potential recession, they also reinforce the existing trade links between the two countries.
There are significant indicators pushing against the timeline of our Germany forecast, but we still see that German economic growth remains dependent on exports. Germany has increased exports to the U.S. and Asia, thus decreasing dependence on EU trading partners. But the EU still buys more than 50 percent of German exports. While both the eurozone and the EU have seen growth in the first quarter of 2017, it is modest growth of 0.5 percent. As a result, German exports have grown during the first three months of the year, driven by solid growth rates for exports in the U.S., China and the U.K. In April, exports dropped significantly, showing that it is yet too early to confirm solid growth. But this says little so far, as exports always fluctuate on a month-to-month basis. As we obtain more data this year, we’ll be able to see more clearly if this increase indicates sustainable growth.
Investment appetite relates to a business’s potential for profit and expansion. For that, exports remain key and U.S. economic performance is important to Germany not only because of the two countries’ bilateral trade and investment relations, but also because of the general impact the U.S. has on the global system. The U.S. runs a trade deficit with all of Germany’s main trade partners – an economic decrease in the U.S. negatively affects each of these economies, albeit in different ways. Moreover, taking into account that German exports to the U.S. are mostly automotive and industrial machinery products, their performance is dependent on the American market cycle; sales will increase when the economy is growing and decrease when it is shrinking.
It is still too early to conclude whether our forecast on the German economy is correct. Growth patterns in the first quarter can easily be turned by negative developments in the EU, Brexit negotiations, or anything that will cause a downturn of the American market – all things that Germany cannot control.