Germany - Towards a New Growth Model?

BTMU Economic Brief | July 2016 1

BTMU Economic Brief

Germany – Towards a New Growth Model?

AMIR KHAN ECONOMIC RESEARCH | LONDON T: +44-(0)20-7577-2180 E: [email protected]

The Bank of Tokyo-Mitsubishi UFJ, Ltd. A member of MUFG, a global financial group

JULY 2016

he German economy – while it continues to be one of the key motor of the Eurozone economy – has gone from being heavily reliant on net exports to drive its growth, to one which has become more dependent on domestic consumption more recently. As such,

the purpose of this note is to explore some of the factors which have underpinned this development, as well as to focus on whether this represents a sustainable development going forward. A shift from net exports towards domestic demand… In the years leading up to financial crisis, German GDP growth was mainly driven by net exports (see Chart 1). External demand contributed on average 0.8 percentage points per year between 2001 and 2008. External demand, thus, delivered in excess of 50% of the country’s average GDP growth of 1.4% during this period, while the contribution of internal demand was much weaker.

Spending by private households in particular was often sluggish and did not contribute much to GDP growth – by, on average, just 0.3 percentage points between 2001 and 2008. This can mainly be explained by the much weaker performance by Germany’s labour market at that time compared to now, and modest growth in real wages during this period. This trend continued for

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Inventory Investment Private Consumption

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Chart 1: GDP Growth and Breakdown

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(Source) IHS

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some time following the peak of the financial crisis in 2008/09, with growth contributions from net exports being higher than those from private consumption.

Over the course of the last three years, however, this pattern has changed considerably, with private consumption becoming the main driver of economic growth. Due to strong domestic demand from private households, imports have also been increasing at a high rate. By way of contrast, growth in exports has been constrained, thanks to the slowdown in emerging market economies, to which German exporters exposure has grown since 2000 (see Chart 2 & 3). Against this changing backdrop, we envision that net exports will likely make a negative contribution to Germany’s GDP growth this year and perhaps next. Nevertheless, the German economy will stay on track, with growth expected to reach around 1.4% on average over the course of this year and next, a figure which, if realised, will be modestly down on the previous year’s reading of around 1.5% but which will continue to exceed its potential that the likes of the IMF have estimated to be in the region of 1.3%.

…A development which has been aided by a broad array of factors... The revival in Germany’s private consumption is caused by several factors, which together are combining to form a virtuous cycle:

Firstly, the German labour market is booming. The level of employment, with more than 43m employees, is the highest since German re-unification and the prospects appear to be good if, among other things, forward looking surveys such that by Markit are any guide (see Chart 4). This healthy labour market performance can, in turn be traced back to the Hartz labour market reforms that were pushed through in the early to mid-2000s with a view to improving the labour flexibility and increasing the possibilities for part-time and temporary employment.

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Chart 2: A Breakdown of German Exports and the Growing Exposure to Big EM Economies

(Year)(Note) German exporters total exposure to EMs has grown from

around 20% to 30% over this period. (Source) WITS

(% of total exports)

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EMs Composite PMI Index (LHS)

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Chart 3: The Recent Slowdown among EMs has Adversely Affected Germany's Export Performance

(Y/Y, %)

(Source) Macrobond(Year)


With unemployment at – or near – record lows, this is supporting the bargaining power of

unions. Consequently, growth in wages is quite dynamic, running at in excess of 2% over the past year or more. This, coupled with the fact that up to 3.7m employees are benefiting from the introduction of a minimum wage since the beginning of 2015 means that workers in Germany are benefiting from fairly generous uplift in both their nominal and real wages, with the latter aided by the favourable evolution of headline inflation in Germany, which is running at near-zero levels. Other supports for real income have been the collapse of oil prices which – while they have reversed somewhat in recent months – still remain low by recent historical standards. Finally, public transfers to over 1 million refugees that have settled into the country from such places as Syria will also support private consumption.

Aside from private consumption, government spending has also been more supportive than previously expected. Higher outlays in regard to the accommodation and integration of the aforementioned refugees are also increasing aggregate demand. For 2015 alone, these additional expenditures are estimated to have amounted to at least €10bn (around 0.3% of GDP) and according to Finance Minister Schäuble, these could be even higher in 2016.

…But how sustainable is this shift? We welcome the recent rebalancing in German GDP in favour of domestic consumption, but whether this represents a lasting structural shift remains open to question. Notwithstanding this, as we alluded to above, we expect this trend to persist for the time being at least on back of favourable employment dynamics, ongoing boost from net immigration and low interest rates. Additionally, with the German housing market in rude health recently, this is also creating positive “wealth effects”, which will likely continue to spur German households to spend some of their surplus income.

That said, while the shift that the German economy is currently undergoing is set to continue for the time being, we are doubtful about the staying power of this development. Some factors as to why we think this to be the case include the following:

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Chart 4: Markit's Guage of the German Employment Outlook across the Major Sectors


Even though the labour market is expected to remain healthy throughout 2016, our expectation is that unemployment will reverse its multi-year downward trend at some point as the newly arrived refugees obtain the right to work.

The boost to disposable income from low oil prices and near-zero inflation will eventually run its course, likely resulting in deteriorating income expectations and less willingness to spend.

The strong wage increases seen over the recent past, which have boosted disposable income, will start to hurt Germany’s export competitiveness and – if allowed to persist – may ultimately undermine demand for labour.

Separately, it is also worth noting here that despite the buoyancy of domestic demand recently, a cursory look at Germany’s current account position – which is a broader measure than the trade balance on its own and is reflective of the overall health of a given country’s external sector relative to that of its trading partners – reveals that it is still firmly in surplus territory (see Chart 5). Another way of looking at this is to compare Germany’s savings and investment position, which reveals that the country has large mismatch in favour of savings (see Chart 6), with some of these surplus funds being used to finance the reciprocal deficits of some of its trading partners.

As such, the point to note here is that for Germany to close its favourable current account gap with that of its trading peers not only is there a need for consumption levels in the country to rise in a persistent fashion but, over and above this, its investment outlays also have to increase in a material way so as to address the current imbalance between its savings and investment position. However, with respect to the issue of investment, we don’t see happening at least in the near-term, given the fact that – while corporate sentiment, on the whole, is on the mend – it is still rather weak relative to the peak that was seen in the aftermath of the financial crisis, in large part because demand for new export orders continues to trend down (see Chart 7).

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Current account (LHS)Current account as a percentage of GDP (RHS)


(EUR, billions) (% of GDP)

Chart 5: Germany's Current Account Remains in Surplus Territory

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Chart 6: There is a Mismatch between Germany's Savings and Investment Position

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The other related point to note here is that although the capacity utilisation rate has been trending up, it is still below its pre-crises levels (see Chart 8), meaning that – in an environment of continued uncertainty – companies may still be inclined to continue to make greater use of their existing capital outlays before committing to additional investment expenditure. Concluding remarks While we welcome the recent signs of rebalancing in the German economy away from its traditional reliance on exports towards domestic consumption, we would not go as far as calling the recent shift durable – or for that matter structural – in nature. That said, we do recognise that the German economy is undergoing some subtle changes on back of – among other things – the recent strength of the labour market and the arrival of new migrants into the country, which is serving to invigorate domestic demand in the country. However, as we note in this report, some of these catalysts are likely to be temporary or cyclical in nature and, as such, their influence may wear off over time. For Germany to experience a more lasting rebalancing, we are of the view that the German government needs to play a more active role by, for instance, maintaining a more lax fiscal policy stance over a prolonged period and/or by giving the corporate sector greater incentives to invest more rather than to save their surplus income.

The latter is particularly important, in our mind because we are finding that the German economy is gradually losing some of the competitiveness gains that it benefited from with the adoption of the Hartz labour markets reform, which it implemented during the early to mid-2000s. Against this backdrop, one way for Germany to regain its competitive zeal is to prioritise capital investment over labour as – in an environment of rising unit labour costs – this will help the country to boost productivity and, hence, offset some of the recent rises in its unit labour costs.

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PMI New Export Orders Index (LHS)Corporate confidence (IFO, RHS)


Chart 7: Corporate Confidence Continues to be Held Back by Export Order Weakness

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00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16(Source) Macrobond

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Chart 8: Capacity Utilisation Continues to Hover below its Pre-Crises Peak(%)

2016 Q2: 84.4Pre-crisis peak: 88.8


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Economy & Finance

Germany - Towards a New Growth Model?