How Germany went from Europe’s economic powerhouse to its laggard

Germany’s former economy minister Peter Altmaier promised he would act as the ‘economic locomotive’ that lifted the world out of its Covid-19 crisis – but instead the country now looks more like the latecomer to Europe.

For a time, Germany has been a pillar of relative resilience, with its economy contracting less than most European countries in 2020. However, over the past year, other countries have rebounded faster and even Italy is expected to return to pre-pandemic gross domestic product levels. ahead of Germany, which is teetering on the edge of a winter recession.

“Germany had a very good first half of the crisis, but in 2021 things turned around,” said Gilles Moec, chief economist at French insurer Axa, adding that the weaknesses in the economy were evident. “before the pandemic, when Germany was already underperforming”.

Much of Europe’s largest economy’s recent underperformance stems from its greater exposure to global supply chain bottlenecks that have plagued manufacturing, as well as a weaker recovery household spending, economists said.

The country’s place near the bottom of the European growth chart was confirmed this month when its Federal Statistical Office estimated that domestic output grew by 2.7% last year, less than half expected French and Italian rates and well below the 5.1% growth forecast for the euro zone as a whole.

When Germany’s and France’s quarterly GDP figures come out on Friday, they should underscore the divergent performance of the euro zone’s two largest economies. Analysts even expect the German economy to contract slightly in the last three months of 2021 compared to the previous quarter, while France is expected to grow by 0.5%. This week, the IMF blamed “supply disruptions” for lowering its German growth forecast for 2022 from 4.6% to 3.8%.

The stiffening headwinds underscore the challenges facing Chancellor Olaf Scholz’s coalition government, especially as it plans to cut public spending next year when Germany’s constitutional debt brake will come back into effect.

Robert Habeck, Minister of Economy, said on Wednesday that “the consequences of the corona pandemic are still being felt and that a number of companies are struggling with them”. But despite these “major challenges”, he expects the economy to rebound with growth of 3.6% this year.

While most economists agree on the sources of Germany’s recent weakness, there is less consensus on whether the country is likely to catch up quickly or stay in the doldrums for a while. extended period.

The answer will likely depend on how long supply disruptions continue to deprive manufacturers of many materials, from semiconductors to lithium, preventing them from filling record order books.

“Germany is an open and trade-integrated economy, so it is more affected by the supply problems created by the pandemic,” said Salomon Fiedler, economist at investment bank Berenberg.

One of the hardest hit areas has been the German auto industry, in which domestic production fell 12% last year to 3.1 million vehicles, down more than 50% from pre-pandemic levels in 2019.

Overall industrial production in Germany was still 7% below pre-crisis levels in November, while in France it was down 5% and in Italy, the eurozone’s third-largest economy, it was even slightly up.

Marco Valli, chief European economist at UniCredit in Milan, said Germany was being held back by its greater reliance on manufacturing vehicles, machinery and equipment. “The pandemic has given a boost to consumer goods and it’s much higher for France and Italy,” he said.

Bar chart of manufacturing as % value added showing that Germany is a nation of manufacturers

Economists said Germany’s underperformance in 2021 was also linked to a deficit in household spending, which was still 2% below pre-pandemic levels in the third quarter of last year, while that French household spending had fallen by less than 1%.

“France has seen a stronger recovery in private consumption,” said Katharina Utermöhl, senior economist at Allianz, the German insurer. “While Germany’s fiscal response was bigger, the fear factor among people was bigger.”

Germany has struggled to vaccinate people as quickly as its neighbours, with 72.7% of its citizens fully vaccinated, compared to more than 75% in France and Italy. As unvaccinated people face increasing Covid-19 restrictions, this is likely to further restrict consumer recovery in Germany.

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Another constraint is labor shortages. Detlef Scheele, head of the Federal Employment Agency, estimated that the country needed to bring in 400,000 skilled foreign workers a year – far more than it has done recently – to offset the impact of the aging of its workforce.

Germany should also be affected by the slowdown in China, its second largest export market after the United States. “If the market Germany has been betting on for many years is disappointing, then as an export machine you have a problem,” Axa’s Moec said.

Joachim Lang, chief executive of German business lobby group BDI, said the spread of the Omicron coronavirus variant will lead to further disruptions to factory production in China and other Asian countries that “threaten to affect again supply chains this year”.

Line chart of % of overall merchandise trade (based on a rolling 12-month sum) showing Germany's growing dependence on trade with China

Nonetheless, most economists still expect Germany to start regaining lost ground once supply bottlenecks ease and coronavirus restrictions are lifted. With one final fiscal stimulus this year – funded by issuing no less than €100 billion in additional debt and €7.4 billion from the EU’s recovery fund – the country “could go from extreme to the other: from recession to champion of growth,” said Carsten. Brzeski, economist at the Dutch bank ING.

There were early signs of optimism in IHS Markit’s latest Purchasing Managers’ Index survey of German companies on Monday, which reported its highest level since September and “tentative signs of easing” of supply chain issues.

UniCredit’s Valli predicted the German economy would again lag France and Italy this year – before overtaking them with growth of 3.8% in 2023.

“We expect the supply bottlenecks to have eased in 2023, and then we expect the German economy to catch up,” he said.

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