German Economy – Record High Growth Rates but is it Sustainable?

The German Economy is growing at a pace of 2.2% which is a 6 year high. Its budgetary finances are running at a record surplus and the employment levels are at record high.

The German Economy the Federal Parliamentary Republic with a population of just 8.16 Cr which is just 1/4th that of United States and almost 1/16th to that of India but still it is the third largest exporter in the world.

In 2016, it also recorded a trade surplus of $310 billion which is the highest in the world, almost equivalent to the entire GDP of South Africa.

Currently, as the world economy is seen rising, the Euro Zone is also seeing a good amount of growth and inflation, the 3.65 Trillion Dollar German economy too has also risen with a record 2.2%.

Hence the German Economy seems to be promising as Angela Merkel, the chancellor has sworn in for the 4th consecutive time after the federal elections in 2017.

All of this gives us a hope of another strong showing in 2018; however, there still are a few issues that the German Economy needs to address in order to sustain this current growth momentum.

German Economy is the Fastest Growing Economy in the Past 6 years But Still An Unrest In The Economy?

The German Economic Growth has touched a high of 6 years of 2.2% showing a very strong performance by passing the crucial 2% mark.

With the highest growth after being re-elected in 2013 the economy seemed to be in a superb condition. But still after posting such strong numbers and after being elected in 2013, in 2017 Merkel’s party was not able to come up with a majority. It had just won 246 seats with the required winning majority at 355 in the 709 member Bundestag, as compared to 311 seats in 2013 with the required winning majority at 316.

The present government has been formed by taking the support of Social Democratic Party of Germany. This clearly indicates that the people are not satisfied with the growth that the German economy has experienced.

Some of the problems that the economy faces are:
  1. Overdependence on Exports
  2. A Budgetary Surplus (yes, at times this is also a problem)
  3. Shortage of Skilled Workers
  4. Loose Monetary policy

 

Source: World Bank Database

 

How can this unrest be solved? What are the important parameters for its sustainable growth?

  1. Importance of internal consumption

Internal consumption is the next big key. The economy is highly dependent on exports, a staggering 46.1% (as a percentage of GDP), is the value of goods and services exported.

As the world is moving towards protectionism, internal consumption becomes more important.

In this environment of the global trade war, countries like the USA increasing the import tariffs on Steel to 25% and aluminum to 10% and many other products, it is the internal consumption which will help drive the economy forward.

From the below graph you can see that the world trade is decreasing as a percentage of GDP, which again indicates that internal consumption has to be the growth driver for the economy.

 

Source: World Bank Database

 

  1. The Budgetary Surplus

Germany has experienced a budget surplus of 18.3 billion Euro in the first half of 2017. This surplus was the second highest since the reunification of Germany in 1990.

Unlike the highest which was in the year 2000 and which was supported by the sale of mobile phone licenses, this surplus was due to increase in the tax revenue which was higher than expected due to the economic boom.

How does this surplus get utilized for the growth of the economy is yet to be seen. This budgetary freeway can be used by the government to reduce the amount of direct taxes so that there is more money in the hands of the public. Wages and disposable income can be increased with the help of lower taxes which in turn will solve the problem of internal consumption as discussed earlier.  Here are areas in which the Government spending, if increased, can be beneficial.

  • A spending on the record high asylum seekers who have arrived in Germany can also help in increasing the internal consumption.
  • Another thing which is highly discussed is the government spending on Education. Germany spends just 4.95% as a percentage of GDP on education which is less than some of the European peers like the United Kingdom which has 5.73% and Sweden which is as high as 7.68%. Hence this opportunity of the surplus should be used to increase the spending on education by updating the infrastructure and increase the compensation of poorly paid lecturers who are demanding for more compensation.

 

  1. The Impact of the Refugee Policy

How the Chancellor chooses to deal with the Refugee policy is also very crucial.

Refugee policy has always had a huge influence on the German economy. It has always been a key policy influencer both in political as well as economic terms. Germany’s population is aging. There will soon be a future need of young workers to support the major industries for which Germany is known.

As evident from the graph below currently 21 % of the Germanys population is 65 and above as compared to the world average of 8%.

The population in the age of 65 and above has been increasing continuously over the last the previous 5 years. Hence the country requires refugees or immigrants who are young and currently who have traveled all the way from Syria in order to seek work. This will also serve the purpose of increasing the consumption as more people join the workforce who would start spending as they start earning.

However, it is argued that it would lead to a reduction in the overall wage growth. However despite of that it would lead to an increase in the overall consumption.

The refugee intake was 745,545 persons in 2016 v/s  362,153 persons in 2015. (Source AIDA- Asylum Information Database).

Source: World Bank Database

 

  1. The Monetary Policy

The German economy is experiencing a very good amount of stimulus as the European Central Bank (ECB) has lowered the marginal lending facility to just 0.25%. The main refinancing operations for Fixed rate tenders at −0.40% and Variable rate tenders at 0.00% thus giving an ultra-low borrowing cost.

There were monthly purchases of 60 billion Euros of bonds by the ECB as part of the Quantitative Easing Programme. This free flowing money from the ECB has led to unnecessary lending to some of risky assets, to cover the losses in income through the interest.

New bubbles are also seen forming in the capital and real estate market. Already the monthly purchases have reduced from 2018 to 30 billion Euros. The inflation rate is also seeing a slow increase. This will lead to eventually increase in the interest rate. Cost of borrowing will increase and may have adverse effects after a 9 year regime of lowering of interest rate. Soon this tap of money is going to close as the Euro Zone economy grows and the interest rates increase.

Hence these risks arising out of ECB Monetary Policy need to be accounted for going forward.

 

Importance and effects of EU on the German Economy

  • Until now we have discussed everything, keeping in mind the German economy alone. But it’s a part of and unarguably the leader of the European Union. Germany contributes 23.277 billion Euro to the EU budget but the EU spending to the German Economy is half at 10.082 billion Euro (Source: europa.eu). Hence here we can see that Germany contributes disproportionately more to the European Union.

 

  • Despite of this skewed calculation, Germany is still the beneficiary by entering the EU despite the disproportionate contribution to the budget. With the help of EU it has got the liberty to trade freely in whole of the European Union without any taxes on the exports and imports. The European Union trade accounts for 59% of Germanys export. Also the Euro currency has been depreciating because of problems in other EU countries, thus more favouring the German exports as they become cheaper. This would not have been possible had Germany traded in its own currency. The German currency would have appreciated because due to the trade surplus. Hence Germany does have a clear advantage to stay in the European Union.

 

  • As you can see from the below graph and as discussed earlier, the highest contributor to the European Union budget is Germany which is contributing 19% of the total budget hence its influence remains strong. UK leaving the European Union, has made Germany’s influence in the EU stronger.

 

  • But with Brexit there has been an ongoing debate whether the EU will stay intact. This debate gets stronger as suggested by the recently concluded Italian Election, giving the Centre-right Coalition the largest majority, though not a majority enough to form the Government.

 

  • This Coalition is in support of Italy leaving the European Union. Italy is 3rd largest economy in the European Union after Brexit which clearly is a sign of threat to the European Union as well as the German Economy who benefits a lot from the European Union.

 

Source: www.staista.com

Conclusion

In conclusion, the policies of the German Government in the days to come, coupled by the Geo-Political situation of the EU are poised at important junctures. It will be interesting to see how the Chancellor deals with current problem of high dependency on trade and whether the German economic boom will sustain.

– Report by Mr. Darsh Gada (L.N. Welingkars)  

Under the guidance of Mr. Rahul Ingle (The Money Roller Team)