Despite political uncertainty, German economy continues to expand – even as employment growth slows down

Press Release of December 20, 2016

German economy’s growth rate will drop next year, primarily due to calendar effects – labor market expansion losing some momentum – numerous risks for the global economy

According to a new forecast by the German Institute for Economic Research (DIW Berlin), the German economy’s upward trend will continue through 2017 and 2018 – even though the current global economy is characterized by substantial risks. German GDP growth is expected to amount to 1.2 percent in 2017, a figure that is lower than this year’s 1.8 percent primarily because there will be fewer workdays next year. DIW Berlin’s autumn forecast predicted a growth rate of 1.0 percent for 2017, which has now been adjusted upward. The growth rate should be higher again in 2018, amounting to 1.6 percent.

 

Yet the significant risks to economic development –government elections in several European countries, tough negotiations related to the Brexit, and structural problems in the Italian banking sector, among others – should not be ignored. Germany’s substantial 2016 budget surpluses will decrease significantly in 2017 and completely disappear by 2018, at which point slight deficits may also materialize.

Private consumption, which remains the German economy’s primary growth driver, is expected to decline over the forecast period. The very strong employment growth of the past few years has been losing momentum, and this alone has been dampening income development. Furthermore, higher energy prices will lead to a rise in inflation, which in turn will have a negative effect on purchasing power. The projected inflation rates for 2017 and 2018 are 1.4 and 1.5, respectively. In 2017 unemployment levels will remain low (5.9 percent). Exports are developing favorably, but demand from the EU is likely to suffer in the coming months as a result of the Brexit decision as well as the political uncertainty that is currently plaguing several countries.

In SHORT

Marcel Fratzscher (President of DIW Berlin): “The European economy is experiencing an upward trend – but at the same time, we’re dealing with an unusually high level of economic uncertainty. There are numerous risks for the economy, from problems in the European banking system due to the threat of protectionism, to a number of unfavorable geopolitical developments. Germany should aim for a proactive economic policy that sets the stage for increasing both private and public investment.”

Ferdinand Fichtner (Head of the Department of Forecasting and Economic Policy): “The overall situation for German exports is quite favorable. And even though the global economy isn’t booming, it is growing and in the short term, the election of Trump could actually have a positive impact on demand and the U.S. economy. Nevertheless, there remain significant political risks, such as the uncertainty in Italy and next year’s elections in France. As well, the global tendency to protectionism is distressing; if it continues, it will act like poison in Germany’s open economy.”

Simon Junker (Deputy Head of the Department of Forecasting and Economic Policy): “The German economy is currently operating slightly above the efficient level of capacity utilization, but this positive output gap will close soon. The Brexit decision and the gloomy economic outlook have temporarily dampened corporate investment over the past few months and investment will only be modestly increased in the near future.”

Kristina van Deuverden (financial expert and Research Associate in the Department of Forecasting and Economic Policy): “Public budget surpluses are still ample, but they will drop considerably, to the point where we may even see a deficit in 2018. Although surpluses will return, this will only be due to strong increases in the social contribution rates. To avoid this situation, it’s important to act quickly and closely examine the structure of social security spending.”

Global economy recovering, but risks remain numerous

Things are looking up for the world economy: after a slight slowdown in the first half of 2016 due primarily to problems in the emerging countries, the economy is back on an upward growth path. Brazil is expected to come out of recession, while stable oil prices should act as stimuli for economic growth in Russia. In industrialized countries, high consumer demand will continue to drive growth. As well, the expenditure programs announced by U.S. President-elect Donald Trump – like those for infrastructure, among others – are also expected to boost global economic growth during the forecast period. All in all, DIW Berlin predicts a growth rate of 3.3 percent for 2016, 3.6 percent for 2017, and 3.7 percent for 2018.

Political uncertainty in Europe remains high. France, the Netherlands, and Germany, among others, will all be holding major elections in the coming year; structural problems are plaguing the banking sector, especially in Italy. The outcome of the Brexit negotiations regarding future relations between the UK and the EU are uncertain; this outcome could have a significant impact not only on the UK economy, but also on the rest of the EU. As well, protectionist tendencies – such as those being championed by U.S. President-elect Trump – could negatively impact the global economy later on in the forecast period.

Public budget surpluses are dwindling

Germany’s public budget surplus will decline sharply during the forecast period, from 26 billion this year to 4 billion in 2017, with slight deficits expected in the year 2018. Less dynamically growing revenue, which is partly due to the fact that employment growth is slowing down, is being offset by a marked increase in expenditure – especially on pensions. A look at the public finances reveals that there is no spare money for expanding social benefits or for fiscal perks driven by electoral motives.

Increasing contribution from foreign trade in the medium term

According to the forecast, the German economy will grow by an average of 1.5 percent per year until 2025. Facilitated by solid global demand, foreign trade will again make a positive contribution to growth later on in the forecast period. In Germany, consumption growth will be hindered by a slightly higher inflation rate. Most of all, however, demographic shifts are having more and more of an impact. The repeated increases in social contribution rates are dampening the development of disposable income; as well, expenditure on health services is increasing. Both of these changes are shifting demand from private to public consumption.

Topics: Business cycles