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German economy growing despite uncertainties and risks; global economy continuing to cool down

Press Release of March 14, 2019

According to DIW Berlin estimates, the German economy will continue its solid growth performance in 2019 and 2020. Overall, however, the economy is cooling noticeably and production capacity utilization is returning to normal. This is primarily due to the global economy weakening; it has been strained by China’s weakening economy, trade conflicts, and political uncertainties such as Brexit. The German economy will be particularly affected by these developments, as it specializes in exporting capital goods. However, the German economy will likely gradually make up for its dip in growth, helped by the fact that private households have been benefiting from fiscal policy stimuli since the beginning of 2019 and the increasing signs of a recovery in the automobile industry. Nevertheless, DIW Berlin has lowered its growth forecast for the German economy to 1.0 percent for this year in light of the gloomier business expectations in many sectors. The outlook for 2020 remains virtually unchanged, however, with GDP forecasted to grow by 1.8 percent.

In the short term, non-recurring effects will dominate the German economy. For example, the automotive industry struggled with weaker sales until winter 2018 due to a delay in certifying their fleet, which was required to adhere to the new vehicle emission and fuel consumption standards prescribed by the Worldwide Harmonized Light Vehicle Test Procedure. However, the latest sales figures show that the sector is gradually compensating for this slump. The chemical industry also appears to be recovering after production dropped by more than 20 percent in the autumn due to low water levels on inland waterways. Moreover, fiscal policy is boosting economic growth: some of the Grand Coalition’s decisions, such as financing health insurance by splitting the costs equally between employers and employees, have resulted in strong income growth for private households since the beginning of the 2019, increasing private consumption.

The domestic economy will continue to support growth over the further course of the forecast period. The labor market is showing no signs of weakening, and employment growth is continuing uninterrupted. In 2019, employment should reach a new record level and the unemployment rate of 4.8 percent should reach a further low since German reunification. Real wages are developing strongly—growing by 1.5 percent—due to price increases, which are currently noticeably lower, and the expected low inflation rate of 1.5 percent. The construction industry is booming, and despite the uncertainties, companies are investing in expanding their production capacity.

However, the currently harsh external economic environment is negatively impacting sentiment. Nearly all sentiment indicators have declined significantly in recent months. Primarily industrial companies’ business expectations are declining globally while the service providers remain confident. There are many reasons for these poor expectations: in the USA, fiscal policy stimuli is gradually waning and the federal government shutdown slowed economic growth. In Europe, the Italian economy is of particular concern, as growth has lagged well below expectations. In Asia, the Chinese economy has weakened recently. Globally, investment goods—one of the German economy’s specializations in foreign trade—have lost momentum in particular. This loss of momentum is especially troublesome for the German economy and is partly a result of the uncertain economic environment, although the trade disputes between the USA and China have calmed down. Signs of trouble remain, however, as the conflict between the USA and the European Union over EU automobile exports to the USA is flaring up again. The introduction of tariffs would pose a considerable risk for the German economy. Ongoing discussions about Brexit are also unlikely to have a positive impact on the economy. In view of the economic slowdown and low inflation, the European Central Bank has already announced that it will continue to provide expansionary monetary policy stimulus. The Federal Reserve has also indicated it will reduce the pace of interest rate hikes in reaction to the weaker economic development in the USA.

The situation is no longer as advantageous as it was a year ago and risks to the forecast have increased significantly, affecting the international environment. China’s government has announced comprehensive economic stimulus packages to support the economy, although if and when these packages will have an effect remains to be seen. Domestic economic forces remain intact in the other export markets, where the slowdown is mainly due to a lack of stimuli from the manufacturing sector. If the weakness in the industrial sector—which is probably caused by uncertainty to a large extent—were to spread to the service sectors as well, global demand could lose further momentum, and the German economy would suffer as a result. However, the German economy is already also facing major challenges in some key industries: for example, German automobile sales were lower, primarily due to certification problems. However, it may also be the case that Germany is increasingly losing ground in global competition: high-revenue car models such as SUVs are predominately being manufactured outside of Germany, and diesel vehicle sales are also slowing in view of the debate on particulate matter. If, for these reasons, the production declines of summer 2018 turn out to be more permanent than thought, this would mean significantly lower overall economic growth in Germany.

Despite these risks, however, DIW Berlin stands by its fundamentally positive assessment of the economic situation, which is largely based on the continued strength of the German domestic economy. Public budgets should therefore continue to close with substantial surpluses. Nevertheless, the financial leeway is shrinking. The surplus will probably fall from 58 billion euros in 2018 to around 37 billion euros in 2020.

At the same time, the level of debt has fallen significantly after years of budget consolidation and is now below 60 percent of annual economic output, in line with the Maastricht criteria. The interest rate level, which remains extremely favorable, opens up opportunities for future financing investments which are necessary and highly profitable, thus generating important triggers for growth. Moreover, an investment stimulus would support the cooling economy. Yet it is not just a matter of updating transport infrastructure to compensate for the wear and tear over the years; the aim must be to push ahead with projects necessary for future development, for example in the areas of digitization and R&D, which would increase growth potential and competitiveness.

Topics: Business cycles

Malte Rieth

Research Associate in the Macroeconomics Department