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German economy back on track, despite some rough waters

Press Release of March 16, 2016

DIW Berlin’s forecast: GDP to rise by 1.6 percent in 2016 – robust labor market, wage increases, and refugee expenditure fueling consumption – investment and global economy inhibiting growth

According to the German Institute for Economic Research (DIW Berlin), the German economy is expected to grow by 1.6 percent this year, despite a gloomy global economy. This prognosis is similar to the one made in December 2015. As was the case last year, consumer demand is contributing significantly to this growth: more and more people are taking on employment, and wages are rising noticeably. These factors, as well as the purchasing power gains due to the low energy prices, are fueling private consumption. As well, the expenditure on the care, accommodation, and integration of the refugees is also increasing consumption. However, investment in equipment and machinery has been extremely modest, and has actually experienced some decreases recently. From the spring onward, demand for German exports is likely to increase among many foreign markets. Overall, however, the global economy is exhibiting weak development: this year, global economic output is expected to grow by only slightly more than three percent, which is the slowest it has been since the financial crisis in 2009 (as was the case last year). Many emerging countries that export raw materials are still struggling with low oil prices, and the growth path of the Chinese economy is currently not very promising.

IN SHORT

Marcel Fratzscher (President of DIW Berlin): “The German economy is expected to roughly maintain its pace of growth— but without the refugee expenditure that is serving as a stimulus package, it would lose momentum. Companies are still investing far too little due to poor conditions, and equipment investment was actually on the decline recently. The good public finances situation should not be wasted on more election gifts, but rather used for urgently needed investment in education and infrastructure.”

Ferdinand Fichtner (Head of the Department of Forecasting and Economic Policy): “The global economy is stalling, and is currently experiencing its slowest growth since the crisis. As well, many commodity-exporting emerging countries are also suffering due to the low oil prices. But where there are losers, there are also winners: The industrialized countries are benefiting from the increased purchasing power resulting from the low energy prices. Overall, consumption is increasing, but at the same time, weak demand from the emerging countries is inhibiting growth. When demand picks up again in these countries, the global economy’s growth pace will also do so.”

Simon Junker (Deputy Head of the Department of Forecasting and Economic Policy and an expert on the German economy): “Although the German economy is back on track, we’re still in troubled waters. The weakness of the global economy was having a noticeable impact on the German economy at the beginning of the year, but recently, industrial production has been on the rise once again. And we can count on the domestic economy: The labor market is still going strong, and wage increases and lower energy prices are increasing purchasing power. In addition, refugee-related expenditure is also boosting consumption. It remains to be seen, however, how the refugee influx actually develops and how well the integration—especially into the labor market—works out. The economic forecast depends to a large extent on assumptions related to these factors.

Kristina van Deuverden (Research Associate in the Department of Forecasting and Economic Policy and an expert on finance): “Public budgets will conclude this year and the next at a surplus, despite the expenditure related to the housing, care, and integration of refugees. Because spending overall is increasing more strongly than revenues are, there will be less financial leeway. Moreover, social insurance will contribute the most to the surplus, while the surplus is expected to decline among the federal, the Länder and the municipality level until 2017. It is all the more important now to emphasize growth-oriented policy.”

The risks for the global economy have increased. For one, increased volatility in financial markets and the partial deterioration of private financing conditions could have a negative impact on growth. As well, the low oil prices are increasingly putting pressure on energy companies, their creditors, and the state budgets of commodity-exporting countries. This could lead to renewed turmoil in the financial markets. Another risk is persistent deflation in the euro area, which would lead to consumer reticence and complicate private and public debt reduction. Lastly, there are political differences in Europe—such as those associated with the challenges posed by the refugee influx—that could reverse the political integration process. But if the transformation of the Chinese economy leads to major disruptions—which is not what DIW Berlin expects—this would have a powerful impact not only on the global economy, but also on the highly intertwined German economy as well.

Global economy is stalling

The global economy is not yet back on track. Low commodity prices—especially in the case of oil—are having different effects: On the one hand, revenue is falling among commodity-exporting countries such as Brazil and Russia, and government budgets are under increasing pressure. On the other hand, the low energy prices are an important driver in many industrial countries, since they strengthen the purchasing power and increase domestic demand. Overall, it is primarily the emerging economies that are inhibiting global growth: for example, the Chinese economy is weakening due to overcapacities in the industrial sector and the transition to a more consumer-oriented economy. However, more major distortions are not expected. On balance, the global economy should grow by only 3.3 percent this year. Next year, a slightly stronger increase of 3.7 percent is expected if the economies in the emerging countries recover somewhat as a result of a renewed stability in commodity prices.

German industry regaining momentum, but primary growth driver remains private consumption

As foreign demand gradually recovers, German exports are likely to regain momentum. Because exports are still stalling somewhat due to the overall global economic environment, many companies are continuing to hold back with investment. In the second half of 2015, private equipment investment actually declined. However, the decline in industrial production was only temporary, and began to rise again at the beginning of 2016. The domestic economy has been and will continue to be the primary growth driver. Private consumption benefited from the low inflation resulting from the low oil prices, wage increases, and growing employment levels. The unemployment rate, after it sinks once again this year (to 6.2 percent), will rise to 6.6 percent next year—not due to a decrease in employment, but rather because more and more refugees will obtain German work permits and the number of persons eligible to work will therefore rise faster than the number of those who actually find jobs.

Despite the additional expenditure related to the refugees, overall public budget will likely end 2016 and 2017 with surpluses. Tax revenue continues to rise significantly, but it is social security contributions in particularly that are seeing the biggest increases. However, expenditure is also increasing significantly, primarily because the government expenditure for refugees will amount to 15 billion euros this year and 18.3 billion euros next year. The budget balance will drop from last year’s 0.6 percent to 0.5 percent this year, and to 0.4 percent next year.

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