Germany faces a rude economic awakening
A rude awakening awaits Europe’s former economic powerhouse
Anyone would think we’d been swept away into Lewis Carroll’s Alice Through the Looking Glass. Normally when the economic news is good, the incumbent government likes to boast about it, and contrariwise, to play the news down when it’s poor.
That’s logic, as Tweedledee might have said.
But with Rachel Reeves and her newly installed team at the Treasury, it is the other way around. Positive economic news is treated grudgingly, while the negative is mercilessly played up.
This is the worst economic inheritance since the Second World War, the new Chancellor repeatedly insists in preparing us for tax rises – and she will simply not have it any other way.
Nobody would deny that there are big challenges facing the UK economy, particularly when it comes to the public finances, where the national debt has swollen to nearly 100pc of GDP and there is little sign of the deficit being put on a sustainable footing.
But just look at Germany and things don’t seem quite so bad. Admittedly, the public finances in Germany are in rude health relative to Britain, but the wider economy is struggling as rarely before.
While the UK recorded growth of 0.7pc in the first quarter, Germany barely managed to lift itself out of recession, with growth of just 0.2pc. What’s more, the economy contracted anew in the second quarter even as the UK managed a respectable 0.6pc growth.
The contrast is even more striking when it comes to the more forward-looking data, such as the S&P Global Flash PMI composite output index, a measure of current private sector activity, and the GfK consumer confidence index, one of the longest-running measures of consumer sentiment.
The S&P composite reading for Germany slumped to 48.5 in August, against a relatively healthy 53.4 for the UK, with anything below 50 representing contraction and anything above expansion. Much the same story is told by the GfK consumer confidence data.
Germany is stuck in the doldrums, while the UK economy continues to defy the Government’s doom-mongering with what for the moment is steady growth.
Two quarters of expansion do not, sadly, a summer make. It would be most unwise to think that the current juxtaposition between British and German levels of economic activity has established a lasting trend.
Even so, the UK might seem structurally to be rather better placed to navigate the constantly shifting sands of today’s world economy than Germany, which is stuck in a rut and lacks the flexibility to get itself out.
Many of the problems that afflict the German economy – poor levels of business investment, stifling red tape and bureaucracy, Nimbyism, an increasingly workshy labour force sustained by overly generous welfare, dilapidated infrastructure and an ageing demographic – are quite similar to those of the UK.
But the causes are different, and they are more entrenched. Germany is finding it difficult to adapt to a fast-changing world and, unable to change itself, is in danger of being left behind.
The key reason for German stagnation is depressed levels of business and housing investment, which because of Germany’s strengths in manufacturing have traditionally been a much larger element of GDP than in the UK.
You might expect poor business investment to in part be compensated for, given the recent rise in real wages, by growth in consumer demand. That’s what’s happened in the UK. But we’ve not seen it in Germany, with its cultural propensity to save rather than spend.
As for the fall-off in traditionally high levels of business investment, this is partly explained, according to Clemens Fuest, head of Germany’s Ifo Institute for Economic Research, by increasingly crushing levels of red tape and bureaucracy.
“It’s like requiring all citizens to report on their daily movements as a way of deterring shoplifting”, explains Prof Fuest. “Measured bureaucracy has become as bad as that, and for business investment, the effect is devastating”.
Similarly with housebuilding and construction, where rent controls and planning restrictions have seriously undermined supply.
In Berlin, voters have responded to housing shortages and rising rents by threatening larger landlords with expropriation; predictably, the effect has been to further deter new housebuilding.
With rising protectionism, what used to be one of Germany’s most admirable economic qualities – its propensity to export – has meanwhile become a key vulnerability.
This has in turn encouraged German firms already struggling to compete because of high labour costs to invest directly in overseas markets rather than at home.
The enforced switch from petrol and diesel engines, where German engineering has for decades reigned supreme, to electric vehicles, piles on the agony.
Germany’s Mittelstand of medium-sized family owned businesses, many of them heavily geared to the internal combustion engine – again once considered one of Germany’s key economic strengths – is in danger of being left high and dry.
To cap it all, Germany has found itself badly caught out by its heavy reliance on previously cheap Russian energy supplies.
With war in Ukraine, these have all but disappeared. It almost beggars belief that in the midst of such a crisis, Berlin should further shoot itself in the foot by closing its remaining nuclear power stations.
Relative strength in the public finances theoretically offers Germany a lifeline. Where Reeves finds herself condemned to “tough decisions” over tax and spend, Germany has all the fiscal room it needs to supercharge its economy with stimulus.
But Berlin also finds itself hemmed in by its own self-imposed debt brake rules, and in any case it’s not clear that Keynesian style stimulus works in a country which is structurally a world apart from Britain and also has a very different economic tradition.
Tax cuts tend to be saved rather than consumed, and there is already an unspent €80bn (£68bn) backlog of infrastructure projects held up in the works by byzantine logistical and planning constraints.
Germany’s problems are as much down to deficiencies in supply as demand.
Wander around any of Germany’s major cities, or stroll through its rolling countryside and picture postcard villages, and you wouldn’t believe that this is a country living on borrowed time.
Yet beneath the apparent prosperity lies a sea of trouble where millions are locked in part-time work by generous welfare entitlements that give little incentive to seek full-time employment, and where seemingly every problem is met with a “so ist das Leben” (that’s life) shrug of the shoulders.
Reeves would no doubt gladly swap her own challenges for those of her German counterpart, Christian Lindner, but economic stagnation is not a happy place to be, even when sugared by Germany-style work/life balance.
Germany will eventually bounce back – it always does. But there is a rude, and politically destabilising, awakening to go through before it does.
At least in Britain, we are already fully aware of the mediocrity of our circumstances. Germany still has that moment of self-realisation to come.
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