German GDP contracted by an unexpectedly large 0.5% in Q4 2012, according to preliminary estimates of the German government. The contraction is largely due to receding export and capital investment volume and does not necessarily mean Germany is in recession unless Q1 is weak as well. I do have a few comments about the numbers, however. My comments have mostly to do with the German economic model, which I have commented on a few times in the past.
The way I positioned it in 2011 was by asking “What is the secret to Germany’s economic success?” The gist of that post was that the fundamentals for the German economy were favourable. However, because the German economic model is highly geared toward external trade, the country was vulnerable to weak demand growth or recession elsewhere in Europe. And this is what we are seeing from the numbers late in 2012. Even so, Germany has diversified its trade away from Europe, so that problems in the periphery have a more muted impact on Germany’s economic performance than they would have ten years ago. [private_gold]For example, in 2012, Germany had a reasonably high 4.1% export growth and a lower 2.3% import growth. While Germany showed a higher 7.8% export growth in 2011, these 2012 numbers are still much higher than the domestic numbers where household spending was up only 0.8% and government spending was up 1.0% in 2012.My conclusion then is that the German export model is largely successful.
That said, German exports and imports both fell in November as new industrial orders also fell more than expected. And because domestic demand is weak and business investment fell 4.1% in 2012 compared to the 7.3% rise in 2011, Germany’s GDP numbers have been sub-par in 2012. I would expect 2013 to be better if only because we have seen some wage increases and business sentiment is improved, suggesting an increase in capital investment is likely.
Now in 2011, I continued my piece on Germany’s economic success by looking at the downside. There are a few points:
- Demographics: Germany is aging fast and aging societies are marked by slowdowns in GDP growth, something we have seen in Germany over the past decade (see chart here). It is this slowdown in domestic demand that has precipitated Germany’s need to look abroad for economic growth. And it is this need to look abroad and be export competitive which has caused German companies to suppress wage growth, leading to even weaker domestic demand.
- Trade-dependence: despite the trade diversification in Germany, austerity in the periphery has had a negative impact on Germany’s economic growth. So, it goes without saying that continued austerity into 2013 will have a negative impact on German growth.
- Banks: They are under-capitalised as the recent OECD report highlighted. This is something I have repeatedly harped on because it is a major issue driving German policy regarding peripheral bailouts and banking issues. The German government very much wants to keep the German bank capital problem from becoming an issue that puts the country in a favourable light. This is a motivating factor in supporting bailouts in order to avoid writedowns. Germany’s banking system outlook remains negative, according to Moody’s.
- Public debt: Despite 2012’s 0.1% budget surplus, Germany still has a relatively high government debt load above 80% of GDP. Of all of the core countries which are highly rated within the euro zone, this is easily the highest figure. The Netherlands, Finland, Austria, and Luxembourg are all lower. Outside of the euro zone, in Europe countries like Sweden, Latvia, Switzerland and the Czech Republic all have much better debt profiles than Germany. The dirty secret then is that Germany is concerned about its own public finances.
- Wage pressure: both German workers and German pensioners are feeling the strain of the one-two punch of reduced wage increases and reduced government social spending. By one measure, pensioners have lost 20% in real terms over the last decade. The left wing party Die Linke plan to run on an anti-wage suppression platform which is sure to garner them a lot of votes. And depending on how the economy does this could make the possibility of a leftist coalition government greater. The CDU/CSU is trying to win support via its focus on fiscal discipline and prudent economic stewardship. A weak economy makes this selling point weaker.
So far, the German economic model has held up pretty well. Within the euro zone, the Germans have one of the most vibrant economies, largely due to export success over domestic demand. The success has been so good that housing prices are rising to the point that it is causing pain for Germany’s renters and those looking for starter homes. The pain for renters highlights the weakest link in the German model, wage suppression. Despite the lowest unemployment rate in 20 years in Germany, Germany’s employment metrics compare unfavourably to countries like Switzerland that also have an export-based economic model. And the Swiss have had to deal with a high Swiss Franc to boot.
2012 was a transition year for the German economy as I predicted at the beginning of 2012. There was a noticeable downdraft in growth. With the rest of the euro zone in recession, unless we see wage gains in Germany, it looks like this pattern will continue well into 2013.