Germany: Europe’s economic powerhouse

The German economy is the largest one in Europe, and economic growth has continued to out-perform other eurozone economies throughout the current year, driven mainly by exports and investments. In June, the government presented a budget consolidation package, with the aim of reducing its structural deficit and bringing cumulative budget relief of €82 billion. In principle, the cuts are going in the right direction but many questions remain over the effects the austerity measures will have on the country’s economic development in the near future.

Manufacturing industry fuelling growth

German industry has recovered from the deepest recession in its modern day history, even though two years after the beginning of the crisis, current production levels are still 17 per cent below their historical peak. Industrial production in Germany dropped by more than 23 per cent between the peak of the economic cycle in the first quarter of 2008 and the trough in the second quarter of 2009. Among the six largest industrial sectors in Germany, which account for 66 per cent of total sales during the same period, the automotive and the metal industry recorded the steepest decline in production.

However, order intake in the entire German manufacturing industry has recovered substantially with strong impetus coming from foreign orders due to higher economic momentum outside of Germany and the weakness of the euro. The automotive sector has also rebounded strongly during the last few months. In fact, at the end of the first quarter of 2010, output was almost one-third above the level registered at the first half of 2009. The fast recovery is linked to the fact that many car factories were shut down temporarily due to declining demand in order to avoid an excess of supply.

Looking forward, there are positive expectations that orders and production in the German industry will continue to strengthen. However, the momentum could be slowed down, as governments around the world are currently cutting back on stimulus measures, which can affect the purchasing power of consumers.

An economy dependent on trade

The strength of the German economy during the past months has largely depended on the growth of its exports. The dependence on the export market is not new to Germany. In fact, between the year 2004 and 2007, exports accounted for nearly two-thirds of total economic growth in the country. However, in the course of the economic crisis, calls that Germany should not focus solely on exports started to grow louder.

With around 82 million inhabitants, Germany is the most populous country in the European Union and thus has the largest domestic market. While moving away from export-driven growth would make little sense in the current scenario, recent developments in Greece and other peripheral European states, could help in paving the way for more domestic growth and promote domestic demand as a second pillar next to exports.

One way of boosting domestic growth is to foster private consumption, which in a wealthy country like Germany, private demand would be based largely on the services sector. Measures to support demand usually have a more direct effect, such as cuts in income tax or VAT, pay rises in the public sector. However, given the current budgetary situation these instruments can hardly be applied at present.

Austerity package and market discipline

The German government has presented a four-year consolidation package with the aim of reducing its structural deficit. About 65 per cent of the austerity package will consist of spending cuts, which will largely focus on the labour and social security budgets. Expenditure for social security benefits are to be reduced by shedding mandatory state benefits and subsidies and by interpreting social security legislation more narrowly. Moreover, the government is also planning to save money by increasing the efficiency of public job placement procedures.

Overall, it is estimated that the savings in the social security and labour budgets will amount to about 37 per cent of the total package. Another 28 per cent of the budget relief is projected to come from administration, for example in the form of job redundancies, and a reduction via the planned reform of the armed forces. Meanwhile, revenues are to be increased by putting a larger burden on the corporate sector, with the banking sector expected to bear some of the costs caused by the financial-market crises.

Tax privileges given to energy-intensive companies are to be scaled back, while passengers who take off from a German airport will have to pay an air travel levy. Ultimately, the consolidation package pursues two goals at the same time. It aims to support Germany’s European Union obligations, established in the Stability and Growth Pact, by reducing the fiscal deficit to less than 3 per cent of Gross Domestic Product (GDP). Moreover, it will also help reduce the structural deficit from 2011 in order to drop below 0.35 per cent of GDP by 2016.

Growth and the way forward

The debate about how fiscal measures will effect the growth of European counties has been a source of debate. Recently, even the president of the European Central Bank, Jean Claude Trichet, hinted that austerity measures will not have an adverse impact on the economy, because these measures are designed to bring fiscal and economic responsibility to each Member State of the EU.

Meanwhile, the dichotomy that will persist over this debate is that in order to strengthen the domestic market and lower dependency on an export driven economy, austerity measures would clearly not help to support private consumption. Notwithstanding everything, however, the German economy has, to date, been a clear out-performer compared to other eurozone economies and the expectation is that exports will remain in the near future, the engine of economic growth and stability.

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