By Julius Probst
There is reason to believe that Germany may able to overcome the current economic downturn much better than many of its European peers. Combined with the fact that the country got somewhat lucky and had a good response to the health crisis, there’s Germany’s debt to GDP ratio, which was among the lowest in the Euro Area before the current crisis. More importantly, German Bunds are one of the very few global safe assets right now, and the current safe asset shortage allows Germany to borrow at negative interest rates throughout the entire maturity structure of the yield curve.
During the current freefall of economic activity due to the lockdown, Germany was able to ramp up its fiscal spending to a much greater extent than many other EA countries. The German stimulus currently amounts to more than 10% of GDP, and the actual number is probably higher when you take deferrals and other liquidity guarantees into account.
However, having a closer look at Germany’s economic model, and particularly its reliance on an export-driven growth model, I’m forced to doubt the probability of a problem-free recovery – and that is the core of this blog post.
The first thing to note is that Germany‘s export to GDP ratio increased significantly after adopting the Euro, and has been approaching 40% in recent years. This is significantly higher than that of other large European economies, like France or the UK.
Macrobond Moment: If you want to compare this ratio to that of other countries, you can download this chart and use the “change region and duplicate” feature in Macrobond – where we automatically select the equivalent series that’s been mapped across countries. Here’s a quick tutorial on that. And if you don’t currently have Macrobond,you can try it out.
In terms of the exporting goods, it turns out that Germany is extremely reliant on the car industry. Car and car parts make up about one-sixth of total German exports as of 2020.
Most of those exports are going to the US, China, the UK, and Southern Europe. As I have written before, I believe Southern Europe will face a significant depression in the coming years as a result of the Covid shock. Given that trade is highly dependent on geography (proximity), Southern European weakness should also be a big concern for the German export-oriented economy.
As one can see below, car sales have plunged significantly across Europe, between 60% to more than 90%, depending on the country in question. This unprecedented decline in sales will negatively affect the car industry for the rest of the year. While production has slowed or stopped in recent months, future sales will first come out of the huge increase in inventories that has occurred during the current shock.
And as a result of the current economic downturn, CDS for German car manufacturers have increased significantly over the last few months, to an extent not seen since the Great Recession one decade ago.
Furthermore, equities in the automobile industry have been among the worst performers this year.
By being so reliant on external demand in general, and the car industry in particular, Germany’s economy might also turn out to be quite vulnerable in the period ahead. The graph below displays the contributions to GDP from private and government consumption, investment, changes in inventory and trade.
Since the introduction of the Euro, Germany’s exports have had a significant impact on overall GDP growth. Using our Statistics tool, I have calculated the average contribution of net exports since 1999, which has been 0.08% for an average quarterly GDP growth rate of 0.35%. The contribution of net exports to total GDP growth has therefore been more than 20% over the last two decades.
Remember that European quarterly GDP statistics are not annualized unlike the US figures, so a quarterly growth rate of 0.35 corresponds to an annual GDP growth rate of 1.4% (1.0035^4).
During the early 2000s, when the German current account moved from being balanced to having a surplus of more than 7% of GDP within just a few years, the contribution of exports to German GDP growth increased significantly.
Germany is not only very dependent on the car industry, but manufacturing in general. Compared to other large European economies, especially the UK, manufacturing is still a much larger component of total GDP. While the UK economy has become extremely service- and finance-oriented since the 1990s, especially with London being one of the top global financial centers, Germany does not have an equivalent. Instead, Germany’s strength is its strong manufacturing base.
Manufacturing is obviously a high-productivity sector. Using data from the German Statistical office, I have ranked the gross value added per working hour for different sectors in the economy. As one can see, GVA in manufacturing is some 10% higher than the national average (I have excluded the real estate sector from this bar chart since it is a huge outlier).
Macrobond Moment: I inserted a sorting analysis to show the series in the bar chart in descending order.
Obviously, productivity is also highly correlated with income per worker, and manufacturing therefore also pays relatively high wages compared to other sectors: The average annual income in the sector was almost 60.000 Euros as of 2020, which is more than 20 % higher than the national average of 45.000.
The manufacturing sector also employs some 7.5 million workers, a considerable share of the total German workforce. There are already reports of lay-offs in many companies that supply the car industry.
While Germany has a relatively generous program of short-time working, where the state replaces a substantial part of the workers’ wages, companies might ultimately have no choice than to let people go if the current state of weak demand persists.
There are currently more than 800.000 workers employed in the German car industry alone, and at least 100.000 jobs are at high risk as a result of the pandemic. Just the job losses from that sector would translate into a significant reduction in domestic demand via the standard Keynesian multiplier effect.
Given the economic dynamics at play during the current crisis, I wonder whether what was previously an advantage to Germany, its reliance on a strong manufacturing sector and a large car industry, will now turn into a weakness over time.
Using Macrobond‘s performance analysis, I have compared the total return for US equities and European/German equities. As one can see the former have outperformed the latter by a wide margin over the last decade.
While part of the divergence can also be attributed to weak European growth, the US is also outperforming thanks to the ICT sector, which is much more predominant than in Europe.
Macrobond Moment:I used the currency conversion tool to calculate both return indices in Euros with one click as it only makes sense to compare returns in the same currency, be that euros or dollars.
But it is not only in terms of equity valuations that the US has done better. Some research suggests that US economy-wide productivity has outperformed European productivity since the 1990s because of the ICT sector, which is larger and more innovative in the US.
Consider that a lot of recent innovations, even in the car industry, have come out of Silicon Valley – driverless and electric vehicles, for example – whereas Europe seems to be lagging behind in many key technologies. I find it striking that Internet giants like Apple and Alphabet seem to have a competitive edge in the production of autonomous vehicles compared to the classic German and European car makers.
While in the aftermath of the Great Recession, Germany was able to pull itself out of the crisis by relying on Emerging Market growth, and especially China, it is far from clear whether this will work today. And as I have argued above, it is questionable whether an export-led growth strategy is desirable in the long-run. Combined with the fact that the US IT sector is more innovative, there is some reason to be pessimistic about Germany’s strong reliance on an old and maybe outdated industrial product: cars with a combustion engine.
As an addendum, I should also note that I wrote this blog post before Macron and Merkel‘s ambitious announcement of a EU recovery fund of 500 billion Euros. This could potentially be a game-changer for Europe, but also it is far from certain whether the proposal will pass. Until then, we’re on the edge of our seats.Disclaimer: We don’t usually have views and opinions about economic and financial states of affairs, (not ones that we express publicly as a company, anyway). We do believe, however, that people can and do appreciate a variety of perspectives. What you’ve just read is the perspective of the author. While we think our writers are very smart, Macrobond Financial does not expressly endorse the views presented here. And, as the old adage goes, you shouldn’t believe everything you read (not without finding the data, performing a few analyses and presenting it in a nice chart). We want to make it clear that we are not offering this information as investment advice. That being said, if you have Macrobond, you can easily check everything that’s mentioned here, and decide for yourself. If you don’t have Macrobond, now you have a great reason to get it.