Is the German model faltering?
An article by Dr. Jörg Zeuner
Chief Economist and Head of RIS
The German economy shrank by 0.1 per cent in the second quarter. What was once the driving force of the eurozone is now the laggard. German companies are among the hardest hit not only by Brexit and the trade dispute but also by the difficult economic situation in Turkey. No wonder we are beginning to fear a recession here. Is our old economy insufficiently equipped to meet the challenges of our time, from climate change to digitalisation? The stock markets seem to think so. But what needs to change for the German economy to get back on track?
Germany benefited hugely from the introduction of the euro. Its net exports to the eurozone went through the roof at the time. The euro crisis beginning in 2009 put an end to this boom. But German companies knew what to do. The country’s key industries – engineering, automotive and chemicals – shifted their sales markets to the UK, the US and China. The trail of capital spending often followed them. The BMWs and BASFs of this world took delight in the rise of China and strength of consumer demand in the US. But the increase in protectionism – whether in the US or in the UK – and the latest escalation of the trade dispute are causing globalisation to falter. Germany is feeling the effects of weakening global trade more strongly than others, and this has turned it into the eurozone’s economic laggard.
Germany the growth laggard
compared with the previous quarter
Europe lacks fertile ground for tech
German companies are not just suffering from the downturn in global trade and the end of the global investment boom, they are also facing structural problems. The DAX 30 index shows that the strength of the German economy mainly lies in the old economy with its emphasis on exports. The industrial, chemicals, automotive and financial sectors make up almost two thirds of the index. In the US, these sectors account for just under 40 per cent. However, the new economy, which includes growth-oriented, future-focused industries such as tech and biotech, is more strongly represented in the US. Tech companies comprise nearly a quarter of the S&P 500 index but only 14 per cent of the DAX 30. The sluggish expansion of broadband and mobile phone coverage, the dearth of venture capital and a lack of support from the major banks are not exactly providing fertile ground for technology start-ups.
The automotive industry is also falling behind, with dieselgate, new emissions standards, and the growing importance of electric vehicles and self-driving cars just some of the challenges it is facing. And if the vehicle manufacturers were not suffering enough from the trade fiasco, there is still the lingering threat from US President Donald Trump to impose tariffs on cars.
Furthermore, German companies are not equipped to meet the agreed climate targets. A huge amount still needs to be done to ensure that by 2030, carbon emissions in Germany are reduced by 55 per cent relative to 1990. These changes have been initiated in only a handful of sectors so far.
France leading by example
Climate change, digitalisation and new drive technologies: German industries are faced with numerous challenges that require urgent action. In the case of digitalisation in particular, this often entails a switch to new business models. So it is all the more regrettable that German companies have, for a number of years now, increasingly chosen to save rather than invest. They should look to France. French firms have made much more aggressive use of the negative interest rates. They have been borrowing far more in order to finance capital spending and acquisitions. Many have been investing in new business models and the latest technologies so that they are better able to face the challenges of the future.
However, we have to cut German companies some slack. There is no doubting their capacity for innovation. During the euro crisis, for example, they showed that they are extremely flexible. And the overhaul of their business models is in some cases already under way. We actually rate the DAX 30 companies quite highly when it comes to innovation. But they are being held back by an environment that is not exactly conducive to investment, despite negative interest rates. In Germany and in Europe, we need a clear and stable business climate so that German businesses can get back to focusing more on European markets. More extensive broadband coverage, higher spending on R&D and training and modern immigration laws would all form part of this. Global risks will be difficult to control, of course, but we should be more than capable of mitigating the uncertainty in Europe and Germany. Only by leveraging new potential for growth in Europe will we be able to make ourselves less dependent on the rest of the world.
Europe is in demand
The power to leverage new growth lies in the hands of the EU member states themselves. It begins with much higher net government spending on infrastructure, training and innovation and measures to streamline the state. European nations need to invest in the transition to a carbon-neutral economy as well as in digitalisation and future-focused technologies. If we want more electric vehicles and more tech companies, the new European Commission should strive to modernise and standardise the environment in which businesses operate. Ultimately, the eurozone countries must put in place a framework that strengthens the currency union from a structural standpoint. This will mean sharing risk, but it will also unleash the forces of growth. There is no better time to do this, because at 85 per cent of GDP, the eurozone has the lowest level of debt of the G3 economies. And the negative interest rates will only be an advantage if we invest.
The German economic model is clearly not obsolete and is being carried by a large number of very successful small and medium-sized enterprises. But the country will make life unnecessarily difficult for itself if it does not face up to the challenges. Germany needs to do a lot of the work itself, but we should be thinking as Europeans. If we do not stand shoulder to shoulder in Europe, then not just Germany but the whole of Europe will find itself in a Japanification scenario. If we return to a European growth policy, business will follow and invest. Then nothing will stand in the way of solid returns in the capital market.
Unless otherwise noted, all information and illustrations are as at 11 September 2019