Country in focus | Germany

Country in focus | Germany

In GDP terms, the German economy is the fifth largest economy in the world and Europe's largest. Germany is a leading exporter, being the third largest exporter in the world with €1.13 trillion in goods and services exported last year, and benefits from a highly skilled labour force. Germany is a founding member of the European Union and the Eurozone. However, Germany faces significant demographic challenges to sustained long-term growth. Low fertility rates and a large increase in net immigration are increasing pressure on the country's social welfare system and necessitate structural reforms.

Reforms launched by the government of Chancellor Gerhard Schroeder, deemed necessary to address chronically high unemployment and low average growth, contributed to strong growth and falling unemployment. These advances, as well as a government subsidised, reduced working hour scheme, help explain the relatively modest increase in unemployment during the 2008-09 recession, the deepest since World War II. The new German government introduced a minimum wage of about €8.50 per hour that took effect in 2015.

Stimulus and stabilisation efforts initiated in 2008 and 2009 and tax cuts introduced in Chancellor Angela Merkel’s second term increased Germany's total budget deficit, including federal, state, and municipal, to 4.1% in 2010, but slower spending and higher tax revenues reduced the deficit to 0.8% in 2011 and in 2015 Germany reached a budget surplus of 0.9%. A constitutional amendment approved in 2009 limits the federal government to structural deficits of no more than 0.35% of GDP per annum as of 2016, though the target was already reached in 2012.

The German economy suffers from low levels of investment, and a government plan to invest €15 billion during 2016-18, largely in infrastructure, is intended to spur needed private investment. Following the March 2011 Fukushima nuclear disaster, Chancellor Angela Merkel announced in May 2011 that eight of the country's seventeen nuclear reactors would be shut down immediately and the remaining plants would close by 2022. Germany plans to replace nuclear power largely with renewable energy, which accounted for 27.8% of gross electricity consumption in 2014, up from 9% in 2000. Before the shutdown of the eight reactors, Germany relied on nuclear power for 23% of its electricity generating capacity and 46% of its base-load electricity production. Domestic consumption, bolstered by low energy prices and a weak euro, are likely to drive German GDP growth again in 2016.

German economic growth last year was supported by exports and private household demand. Export performance has been very good over the past 10 years, keeping the share of industry in domestic value added at an unusually high level of 22%. Exporters continued to gain significant market shares in part owing to the depreciation of the euro. Exports of transport, electronic and optical equipment as well as chemicals, for which Germany has a long standing comparative advantage, were particularly strong. Empirical evidence suggests that decentralised management, with significant worker involvement, has provided incentives for product improvements, helping exporters to compete on quality, while offshoring production to low wage countries has reduced costs of intermediate inputs. However, weakening growth in emerging economies has started to weigh on exports. Demand is therefore shifting from external sources to private households, which are projected to remain the main driving force for growth in the near term. Household consumption will be backed by strong real wage growth, as cheap oil has impaired consumer prices, while a tight labour market and the introduction of the national minimum wage have pushed up nominal wages. Demand for housing continues to rise, pushing up housing rents and prices in urban centres and spurring construction. Loose monetary conditions and expansionary fiscal policy, in part reflecting government spending for the needs of newly arrived refugees, provide further stimulus to domestic demand. Wage growth has raised labour unit costs somewhat, but price competitiveness remains strong and inflation is still very low. Mortgage lending to households has picked up, while lending to non-financial businesses remains subdued.

Overall, GDP is projected to remain solid in 2016 and 2017, as domestic consumption remains strong and the demand for German exports in the euro area recovers and compensates emerging economies weakness. The newly arrived humanitarian immigrants will start looking for jobs only gradually and immigration is assumed to diminish. The cyclical unemployment rate is expected to remain low, but the natural rate will rise because of the large number of refugees with a long distance from employability. Consumer price inflation is projected to rise, as wage growth has picked up, there is little remaining economic slack, and as the effect of the fall in oil prices will wear off. Weaker export growth, robust domestic demand growth and lower net foreign capital income are projected to reduce the current account surplus.

A sharper slowdown of activity in emerging markets and renewed weakness of activity in the euro area could weaken exports more strongly than projected, reduce investment, and spill over to consumer confidence. The German economy depends more on world trade than most because of the high weight of exports in GDP and the relatively high share of investment goods exported to emerging economies. 

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