Germany’s near-recession in the second half of 2018 was a surprise to many. It should not have been.
World trade growth slowed starting early 2018 just when the German auto industry was dealing with a wrenching drop in domestic sales. This concurrent hit to two of Germany’s vulnerabilities — overwhelming dependence on buoyant world trade and accelerating obsolescence of its industrial structure — is pushing the economy into recession. Absent a heroic policy effort, a protracted German slowdown will curb European growth. It could fuel a further rise in nationalism, which would deliver another blow to the vision of a unified Europe.
Since the start of the millennium, the German economy’s reliance on external trade has implied an eerie dependence on the strength of the Chinese economy. As China experienced explosive growth in the early 2000s, German exporters, acclaimed for their high-quality engineering products, found a bonanza: a Chinese government investing on a historically unprecedented scale in leading-edge infrastructure, consumers with an insatiable appetite for Mercedes and BMWs, and factories ramping up with high-end machine tools. Between 2004 and 2006, heady years of world trade growth, virtually all of Germany’s increase in exports went to China. In late 2009, Chinese authorities rescued German manufacturers teetering from the blow delivered by the global financial crisis. China’s fiscal and credit stimulus on steroids, designed to energize the domestic economy, created voracious demand for German products.
Thus Germany — and Europe, carried along in its wake — powered ahead again in 2017 when Chinese policy makers, frustrated by their inability to hit absurdly high GDP growth targets, injected a new round of stimulus.
However, fearful of further inflating their property and credit bubbles, Chinese authorities pulled back on the stimulus in late 2017. World trade decelerated. German industrial output swooned. GDP contracted in the third quarter of 2018 and barely grew in the fourth quarter. Germany’s blue-chip stock-market index, the DAX
fell sharply. Although the benchmark has steadied in January, a respected German economic indicator fell to a four-year low. The direct blow of slower world trade growth combined with a weaker Germany have rapidly decelerated European growth.
Alongside slower world trade, longer-term pressures on the auto industry have intensified. Car producers and their multilayered network of suppliers sustain about 14% of the German economy. Of particular importance are diesel-fuel based car engines, a German invention on which the industry is heavily reliant. In Germany and elsewhere in Europe, sales of diesel cares have fallen sharply following snowballing revelations that car producers and their suppliers wantonly cheated on emission standards.
In February 2018, a German court ruled that municipal and city authorities could restrict diesel car usage without federal legislation. In May, Hamburg banned diesel cars on certain city roads. Perhaps most importantly, electric cars will gradually replace today’s internal-combustion-engine-based car. And in electric car technology, German producers lag behind world leaders.
Relegation to the world’s second-tier economic league?
Germany’s fabled manufacturers have reinvented themselves in past decades, but always within the same framework of engineering excellence, supported by an enviable apprenticeship system that produced generations of highly industrially literate factory workers.
However, today, the global technological race is in science-and-mathematics-based electronic and computing technologies, where Germany is proving an also-ran. Among the world’s top 15 science and mathematics university programs, East Asian economies — China, Korea, Japan, and Taiwan — take prized spots along with the United States. No German—or European—university makes that prestigious list. Germany could easily fall into the world’s second-tier economic league unless the country’s leaders act with new urgency
Germany is another example of a great economic power fearful of giving up a celebrated past and hence is trapped in the present. The politically powerful car industry is lobbying to hold back change. Helpfully, Chancellor Angela Merkel has argued against higher emission limits. For her, too rapid a shift could hugely disrupt the networks of production that generate wealth.
Germany is another example of a great economic power fearful of giving up a celebrated past .
Merkel feels the ire of aging Germans hurt most severely by the continuing industrial attrition. Such older Germans are at the leading edge of the country’s increasing social and political tensions. As Alexander Roth and Guntram Wolff of the Brussels-based think tank Bruegel have noted, voters for the right wing, anti-Europe Alternative für Deutschland party are predominantly older, relatively poorly educated men in non-urban areas whose well-paid manufacturing jobs are moving to either lower-wage Eastern European nations or are being eliminated by automation. New jobs are increasingly in the service sector on anxiety-ridden temporary contracts with reduced wages and benefits.
The social trauma of this economic transition is eroding public support for Germany’s mainstream political parties. As new contenders vie for influence, the political system is fragmenting, threatening Germany’s vaunted political stability.
Some have dismissed the current economic downturn as temporary, caused by the struggle to meet new emission standards and by the decline in river water levels, which slowed inland water traffic.
However, an inevitably slower Chinese economy and gradual obsolescence of Germany’s old industrial structure will weigh heavily on German growth, which will depress Europe’s already low long-term growth potential. The continuing rise in German political entropy will further erode the country’s grudging financial support of Europe.
Ashoka Mody is the Charles and Marie Robertson Visiting Professor in International Economic Policy at Princeton University and previously was a deputy director of the International Monetary Fund’s European Department. He is the author of “EuroTragedy: A Drama in Nine Acts.”
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