Germany: Europe’s tired engine

Article by: THE ECONOMIST
Updated: August 20, 2012 - 5:26 PM

As the eurozone goes into another recession, Germany is slowing down.

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With restaurant tables – and more – idled in Spain and other parts of the EU by persistent economic problems, all eyes are on Germany’s economy, which is showing signs of sputtering.

Photo: Ginnette Riquelme, New York Times

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After a promising May and June, Steffen Knoop has seen his sales dip by 30 percent. His small Hamburg, Germany-based company, Wascut, sells cooling and cleaning oils for big machines, including those that make cars. "I have a pretty good window on the economy," he said, wondering whether the dip is caused by people taking extra-long summer holidays or something more serious.

Others with a broader and more long-term view of the economic landscape are asking the same question. Hopes are pinned on Germany as the locomotive that will keep chugging even as large parts of the eurozone go into recession. As long as Europe's biggest economy keeps growing, the argument goes, it can gradually pull others out of the mire. Figures released last week duly showed that German GDP grew in the second quarter but only by 0.3 percent. That was better than in France (no growth at all), Spain (minus 0.4 percent) and Italy (minus 0.7 percent).

Until the end of last year, German growth seemed to be gathering speed. Then some warning signs started to appear. The business-climate index of Ifo (Institute for Economic Research), which started falling in August 2011, has edged more or less persistently down. In July, business expectations hit a low not seen since mid-2009. The Markit/BME purchasing managers' index, which measures the state of manufacturing, also started to fall last year; in July it, too, hit its lowest level since June 2009.

At least German exports continue to be buoyant. Most companies with an export bias are reporting good half-year figures (as are many consumer businesses that would normally suffer in a downturn). German companies have found growing export markets in Asia, central Europe and the United States that more than make up for a fall in demand from eurozone countries. Consumption is actually quite steady. Retail sales showed a 2.9 percent increase in June compared with June 2011. The job market is robust, despite big layoffs in retail chains, banks and power companies. Some recent union agreements have raised wages by as much as 4.5 percent. The property market is buoyant, especially in the big cities. Consumer sentiment as measured by GfK, a research company, shows that citizens feel well off and have a willingness to buy, but at the same time are fearful the German economy will be sucked into the eurozone crisis.

The flashing light that worries economists most is the fall in capital investment. If companies are not willing to invest in new capacity, hopes for a domestically driven recovery will be dashed. The fall in investment, particularly capital spending, reported in the GDP announcement is an alarm signal, said Mario Ohoven, president of the Association for Small and Medium-Size Businesses. Germany's big car companies, however, show no sign of pulling in their horns. BMW is expanding capacity in China, North America and Britain. Daimler opened a truck plant in India in June and Volkswagen plans to invest over $74 billion worldwide by 2016.

Yet, despite continued record sales globally, these companies are not immune to what is happening to demand for cars in Europe -- a fall of 6 percent in the first half of the year. BMW sold 0.5 percent fewer cars in Europe (and 1.5 percent fewer in Germany) in the second quarter than in the same period of 2011. Daimler sold 11 percent fewer Mercedes cars in western Europe in July than in July 2011. And those are the thriving carmakers.

Opel/Vauxhall, GM's loss-making European subsidiary, saw a 14 percent drop in car sales over the first half. Over the long term weak demand for cars in Europe threatens seriously to affect the German car industry and its network of suppliers. However attractive the rest of the world may be, the EU still buys 40 percent of all German exports.

Hopes that the German consumer will somehow come to the rescue and reduce Germany's export dependence are misplaced. It is hard for Germany to grow under negative conditions, said Stefan Schneider, an economist at Deutsche Bank. The last time it managed this was with German unification in the 1990s when tax incentives promoted investment in eastern Germany. Similar incentives to encourage investment and outsourcing to peripheral eurozone countries might do the trick. Otherwise, the locomotive is likely to stall.