RaboResearch - Economic Research

Germany: stable economic growth with challenges ahead

Country Report

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The German economy performs well on the back of a competitive export sector and is rebalancing towards domestic demand, driven by a strong labour market. The recent surge in immigration poses a significant challenge for the German economy.

Strengths (+) and weaknesses (-)

(+) Sound institutions and a competitive export sector

Germany’s sound institutions contribute to a strong and competitive export sector that also profits from a prolonged period of wage moderation, strong productivity growth and high world demand for its products.

(+) Large, positive, net international investment position (NIIP)

Germany has had an exports-driven current account surplus since 2002, which averaged around 6% of GDP over the last 10 years. This results in a large NIIP (38.4% of GDP in 2014).

(+) Stable public finances

Although public debt is still above the 60%-threshold, it is on a firmly downward trajectory. This is due to conservative fiscal policies. A debt brake rule prohibiting large structural fiscal deficits came into force this year.

(-) Ageing population and lack of reforms

Germany’s working-age population has declined since 1998, putting a strain on future government finances. Potential output growth is low due to declining labour supply and low productivity growth. Currently, no structural reforms are undertaken to address this.

Key developments

1. Economy is performing well

Real GDP growth remained at 1.7% in 2015, after reaching 1.6% in 2014. Both net exports and domestic demand supported economic activity (Figure 1), benefitting from euro depreciation and lower energy prices. Going forward, we expect growth to stabilise at 1¾% in both 2016 and 2017. This is above potential (about 1.3% according to the IMF). Compared to previous years, we expect growth to become increasingly domestically driven. The private consumption outlook is favourable, as households’ spending power improved on the back of solid average real wage growth (reaching a 20-year high in 2015) and the unemployment rate reaching another post-reunification low at 4.3%. Credit growth and domestic investment, to the contrary, remain tepid, reflecting low demand. Looking forward, population aging will weigh heavily on potential output growth. This could be alleviated by a better integration of women and recently arrived immigrants into the workforce and by (re-)increasing the effective pension age by adding a formal link between life expectancy and pension age. Further reforms, such as deregulation in the services sector and investing in the development of the digital infrastructure, could increase productivity growth. This would in turn make the German economy less reliant on manufacturing and export and thus less vulnerable to external demand shocks.

2. Debt levels are low throughout the economy

Germany’s robust growth is further underpinned by a healthy fiscal position and solid corporate and household balance sheets. The government posted another surplus in 2015, leading the fiscal debt level to decline further to about 72% of GDP. The structural position for 2016 is expected to remain comfortably within the boundaries set by the constitutional debt brake rule and the European medium-term objective. This would afford the government ample fiscal space to further commit to public investment plans that are more ambitious than the current 0.4% of GDP already pledged. Germany’s external position remains solid, with the current account reaching another all-time high in 2015 (8.8%), mostly driven by the oil and gas trade balance, feeding further into the already high net international investment position. 

Figure 1: Growth increasingly domestically driven
Figure 1: Growth increasingly domestically drivenSource: EIU, Rabobank
Figure 2: Immigration inflows into Germany
Figure 2: Immigration inflows into GermanySource: Destasis, Bundesamt für Migration und Flüchtlinge.

3. Refugee inflows pose significant economic and political risks

Over 1 million asylum seekers entered Germany in 2015 (Figure 2). The incoming flow is expected to remain high through 2016, in the likely absence of a European solution to the refugee crisis. Continued strong immigration over the next few years could offset the shrinking of the work force due to aging. However, the lack of a coherent and comprehensive immigration policy has remained unaddressed for many years. Against this background and uncertainty about the qualification structure of most of the immigrants, swift integration of large numbers of refugees into the labour market will be challenging. The recently introduced national minimum wage is a major obstacle in this respect, which will prevent many immigrants from finding employment in the coming years.For a successful integration of the very large number of immigrants into society and the labour market, immigration, welfare and labour market rules will likely have to be adjusted. In addition, substantial upfront expenditures including investment in human capital will be needed. In case of a lack of reforms and insufficient expenditure in human capital, severe risks could emerge in terms of persistently higher structural unemployment and increased social tensions. The government’s handling of the national and international immigration crisis has already lead to a surge in support for populist right-wing parties like the Alternative for Germany that could enter the federal parliament at the next elections in 2017, further destabilising German politics. Thanks to its fiscal surplus, Germany can buffer the unexpected and currently difficult to assess additional expenditure related to immigration by reducing the safety margins vis-à-vis the various deficit ceilings.

4. Risks to the banking sector’s profitability and financial stability

Banks face profitability problems due to the current low interest rates environment as it puts pressure on their earnings. The net interest income from margins will be reduced when loans with a higher yield are rolled over in lower-yielding ones, also exposing banks to higher interest rate risk. The net interest margin of German banks are already well below those of European peers. Recently, Bundesbank supervisors have asked banks that are not directly supervised by the ECB to perform stress tests under various yield curve assumptions. Further consolidation to cut costs would seem a realistic response to the current environment, but appears to be moving only slowly. Life insurance companies face long-term solvency challenges, forcing them to maintain adequate capital buffers. The Life Insurance Reform Act passed in July 2015 is expected to have a significant positive impact on the sector’s solvency according to the Bundesbank, but this may not be enough to offset the impact of low interest rates.

Factsheet of Germany
Factsheet of GermanySource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Germany is the fourth-largest economy of the world. Its economic growth has been primarily driven by exports during the last decades. After reunification, a strong wage increase led to a deterioration of export competitiveness, that gave Germany the nickname ‘the sick man of Europe’. Through a long period of wage moderation and productivity increases, competitiveness recovered. Nevertheless, the country suffered a severe recession in 2009. The recovery was stronger than in most other countries, due to high demand for their export products (especially cars) from emerging markets (especially China). Unlike other euro area countries, unemployment decreased between 2007 and 2013 and that is often attributed to the labour market reforms (Hartz) of 2003. The Merkel government, in power in various constellations from 2005, has very low reform appetite. A minimum wage was introduced in the course of 2014 and 2015 and has initially led to no employment losses. Gross private sector debt is among the lowest in the euro area, which makes private sector deleveraging largely unnecessary. Although public debt is still above the 60% of GDP threshold (72% of GDP in 2015), it is on a downward path (reaching 60% of GDP in 2020 according to the IMF). The debt brake rule that forbids the government to run a structural deficit in excess of 0.35% of GDP from 2016 onwards enhances this further. A long-term challenge for both economic growth and public finances is population ageing. The primary pension is a state pension, which is a pay-as-you-go system that will be difficult to finance with a rapidly ageing population. The banking sector has assets equal to over 300% of GDP and a large amount of banks can be separated in roughly three sectors, private sector banks (39%), public sector banks (including Sparkassen and Landesbanken) (28%) and cooperative & mortgage banks (21%). 

Economic indicators of Germany
Economic indicators of GermanySource: EIU, Rabobank
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