Can Germany Get Going?
By Natascha Gewaltig
Germany remains in a funk. Gross domestic product growth in the euro zone's largest economy is still subdued. And while the trend is toward greater growth, the balance of risks is firmly to the downside.
Action Economics continues to see German GDP growth of 1% or less this year and 1.3% next year. Considerable uncertainty prevails, and much will depend on political developments and the commitment to reform.
There are some heartening signs. Real-sector data point to a pickup in growth in the third quarter compared with the disappointing stagnation in the second. Recent growth appears to be boosted by a marked increase in demand for manufacturing goods. Manufacturing orders already rose 0.8% quarter-over-quarter in the second quarter, after declining 0.7% in the first, which points to stronger growth in the third.
BEYOND THE NUMBERS.
Monthly growth rates have exceeded expectations since May. Plus, the 4.1% month-over-month rise in July is a good sign for growth in the last quarter, even though we expect some correction with the August numbers.
Demand is still coming mainly from abroad, but there are some tentative and encouraging signs of a rebound domestically. Production has not caught up with the strong orders inflow yet, which may partly reflect companies reducing inventory levels again after the strong buildup in the second quarter.
Inventories contributed 0.3% to the second quarter's growth rate, and a possible correction will depress growth in the third. We are looking for a quarterly growth rate of 0.3%, which would be up from 0% in the second quarter and leave the economy on track for growth of 1% or slightly under this year.
Looking further ahead, both the ZEW and the Ifo business-sentiment surveys improved markedly in the third quarter. The future-expectations reading in the Ifo, which leads annual GDP growth by one quarter, rose to 95.5 from 92.9 in June. The ZEW -- more forward-looking but less reliable -- rose to 51.9 from 17.8. This figure would point to a pickup in growth at the start of next year.
So the general upward trend remains intact. However, the risk factors remain worrisome, and not only because of oil prices. Downside risk is due primarily to the political situation.
The overall reading for the latest ZEW survey dropped like a stone, to just 38.6 from 50.0, after the Sept. 18 election did not produce a clear winner. Financial-market analysts may be more sensitive to political developments than producers, and the Ifo actually improved that month. However, 80% of the Ifo responses came in before the general election, so the Ifo's October reading may reflect the disappointing outcome.
The political uncertainty is not only casting a shadow on investment prospects but is also likely to restrain the mood of consumers, who have been very negative in recent years. The latest GfK consumer-confidence survey showed consumers more optimistic about the general economic outlook but still scaling back their willingness to buy.
What's needed: a political leadership that can turn the mood of the country around and spread optimism. But what are the prospects for this change?
After commentators played through all the possible options in the wake of the September election, it's clear that in all likelihood a "Grand Coalition" between the center-left Social Democratic Party (SPD) and the conservative Christian Democratic Union/Christian Social Union (CDU/CSU) will lead the country.
Many fear this could bring the reform process to a standstill, but we believe it offers great opportunities, as neither side will lose out against the other if such a government proposes unpopular measures.
And many of the pending reforms will be unpopular. Both parties are likely to press ahead with a simplification of the tax system, which is good news. It's also good that the SPD will have to bury its plans for extra taxation on high-income earners.
Both parties agree further reforms of the social security system are needed. A coalition with the CDU/CSU may allow the SPD to agree to a relaxation of job security regulation, which will help the labor market.
SHIFT THE MOOD.
The bad news: the parties are likely to agree quickly on a hike in the value-added tax (VAT). This would be fine as part of a general reform that included a switch from direct to indirect taxation. However, at this moment, with high oil prices already eating into real disposable income, such a step could further weigh on consumer confidence and growth prospects.
Indeed, the main question is whether the new government will be able to lift the mood in the euro zone's largest economy and instill some confidence. With the CDU/CSU the strongest party in Parliament, it is likely to get the Chancellorship. That should reassure the business sector.
The dip in the ZEW may have been partly a shock reaction after the election outcome opened the possibility of a coalition Parliament with the Left Party, and the business sector should be happy with a grand coalition and the prospects of further reforms.
DUKING IT OUT.
This is true even though the participation of the liberal FDP in government would likely have provided more opportunities for radical changes. For consumers, much will depend on the personality of the next Chancellor, and his or her ability to sell unpopular measures.
So far, Chancellor Schröder has insisted that he will remain Chancellor, while the CDU/CSU is stressing that as the strongest party, it has the right to the post. This would mean Angela Merkel as the next Chancellor. An alternative would be that both Schröder and Merkel step back and let someone else take the position, which would allow Schröder to concede without losing face.
In our view, it is most likely that Merkel will take over. Schröder will await the outcome of this weekend's delayed election in Dresden, which will not make any real difference to the overall result, and only then declare the election campaign truly over. He could then step back and pave the way for constructive coalition talks next week, with Merkel the prospective new Chancellor.
Some have hailed Merkel as the German Margaret Thatcher. But can she motivate Germany and bring back a sense of optimism? Merkel made mistakes in the election campaign, which may have cost her a stronger position in Parliament.
And the CDU/CSU's loss of votes compared to the last election highlights that she is not always the best motivator. Many also feel her political style is too cold. Doubts surely remain that she will be able to produce the long-awaited turnaround in sentiment and sell reforms to a skeptical public.
The main challenge for the new government will be to lift confidence, continue with the reform process, reduce unemployment, and bolster long-term growth potential. So far no politician has come up with a convincing recipe for that. Germany remains on track for modest growth. But the political snarl promotes uncertainty, and serious risks abound.
Gewaltig is director of European economics for Action Economics