Germany: the sick man of Europe again?

By 5 minute read

The title of “Sick man of Europe” has been given to the country in Europe experiencing economic stagnation. After reunification and in the early 2000s, Germany was often assigned the title. This week Germany just avoided a recession as Q3 GDP grew by 0.1 after a contraction in Q2. So does Germany deserve the title again?

Germany's economic problems have been primarily driven by a decline in net exports. These have subtracted by around 1.5% of German GDP, which is around 40 to 50bln EUR. The other GDP components, like personal consumption, government consumption and even investments have held up fairly well.

Net exports are the difference between total exports and total imports. Normally these two are highly correlated. Currently the weakness of net exports is almost fully explained by a decline in exports. Imports have held up well, indicating that domestic demand is more resilient.

So why have exports been so weak?

For a part the answer seems to lie in the automotive sector. Exports of passenger vehicles and vehicle parts have declined by around 30bln during the last year. Chart 1 shows the number of vehicles produced, which has indeed declined sharply from around 5.7 mln cars per year to 4.7 mln.

Chart 1: German yearly car production. Sources: Aegon Asset Management, Association of the German Automotive Industry, Bloomberg

Why did the car sector slow down?

At the end of last year the EU introduced new emission regulation. Car plants needed to be refitted, which resulted in a temporary production halt. At the time the expectation was that the car production would rebound afterwards. However, this has not happened yet.

The car sector is struggling with the competition from electric vehicles (EVs) in which traditional car manufacturers have been lagging. For instance Tesla is now producing around 350.000 car per year and the production rate is growing fast. The company is aiming for a production goal of 1 million cars in 2020. On a global production of 90 million cars, this does not sound overly concerning, but Tesla is competing in exactly the same segments as several well-known German brands. And it has gained the number 1 market position in a short amount of time in the US and several other countries. It is not possible to exactly calculate the "Tesla" effect on German car exports, but it is likely to be substantial.

It remains to be seen how this will evolve, as from next year the EV production is set to pick up sharply as well.

Are German exports also impacted by the "US – China trade war"?

Chart 2 shows the evolution of net exports (the trade balance) of Germany with several other countries. If the trade balance improves, this will add to GDP and vice versa.

The trade balance of Germany with China and the US has been fairly constant, so Germany has not been impacted directly by any perceived slowdown in these two economies.

Which regions were responsible for the decline in net exports?

Since the Brexit referendum UK net exports have declined by around 10bln EUR. Also net exports to Turkey declined by around 5bln EUR over the same period, which is likely due to the sharp depreciation of the Turkish lira, making German goods more expensive. Net exports to the Netherlands and Belgium have declined by around 6 bln EUR. These are typical transit countries for German exports to other destinations. Considering the relative strength of their economies, it seems likely that this decline is caused by weaknesses in other regions. The remaining decline is attributable to a large number of other countries.

Chart 2: Trade Balance of Germany with other countries. Sources: Aegon Asset Management, German Federal Statistical Office, Bloomberg

What are the implications?

The hit to net exports has brought the German economy to a standstill. It has also likely had an effect on longer term interest rates and possibly on shorter term rates as the slowdown has given the ECB a reason to further ease monetary policy.

The slowdown is concentrated in a relatively small number of regions and sectors, which on the one hand indicates that it is not systemic. On the other hand it does show the vulnerability of the German economy to relatively small perturbations.

Going forward a lot will depend on the evolution of the Brexit process and the trade tensions between Germany's other main trading partners; the US and China. We don't expect a "no-deal" Brexit, but do think that the EU and UK economies will be less integrated in the future, which is likely to lead to further weakness in exports. The trade war between the US and China is likely to stay in some form regardless of the outcome of the US elections next year. Whether that will put pressure on German exports is uncertain, but the effect is unlikely to be positive.

And finally, the German car companies have been late adopters of EVs. It now pays the price for that, which is even measurable in economy wide figures. Going forward they will need to catch up quickly to prevent further damage.

Germany has grown pretty strongly in the last couple of years, so a temporary slowdown doesn't make it the "Sick man of Europe" yet. But it will need to improve its performance to avoid that fate.

Jacob Vijverberg

About Jacob Vijverberg

Portfolio Manager Diversified Income Strategies