German Headwinds

Originally published by Dieter Adam 8 August 2023

Stereotypical Germans love doom and gloom, and at the moment a lot of that German Angst is focused on a debate about ‘de-industrialisation’ – a steady decline in manufacturing that currently still makes up about 20% of GDP (twice New Zealand’s share). In the ‘industrial heartlands’ of Baden-Wuerttemberg and Bavaria, that share is about 40%. So, are those fears justified?

The blue line above shows German industry (manufacturing) output in June, down 1.5% from May, and projected to fall further in the next two quarters; the red line is for the construction industry (https://www.destatis.de/EN/Press/2023/08/PE23_310_421.html ). Across different sub-sectors, the decline from May to June was more pronounced in the car industry (-3.5%), and capital goods in general (-3.9%).

Energy costs are quoted as one of the main reasons for driving production, and especially energy-intensive production, to other countries:

Electricity prices for industry in Germany in € cents are shown above. Different colours represent cost components, with the actual cost of generation and delivery the major component (in blue). Note that the green component – a surcharge to fund the expansion of renewable energy generation – was removed in 2022. Prices have come back a lot, but are still about a third higher than the five-year pre-COVID average – see also below. There are also growing concerns about the ‘Stromwende’ – the accelerated move towards close to 100% renewable power – putting reliable supplies at risk.

As the graph above shows, gas prices in Germany have also dropped significantly from their giddy heights a year ago, but are still much higher than in the USA. Headlines about companies announcing to abandon plans for further investment in Germany in favour of the USA are creating additional concern. Note, also, that with the total cut of gas imports from Russia, the USA is now the biggest supplier of (Liquified) Natural Gas to Germany.

Apart from energy costs, there may be other factors at work that will affect other exporting nations as well. A recent analysis by the IMF demonstrates the increasing number of trade restrictions in place, most of them impacting on the free flow of goods between countries (https://www.imf.org/en/Publications/fandd/issues/2023/06/the-costs-of-geoeconomic-fragmentation-bolhuis-chen-kett ).

The authors then look at the likely permanent impact on global GDP under two scenarios. One is defragmentation – the cessation of almost all trade of goods between the USA and the EU on one side, and Russia on the other, as well as the elimination of trade in high-tech sectors between China on one side, and the United States and European Union on the other. Pretty much the current situation, in other words, resulting in a predicted drop of 0.3% in global GDP – quite minor. Much more serious, however, would be the consequences of a complete split of global trade into two blocks that basically don’t trade with each other:

Such a split would hurt low-income countries worst, but a 2.4% permanent drop in GDP would certainly be felt in advanced economies as well. Fortunately, this still is a far-fetched scenario, and one we will hopefully never see eventuating.