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Are Fears of a German Recession Overblown? 5 Reasons Not to Worry—Yet

Germany is about to fall into recession for the first time in a decade. The world’s fourth-largest economy has become the collateral damage of Donald Trump’s trade war against China and the slow-motion car crash that is Brexit.

In the near term, analysts and policymakers argue there’s not too much cause for alarm: the government and the European Central Bank—if they act in tandem—have all the firepower they need to make the downturn brief and shallow.

But the seeds of much more chaotic conditions in Europe have already been sown, with a poorly-designed currency union whose flaws still haven’t been addressed. While those flaws are unlikely to prove fatal in the coming recession, the decisions Germany takes now could make all the difference the next time the regional economy turns down.

Here’s a few reasons why you shouldn’t be worried—and a couple of reasons why maybe you should.

1. What Recession? 

A recession is just an economist’s way of saying two successive quarters of economic contraction. According to preliminary data, German gross domestic product fell 0.1% in the second quarter. The Deutsche Bundesbank, Germany’s central bank, fears it could fall another 0.2% in the current one. But the Q2 decline reflected mainly two things: Easter was in late April this year, meaning that the usual seasonal dip in activity happened entirely in the second quarter, rather than straddling March and April; and a mild winter let construction activity pick up already from February, two months ahead of the usual pattern. On average, GDP expanded 0.15% per quarter in the first half. 

Jens Weidmann, president of the Deutsche Bundesbank, attends the Annual Press Conference in February, 2019. (Arne Dedert—picture alliance via Getty Images)
Arne Dedert—picture alliance via Getty Images

“I see no reason to panic,” Bundesbank President Jens Weidmann told the Frankfurter Allgemeine newspaper last weekend. “The German economy is coming out of an extended upswing with record-breaking employment and high capacity utilization levels.”

2. Safety Nets

Four straight years of surpluses (plus another 45 billion-euro surplus in the first half of 2019) mean Germany's budget can easily afford to cushion the impact of unemployment, which has risen for the last four months in seasonally-adjusted terms.

So-called “automatic stabilizers”—especially a subsidy scheme to encourage companies not to get rid of under-utilized workers—worked wonders in 2008 and 2009, supporting domestic demand and ensuring the recovery wasn’t held back by bottlenecks when activity rebounded. Berenberg Bank chief economist Holger Schmieding expects them to repeat their magic this time around too.

3. More Stimulus Is Coming 

The government has been slow to stimulate the economy any further, but there are increasing signs of action soon. Economy Minister Peter Altmaier laid out plans to cap companies’ tax rates at 25% this week, while Finance Minister Olaf Scholz is working on plans to abolish the 5.5% “Solidarity Surcharge” on income tax bills.

Schmieding expects that, by 2021, the structural budget will be around 1.2% of GDP looser than it was in 2018. The constitution limits the structural deficit to 0.35% of GDP in normal times, but allows for bigger deficits in exceptional ones.

4. A Healthier Euro Zone 

Ten years ago, Germany was almost the only functioning economy in the euro zone. Today, the countries that took bailouts and reformed all boast decent growth rates and fewer vulnerabilities.

Elsewhere, Italy has just chosen not to borrow its way out of trouble under right-wing populists. Even Greece has just abolished capital controls after throwing out the Socialists who led it to the brink of disaster in 2014. Importantly, the reforms enacted by President Emmanuel Macron have improved France’s growth performance, argues Bernhard Bartels, an analyst with Scope Ratings.

Tax cuts for employers and workers, combined with cuts in non-wage levies and other reforms, have raised the country’s medium-term potential. That makes the concessions to “yellow vest” protesters during the winter seem a price worth paying. With exports amounting to over 45% of GDP, Germany’s economy is acutely dependent on demand in other countries, most of all from its neighbors.  

5. Banking risks are contained 

Had the current slowdown happened two years ago, it could easily have threatened the viability of Deutsche Bank, which was at that stage still a systemically relevant player in most parts of global financial markets. That’s no longer the case, with new CEO Christian Sewing having pruned both its investment bank and a dwindling pile of “hard to value” assets widely believed to be toxic.

. . . But there are reasons to worry

If that all seems too good to be true, well, maybe it is. Germany's recent economic data have been dismal, with industrial output dropping 5.2% in the year to June and business confidence hitting a seven-year low. Germany’s large manufacturing base—concentrated in autos and other, mainly cyclical, investment goods—has been squarely caught by President Trump’s threats of tariffs against both Germany itself and China, Germany's biggest client. Banking sector profitability remains worryingly weak, leaving financial institutions with little spare capital to absorb losses in a downturn.

Moreover, Brexit threatens not only a temporary disruption to U.K. demand for German goods, but the long-term loss of a privileged position in a key market. (The U.K. is the biggest export market of all for Germany's carmakers).

The SUV "Grandland X" is assembled at the Opel plant in Eisenach. (Martin Schutt—picture alliance—Getty Images)
Martin Schutt—picture alliance via Getty Images

And the automotive sector, which still accounts for around one in eight jobs in Germany directly and indirectly, has more to worry about than just Brexit. Shifting car ownership patterns, new fuel technologies, and autonomous capabilities all pose existential threats, according to a study released this week by consultants Roland Berger. “There is currently no recovery on the horizon for 2019—on the contrary, the economic pressures on suppliers are growing and so are the challenges,” the consultants said in a study released on Wednesday.

For some, frustrated by increasingly glaring failures in Germany’s housing market, power sector, and rail and road infrastructure, the need for the government to loosen the purse strings is undeniable.  A study last year by the IdW think-tank in Cologne found that two-thirds of German companies felt their work was being hampered by infrastructure shortcomings.

“The time looks more than ripe for the federal government to finally change direction,” complained Claus Michelsen, an economist with the DIW think-tank in Berlin, “and pursue an agenda of modernizing Germany.”

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