Ahead of Chancellor Merkel’s visit to the UK, we look at how the German economy has fared since the economic downturn in 2008.

Germany’s geographic position in the centre of Europe is mirrored in its economic status as “an anchor of stability in Europe”. The German economy is Europe’s largest and the fifth largest in the world, around a third bigger than the UK’s. A large export sector specialises in cars, machinery and chemicals. But despite its strong performance in the post-recession period, the economy faces the long-term demographic challenges of an ageing population.

Recession and recovery, with low unemployment

Unlike a number of other large economies, the recession in Germany was not preceded by a credit bubble. Instead, it was the collapse in world trade flows that led to a deep recession, with GDP contracting by 6.8% by the beginning of 2009. The recession was short-lived and the economy recovered strongly: by the first quarter of 2011, GDP was back to its pre-recession level; in the UK, GDP is still below pre-recession levels (see chart below).

Unemployment increased only slightly during the recession and then promptly continued its previous downward trend. Currently around 5%, it is now one of the lowest in Europe (in the UK it is 7.2%), with youth unemployment particularly low at just over 7% compared to 23% in the eurozone and 20% in the UK.gdpunemploymentThe debt crisis and subsequent severe recession in the eurozone periphery led to a slowdown of export growth and more sluggish economic expansion over the past two years. GDP growth in 2013 was 0.4%. The stabilisation of the eurozone debt crisis and the improved prospects for the currency area – in the short term at least – support the majority of economists’ expectations that growth will improve. The IMF forecasts GDP growth of 1.4% in 2014 and 2015.

Large manufacturing sector contributes to trade surplus

While the manufacturing sector’s share of economic output has been declining in most of the G7, it has remained stable in Germany at around 22%. This is the highest proportion in the G7 and double the figure for the UK.

Germany’s economy has become increasingly trade-oriented in recent times, with exports equivalent to 51% of GDP in 2013, up from 36% a decade earlier. By comparison, the UK figure was 32% in 2012. Germany exported around £920 billion in goods in 2012, over three times as much as the UK exported (£300 billion). UK services exports, however, were 10% higher than Germany at around £180 billion. Germany’s largest trading partner is France, followed by the US, with the UK third highest.

The strength of its exporting sector combined with more modest growth in demand for imports has resulted in Germany building a significant trade surplus. In 2012, this amounted to £160 billion or 7% of GDP.Exports

Budget is in balance

Deficits in the early 2000s (due to a weak economy) were reversed in the mid-2000s as a result of stronger growth. There was even a small surplus in 2007. Deficits returned following the 2008/2009 recession and peaked at just over 4% of GDP, but were not as large as in a number of countries, including the UK where the deficit peaked at 11%. The subsequent strong recovery whittled away the post-recession deficits and the budget is now in balance.

Gross debt is around 80% of GDP. Unlike many other advanced economies it has stabilised and is forecast by the IMF to decline steadily in forthcoming years, as the size of the economy expands and the annual budget is kept in balance.

Long-term challenges remain

Despite a relatively strong performance compared with other large economies in recent years, Germany’s potential growth rate – the pace at which the economy can expand sustainably over the long term – is low at around 1¼%. This is similar to the eurozone average. In comparison, potential growth is estimated at around 2½% in the US and 2-2¼% in the UK.

A main obstacle to long-term growth is demographic change. With the population having already reached a plateau of around 82 million in the 2000s, it is now gradually beginning to fall. The labour force is projected by the OECD to fall from around 43.5 million in 2012 to 40.4 million in 2025. This may lead to labour shortages, rising wages and an increase in companies’ labour costs, and reduced competitiveness of German firms. Overall, the OECD notes that the effects of this projected decline in the labour supply are estimated to reduce its already-low potential GDP growth by a further 0.9% points in 2025.

Author: Daniel Harari