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A Sputtering Car Goes into Reverse: The German Recession and its Consequences

16. September 2019 I Heiner Flassbeck

The German economy is struggling. Both the publication of the ifo business
confidence index (a survey among 9,000 German firms) and the statistics of incoming
orders for the manufacturing sector at the beginning of September revealed a
continuation of the economic downturn in Germany that cannot be ignored anymore.
The business climate dropped to 94.3 points � its lowest value since November 2012.
Incoming orders (see Figure 2 below) point to a severe weakness of investment.
These factors, amongst others, further strengthen the now widespread expectation
that the Federal Statistics Office of Germany (Statistisches Bundesamt) will
announce negative GDP growth for the third quarter of 2019. Since this would mark
the second consecutive quarterly contraction, it means that the German economy
would be officially in a technical recession.

The recession in Germany comes at a time at which the only readily available
instrument in the Monetary Union (EMU) to fight recessions, namely monetary policy,
is not available anymore. Moreover, German policymakers, the media, and
professional economists have imprudently ignored the downturn, so that a discussion
about appropriate countermeasures on the fiscal side remained silenced and valuable
time was lost. The repercussions for several fragile member states of the EMU, such
as Italy and France, could turn out to be ominous.

The German recession has been in the making for a very long time and, as we argue
in this article, had kicked in already in 2018. We arrive at this conclusion due to
the fact that the key cyclical indicators, incoming orders and production in
industry and the construction sector, have been on a near continuous decline since
the beginning of last year. What we have seen over the past couple of months is
more of a new low, which makes it impossible to further deny the German recession.
The production in the crucial sectors of the economy, as the revised data from last
week show, is now below the level reached before the beginning of the widely
celebrated upswing in 2016. Incoming orders, in particular those of domestic
origin, indicate that domestic demand in Germany is flat and corporate investment
is falling.

Statistical wizardry to avoid discussions about the �recession�?

This argument stands in stark contrast to what is published as official

calculations of the GDP. During 2018, Germany�s GDP, as published by the
Statistical Office, has been more and more detached from the primary statistics at
hand (and entailed larger revisions than in any time in the past decade). The
reason, however, is not a structural shift in the German economy, as claimed by the
government, but methodical problems in the calculation of the �official� GDP.
Without having recent and updated data available to prove their point, the
government and its statistical office insist that the (invisible) services sector
is booming and compensates the weakness of the visible industries. This is
extremely implausible, and we question such conclusions as long as reliable
statistics contradict them. In their absence, official posturing seems to be just
an attempt to delay the acknowledgement that Germany is in a recession.

Figure 1: Quarterly production and GDP estimates in Germany (2015=100)

Source: Federal Statistics Office of Germany

What we actually see in the primary data is that the orders in the manufacturing
sector, the most important and reliable business cycle indicator in Germany,
markedly cooled down during the last quarter of 2017 and have been declining
consistently since the start of 2018. Relatedly, output in the goods-producing
sector began to stagnate towards the end of 2017, and displays an outright decline
into the second quarter of 2019 and into July 2019.

Finally, as previously mentioned, the ifo business climate index has been in steady
decline since the start of 2018. From January 2018, it dropped from 105.1 points to
102.5 points in April, and, with the exception of August and September 2018,
continued to fall ever since to the present level of 94.3 points. In the
manufacturing sector, the situation appears almost dramatic. Ifo states that in
this sector, �the fall in the business climate indicator has yet to find a floor�
and that �the last time that industrial companies demonstrated such pessimism was
in the crisis year of 2009�, whilst �not a single ray of light was to be seen in
any of Germany�s key industries.�

Figure 2: Manufacturing sector indicators (2015=100)

Source: Federal Statistics Office of Germany, ifo Institute

In sum, therefore, a sober assessment of the primary data indicates that the onset
of the recession should more accurately be dated back to 2018, and not, if
anything, to the third quarter of 2019. We highlighted this danger in our MAKROSKOP
business cycle report in April 2018, as evidence was mounting that the observed
trends were signs of a serious downturn, and not a mere statistical fluctuation. By
the end of 2018, we found our initial assessment to be confirmed, yet a wider
political reaction is still absent.

All of these warning signs, however, were completely ignored by the majority of
professional economists. German economic �think tanks� across the board found, in
contrast to our assessment, the German economy to be in a �boom period� in early
2018. In late 2018, it was acknowledged that the pace of the economic expansion had
decelerated, yet the outlook for 2019 remained positive. The deceleration itself
was later retrospectively attributed to exogenous factors, such as the low tide in
the Rhine and various supply side constraints. The German media widely jumped on
the bandwagon, calling as late as April 2019 for optimism about the German economy.

What�s the reason and why does it matter?

The latest data from primary statistics all over Europe reveal similar recessive
(or at best stagnating) tendencies for most European economies. This is
particularly dangerous, given that a recovery outside Germany has been absent for
many years and the latest turnaround had been modest: Output in Italy and France is
low and unemployment remains remarkably high. Due to the German obsession with
fiscal austerity and its deflationary wage policies, aggregate demand in the single
market � by far the most important market for all European states � remains
insufficient to generate high employment and induce corporations to invest.

Expansionary fiscal policy, the most effective tool to deal with such a shortfall
in demand, is banned by ideologically-driven legal constraints originating in
Germany. Given the fragile trade relations of Europe with the US and of the US with
China, an attempt by European economies to export themselves out of the crisis
through a weak euro risks provoking unpredictable forms of retaliatory action by
the US Administration and other countries around the world.

A renewed economic downturn in an already poorly performing European economy may

turn out to be the proverbial match thrown into a powder keg. Notwithstanding the
severity of the situation, the German government still shows an extraordinary
amount of resistance to any weakening of its adherence to the Swabian housewife
mentality towards government finance. In May 2019, Olaf Scholz, the German finance
minister, contemplated a revision of the budget, further potential cuts, and the
notion of �making an even greater effort� to avert the downturn. More recently, he
reaffirmed his stance by arguing that new debt would only be necessary in a
contraction similar to the one in 2008. Chancellor Angela Merkel regards sticking
to the Schwarze Null (federal budget in black figures) as another �form of
sustainability�, and she has support within her own party as well as among numerous
conservative German economists.

Yet, anyone has been following the debate in Germany will also have found some
prima facie indications of change. Regardless of the balanced budget affirmations
of the German government, SPIEGEL announced that Scholz and Merkel may consider
boosting spending through new debt in a recession. The same tendency was palpable
during the latest discussion in Parliament on the 2020 budget. Moreover, several
individual CDU politicians came out questioning the most sacred of cows in Germany,
and even the lobby of industry is beginning to change its tone.

The window of opportunity for change has undoubtedly opened a little, but the force
of inertia should not be underestimated. Strong doubts remain as to how reliable
and sustainable the winds of change will be, not least because a lot of political
and intellectual capital has been invested in the balanced budgeting follies.
Nonetheless, after a decade of ruinous economic policies, dictated by Berlin and
swallowed by Paris and Rome, it is high time to rediscover reasonable
macroeconomics to avoid further strengthening of the �populist� movement, driven by
an escalation of social and political unrest.