Dilemmas of the Last Triple-A Eurozone Economies
Until recently, the Eurozone crisis was cushioned by the strong performance of the German economy. But those days are fading.
During the past four years, The UK has suffered a double dip. France is flirting with recession. Italy’s EUR 2 trillion debt forced a technocratic regime to take over in fall 2011. Spain is drifting toward a new bailout with employment exceeding 25% and youth unemployment more than 50%.
Until recently, Germany fared much better in relative terms than other core economies in Europe. However, the slowdown of economic activity in the second half of 2012 will be morphing into recessionary conditions in early 2013.
Export-led model, dependent on the US and China
As its export-led growth is eroding, Germany is hoping to rely on private consumption, but the latter cannot compensate for the slowdown in export growth.
German resilience is based on the Mittelstand companies, many small- and medium-size enterprises which historically have supported German growth in global markets. Unlike large but multinational corporations, these family firms place profits before people.
What does not bode well for the future is that Germany’s export growth depends on just a few sectors and regions.
The Eurozone does absorb some 40% of German exports, but other regions account for even more, 60%.
In the first three quarters of 2012, exports to the U.S. and Asia, respectively, generated each some 35% of total export growth in Germany; that is, 70% of the total growth.
Further, exports are highly concentrated in terms of sectors. Cars, pharmaceuticals and mechanical engineering to the U.S. accounted for three quarters of export growth. In China, the accumulation is far greater: the auto industry generated nearly 100% of all German export growth.
High concentration can result in great structural risks. If Washington fails to manage the fiscal cliff, or China’s growth engines would slow down, the adverse impact would be very significant in Germany.
Economic erosion, social ills
Signals of steady, though low economic erosion abound. Unemployment rate has climbed to almost 7%. Although business climate has been rebounding, consumer sentiment remains cautious, working against domestic demand. Inflation has slowed to less than 2% on an annual basis.
Even venerable corporate institutions are scrambling. Recently, GM subsidiary Opel announced it will stop assembling cars in Bochum, Germany by 2016. Similarly, the steelmaker ThyssenKrup posted a loss of EUR 4.7 billion, coupled with huge writedowns on mills in the U.S. and Brazil.
Regional banks (Landesbanken) are not immune to possible re-escalation in the financial sector. Problems may be more extensive. Recently, a former employee of Deutsche Bank claimed that it concealed billions of euros in losses during the financial crisis, in order to avoid a government bailout.
Concurrently, urban poverty has been growing at an alarming rate. While the nationwide rate exceeded 15% in 2011, it increased to 20% in big cities. According to the Institute of Economic and Social Research, almost a quarter of all people living below the poverty line resided in just half a dozen cities: Liepzig, Dortmund, Duisburg, Hanover, Bremen and Berlin.
Unsurprisingly, right-wing extremist attitudes are on the rise, especially in the formerly socialist east. According to the center-left Friedrich Ebert Foundation’s nationwide surveys, right-wing extremist attitudes have climbed from 8.2% to 9% across the country. In relative terms, the shift was the greatest in eastern Germany, where the figure soared from 10.5% to 15.8%. Xenophobic sentiments are now said to characterize every fourth German.
Toward 2013 elections
For now, Chancellor Merkel has managed to sustain great national popularity. However, the support of her center-right Christian Democrats (CDU) has been eroding in the local state elections. At the same time, Germany’s social democrats are uniting behind their candidate Peer Steinbrück.
In the end of November, German parliament Bundestag voted to approve still another round of aid measures for Greece. Despite nagging doubts among the center-left, the parliament approved Chancellor Merkel’s new measures, by an overwhelming vote of 473 to 100.
According to polls, most Germans would prefer to see Greece go bankrupt. However, a Greek default is perceived to be followed by the contagion effect, first in Southern Europe and then in the core economies. It continues to be seen as too risky.
Unlike a year ago, the debt measures will now, for the first time, have a direct impact on private creditors. If the reduced interest income is combined with the decision to reserve profits by the European Central Bank for Greece, the revenues of the German 2013 budget will take a EUR 730 million hit.
In fact, with current policies, Berlin may have to absorb billions of losses over the subsequent years.
Short-term uncertainty, medium-term erosion
The main risk facing Germany is an escalating Eurozone crisis, which would spill over into Germany through real and financial channels.
Unsurprisingly, a leading German economist Hans-Werner Sinn has argued that the continuation of current bailout policies will come with huge risks. Indeed, he believes that Greece and Portugal should temporarily leave the Eurozone.
Even if the two dominant parties can sustain their political leadership, economic erosion highlights the fact that German voters will increasingly oppose fiscal transfers, debt mutualization and expansive bailouts.
The timing could not be worse. Germany is struggling to increase the labor force, raising the quality of human capital, and productivity in the services sector. Despite its relative strengths in the short- and medium-term, it is coping with aging population and the associated negative growth effects.
Berlin is anxious. For all practical purposes, Europe is about to enter a medium-term stagnation, or a lost decade.
An abbreviated version, “If Germany sneezes, does the Eurozone catch a cold,” was released by CNBC on December 12, 2012