Germany’s buoyant mood prevails amid warnings of complacency

Few cities could switch in a few days from welcoming tens of thousands of refugees to hosting millions of drinkers at the world’s largest beer festival. But that is precisely what Munich has done, holding the annual Oktoberfest despite the effort of dealing with Germany’s asylum seekers.

The city’s success highlights the strength and depth of Germany — and of its economy. Without vast resources, it would have been impossible for chancellor Angela Merkel to welcome up to 1m, or on some estimates even 1.5m, refugees this year, as she looks set to do. The chancellor told the Bundestag last month: “As these last days have shown, robust finances make it possible for us to react immediately to emerging challenges.”

Her comments sum up the general economic optimism permeating Germany. Even though the crises in Ukraine and Greece, the Middle East turmoil and China’s faltering growth have left their mark, German exports are hitting records, while domestic consumption is strong, with wages rising and unemployment at its lowest level since reunification 25 years ago.

“Global economic conditions are not completely without risks,” said the chancellor. “But we as the government are counting on economic growth of 1.8 per cent this year and next.”

Yet there are dangers lurking, even in the domestic economy. With the population ageing rapidly, employers face growing skills shortages that will not be solved rapidly by the current immigration wave as it will take time to train the arrivals. Business leaders complain about creaky infrastructure, especially energy networks and worn-out roads and bridges.

Many economists warn about complacency in the government, pointing to the partial reversal of key labour market reforms, notably a cut in the retirement age for certain workers to 63 at a time when the general retirement age is rising from 65 to 67.

Ms Merkel, in turn, frets about technology and industry’s sluggish response to digitalisation, which is seeing US-based internet groups target markets where German companies have long been strong, notably cars.

Meanwhile, the scandal at carmaker Volkswagen, which has admitted cheating in US emissions tests, has raised questions not only about VW’s future, but also about the damage done to “Made in Germany” — German manufacturing’s global reputation for quality and reliability.

“Germany has wonderful companies and competitive industries,” says Jörg Krämer, chief economist at Commerzbank. “But its competitiveness has started to erode . . . We have a perception that the German economy is unsinkable, which is wrong.”

Germany has had by far the strongest recovery in the eurozone from the global financial crisis, with cumulative gross domestic product growth since the end of 2007 to 2014 of more than 5 per cent. The common currency area as a whole remains stuck below zero. However, even Germany lags far behind the US, which has seen growth of more than 11 per cent, powered partly by the development of internet-based industries. Even in the EU, German is not the leader, with non-eurozone neighbour Poland surging 25 per cent over the same period.

In the current year, economists see a slight slowing, because a weakening in domestic capital investment and declining net exports in the face of faltering global demand. Deutsche Bank says “disappointing” GDP figures for the April-June quarter, the latest for which data are available, have “tainted” the outlook for 2015.

Deutsche warns of the danger signals flashing in world financial markets: “All this highlights the very heightened uncertainty about the global outlook, which in turns points to risks for the German economy as it remains very vulnerable to external shocks.”

But the global economy also drives some fair winds across Germany. The economy is among the biggest beneficiaries of the fall in world oil prices. Germany also gains from the European Central Bank which has extended years of easy money policies with QE — government bond buying.

While the ECB aims to revive demand in the weaker corners of the eurozone, German borrowers also reap the rewards. Chief among these is the government, which has seen the interest burden on its debts collapse, helping hawkish finance minister Wolfgang Schäuble achieve a balanced budget in 2014, a year sooner than planned.

With tax revenues surging, because of buoyant consumer spending, the government could see €20bn surpluses both this year and next. Despite pressure from the International Monetary Fund and others to relax the purse strings to stimulate the eurozone economy, Mr Schäuble is determined to reduce the ratio of public debt to GDP from more than 80 per cent five years ago to 60 per cent in 2020 — the eurozone’s would-be ceiling level. He has set aside an additional €6bn for next year for extra refugee costs, but insists the crisis will be financed “if possible” without new government debts.

The overall economic impact is unclear — since almost all the money for refugees will be spent in Germany, it is expected to boost growth a little and so raise tax revenues. DIW, the Berlin-based economic institute, estimates the crisis could drive up GDP growth next year by a quarter of a percentage point.

Germany’s greatest long-term challenge is demographic, with some 500,000 people forecast to retire each year. By 2050, the UN says, the percentage of Germans aged under 15 is forecast to fall to 13 per cent. The number of people over 60 is expected to rise from 27 per cent to 39 per cent.

With fewer Germans working, it will be difficult to maintain GDP growth even at the current long-term rate of 1.2 per cent. Pensions and healthcare costs are expected to grow more rapidly, increasing the burden on a shrinking working population.

The European Commission forecast this year that the total cost of caring for the elderly would rise in Germany from 19 per cent of GDP in 2013 to 23.8 per cent in 2060, assuming economic growth of 1 per cent. Germany’s costs are expected to rise more than the EU average due to rapid ageing and generous pensions.

This prospect has encouraged the finance ministry to redouble its debt reduction efforts — and to look positively on the large current account surpluses. The income from accumulating foreign assets may be needed to help finance domestic public spending.

However, Marcel Fratzscher, head of DIW, is more concerned about low investment in Germany, which he says is undermining growth. Germany invests about 17 per cent of GDP, compared with an average of about 20 per cent for the OECD, the developed countries’ club. This year, a commission urged the government to increase public investment — and use tax and other policies to encourage private investment. Prof Fratzscher estimates that reaching the OECD average would entail boosting investment by €80bn annually.

Business leaders are worried about the energy market, where Germany’s pioneering push into green technologies has raised electricity costs and led to questions about the stability of supply, at a time when Berlin is committed to phasing out nuclear power by 2022.

Finally, there is the digitalisation challenge. Ms Merkel has lobbied industry for more research and development to help Germany close the gap with the US and leading Asian R&D centres. German companies often locate R&D investments abroad, to tap foreign talent and be close to fast-growing markets.

“German companies are operating in a global economy. Diversification is a natural response,” says Mr Krämer.