In light of these pressing issues, we sought out Professor Dr. Oliver Holtemöller, Deputy President and Head of the Department of Macroeconomics at the Leibniz Institute for Economic Research Halle (IWH), to get this thoughts on the economic situation and the outlook for the coming years.
Natalia Jakubowska, Trans.iNFO: What economic phase is Germany currently in?
Professor Dr. Oliver Holtemöller, Deputy President and Head of the Department of Macroeconomics at the Leibniz Institute for Economic Research Halle (IWH): Germany is experiencing a slowdown. Economic activity is expanding more slowly than potential production, leading to a decrease in utilisation rates. This is what we define as a downturn.
Is Germany now the “sick man of Europe,” or would you not go that far?
No, I wouldn’t say that. The situation is different now than it was at the beginning of the 2000s when this term first appeared. At that time, we had significant problems in the job market.
Today, we face structural challenges again, primarily in the areas of industry and the energy transition. So wouldn’t describe Germany as the “sick man of Europe”.
Economic performance has deteriorated very rapidly and significantly over the last three years. What past failures does this result from?
The term “failure” implies assigning blame. First, we had a pandemic, and then we experienced a major energy price shock. Neither of these events can be attributed directly to anyone in Germany.
The question is, could we have responded better? Of course, hindsight is always clearer. Therefore, I wouldn’t speak of failures in this context. We have significant long-term structural challenges for which there are currently no straightforward solutions.
These primarily involve issues related to demographics, the design of social security systems to be sustainable with changing demographics, and digitalisation. Unfortunately, international comparative reports show that Germany is not among the leaders in digitalisation. Additionally, we are undergoing an energy transition, which adds to the challenges.
There is widespread uncertainty among both the population and businesses about how to navigate these changes. Economic policy has also contributed to this uncertainty through internal disagreements and a lack of clear strategies. In many areas, medium to long-term objectives are not well-defined, which also affects investment decisions.
Would you say that the welfare state is too strong?
Given the current demographic trends, maintaining the current system is not sustainable because of the aging population and the decreasing working-age population. This means that social security systems will face increasing shortfalls in contribution income while pension expenses rise due to an aging population.
The current system is not stable. Various solutions can address this problem. If one believes that social benefits are not excessive, then contributions will need to increase more in the future. I cannot say definitively what the majority would prefer to do.
Demographics, digitalisation, energy transition — these are huge challenges. Are simple structural reforms enough to overcome this?
We need a fundamentally different approach, one that places more trust in market forces. Market adjustments often lead to effective solutions in many areas.
However, in Germany, there’s a lack of trust in market-based adjustment processes among policymakers, not just the current government but preceding ones as well.
In the process of decarbonisation, we could achieve emissions reduction targets more efficiently through a higher CO2 price and corresponding behavioral adjustments by individuals than through detailed government interventions.
The energy transition in Germany is being implemented unnecessarily expensively, which has led to dissatisfaction in society.
To what extent can emissions reduction targets be achieved more quickly through a higher CO2 price? Can you specify that?
Increasing the CO2 price would result in reducing CO2 emissions where it’s least costly to do so. Instead of the government determining who should replace their heating system and when, a market-based approach is more efficient.
Decisions such as these should be left to individuals, while the government establishes a price path for gas, oil, and other fossil fuels. Individuals with high consumption and outdated heating systems would naturally find it economically favourable to upgrade their systems.
This principle can be applied across all industrial sectors. However, the German Government is attempting detailed control, inefficiently identifying areas and timing for action. This bureaucratic approach is costly and less likely to identify the most efficient path for reducing emissions.
The German economic model relies still on its industrial sector, which is relatively export-oriented and heavily depends on fossil fuels. Does Germany need to completely reinvent itself now?
I’m not fond of the term “economic model.” Each company is capable of assessing its market and positioning itself accordingly. The role of politics is to create favorable framework conditions for businesses.
International interdependence is crucial, and it’s unwise to forgo the benefits of international trade. Dependency can be mitigated through diversification rather than putting all resources in one basket. Raw material dependencies, especially on China, are concerning.
The semiconductor industry is another example. Achieving complete self-sufficiency would significantly impact prosperity. It’s more beneficial to ensure that the international division of labour continues to function effectively.
Perhaps new sales markets should be explored? Every third car from Germany is sold in China.
Each company should explore new markets independently. It’s essential to avoid giving the impression that the government will take over this task from companies, creating a situation where profits go to companies and losses are borne by taxpayers. The gas-intensive industry in Germany managed to secure government support during the price shock by presenting worst-case scenarios.
However, even without Russian gas, the situation wasn’t as dire as anticipated, and energy prices have since decreased. Ultimately, it’s the responsibility of individual companies to develop competitive business models for international markets. Politics cannot relieve companies of this responsibility.
So, does the economy need a new economic sector as an economic engine to replace the auto industry? Which economic sector could that be? The service industry, for example?
If it naturally evolves through market processes, then yes. However, it’s uncertain whether strategic industrial policy is effective here. Markets often perform better in such matters. We cannot predict today what the predominant technologies will be in 10, 15, or 20 years.
Sensible social systems should support individuals affected by structural changes. However, it’s not promising for the government to dictate which sectors the economy should engage in and which it shouldn’t.
Nevertheless, the auto industry receives substantial state support, more than other industries.
The government is developing an industrial strategy to promote certain industries, which I disagree with. Policymakers should focus on creating favorable conditions for all companies.
This includes ensuring a stable energy supply, promoting digitalisation, investing in education, and improving transportation infrastructure. I don’t think it’s appropriate for politicians to decide which sectors receive support and which don’t.
Is Germany still an attractive production location? The effective tax burden is 28%, well above the EU average. Are companies migrating from Germany en masse?
We don’t see mass migration of companies from Germany in the data. Given the economic situation, investments in Germany remain relatively stable. Private consumption has recently been the component negatively affecting GDP growth, but this isn’t particularly alarming.
Although things aren’t perfect, there’s no need for excessive pessimism. Germany remains an attractive location due to its imperfect yet reasonably good education system, infrastructure (though it needs improvement), and the ongoing establishment of new businesses here. It’s premature to lament about the state of affairs.
What does the weakening economy mean for Germany’s European trading partners such as Poland and France?
A weaker economy in Germany would mean reduced imports from these countries. Trade ties within the European Union are strong, so the effects will be noticeable, although quantifying them precisely is challenging.
What is your outlook for the next few years? How will the economic situation develop?
We anticipate the German economy to recover over the year, though with a very low annual average growth rate. The recovery will be driven by developments in real incomes. In the past years, real incomes among private households experienced losses, dampening private consumption.
Now, incomes are stabilizing, partly due to improvements in export-import price relationships, known as terms of trade. Additionally, collective wage agreements have been reached in many sectors, providing some compensation for private households.
Overall, real disposable incomes are expected to rise, stabilizing overall economic demand. We’ve also reached the end of the interest rate hike cycle. Economic weakness in interest-sensitive areas, such as the construction industry, has been exacerbated by rising interest rates, leading to decreased demand. The next interest rate move later this year will likely be a downward one.