Economic upswing continues - but is exposed to increasing risks

The cyclical upswing of the Germany economy is likely to continue in the coming years, but it will lose momentum and be exposed to increasing risks. This is the central message of the Joint Economic Forecast published by the leading economic research institutes on 27 September. The domestic demand is currently the main driver of the economy. On the one hand, employment and wages have risen sharply and this has stimulated private consumption. In addition, high capacity utilization and low financing costs are supporting investment activity. On the other hand, foreign trade is having a dampening effect. The economy in the most important German sales markets slowed in the first half of 2018. The first effects of protectionist measures could also contribute to the slowing of exports, although this effect is unlikely to be too strong yet. What is unusual, however, is that the upswing seems currently being held back by production bottlenecks. In any case, in the ifo business surveys a historically high proportion of companies report production impediments due to labour shortages and problems in procuring intermediate goods. This also fits in well with the fact that order books in the manufacturing sector are well filled, whereas production has stagnated at best since the beginning of the year.

Admittedly, a special development in the automotive industry is currently also contributing to this. From 1 September 2018, new vehicles can only be registered when being certified according to the new WLTP exhaust and fuel consumption test procedure. There are considerable bottlenecks with this certification, which have led car manufacturers to build up warehouses, temporarily stop production and deliveries. Furthermore, they passed numerous vehicles on to the trade at considerable discounts, which then turned them into used cars by means of daily registration, which do not have to be certified according to the new procedure. Since such an important sales channel is initially "clogged" and the problems with the test procedure should not be overcome overnight, car production could still be curbed for some time. In view of the industry's great weight, this will have an impact on the economy as a whole, and it will have an impact above all on the steel industry.

However, automobile production should gradually return to normal, and fiscal policy will also provide stimulus at the beginning of 2019. Both factors suggest that the economy will initially accelerate in the winter half of the year. However, a gradual slowdown in the pace of expansion can be expected thereafter. In the course of the weakening global economy, foreign trade impulses will probably no longer be as strong. In addition, the domestic labour force is increasingly exhausted and immigration is slowing down. Overall, the upswing is thus likely to gradually lose momentum. Against this backdrop, the Joint Economic Forecast expected the gross domestic product to grow slightly more by 1.9% in the coming year after a plus of 1.7% this year. The forecast for 2020 is significantly influenced by an unusually large number of working days. It will lift the growth rate to an annual average of 1.8%, but adjusted for this working day effect, growth will be only 1.4%.

However, the risks for the German and international economies are considerable and have increased compared with the spring. Above all, the advance of protectionism poses a danger. In particular, the trade conflict between the USA and China is threatening to escalate, which will have an impact on the global value added chains and thus also on German companies. Relations between the EU and the USA have eased somewhat. However, the course of the year to date has shown that the protectionist foreign trade policy of the USA does not leave it to threats.

Another source of danger are the crises in Argentina and Turkey. Currently, they are still perceived more as specific national problems. There is a danger, however, that investors will generally lose confidence in emerging markets and that their financing conditions will deteriorate significantly, thereby stalling the economy there.

For the economy in Europe, the possibility of a disorderly withdrawal of Great Britain from the EU poses a significant risk. The forecast is based on the assumption that Brexit will proceed in an orderly fashion and that a transition period will be agreed. As time is running out and disagreement in the UK is considerable, the option of a disorderly "no deal" exit is not off the table. In such a case, the German economy is likely to be hit particularly hard, as the UK is the third most important export market.

Finally, in Italy, the government recently confirmed that it intends to finance tax and pension gifts through additional debt despite high government debt. The conflict with the fiscal rules of the European Union is inevitable, and this could ignite the euro crisis. Italy already has to pay a significantly higher interest rate for its government bonds than six months ago.

The contribution is by Prof. Dr. Roland Döhrn, RWI - Leibniz Institute for Economic Reseach, Head of Department Macroeconomics and Public Finance, RWI, Essen

Photo: RWI, Essen

The guest commentary reflects the opinion of the author, not necessarily that of marketSTEEL's editorial staff.