MNI INTERVIEW: German Economy "Stuck," Top Economist Says

MNI (LONDON) - Germany feels “stuck,” with little indication that its economic problems can be solved by any political constellation, Kiel Institute for the World Economy (ifw) president Moritz Schularick told MNI, adding that Chinese ownership increasingly looks the best way to secure the survival of some car firms.

With chances of a snap election rising after a leaked paper from Finance Minister Christian Lindner called for relaxing environmental targets and cutting taxes and welfare payments, the likely victor in any upcoming vote -- Friedrich Merz's Christian Democratic Union -- appears torn on the key issue of whether to reform strict borrowing rules in order to boost investment, Schularick said.

“It does seem almost as if policymakers have given up and are just accepting their fate while talking about the confidence fairy. I don't think that the tax burden or even energy prices are the main driver of the problems Germany faces; we have a mix of structural issues in industry and weak global demand,” he said in an interview.

“I think they understand that without changes in the fiscal set-up their capacity to do things - even cutting taxes - will be very, very limited.  They will come around eventually, but it could well be that they come around too late, because it's not clear at all that the next Bundestag will still have a two-thirds majority for the democratic parties.”

Parties from the far right and left may take “a blocking third” of parliamentary seats, meaning that changes to the constitution, including to the “debt brake” which caps borrowing, or expensive measures to address climate change and the green transition, or to boost defence or assist Ukraine in its conflict with Russia, would become impossible, he said.

CHINA HEADWINDS

For many years a major growth driver due its demand for German goods, China has gone from being a tailwind to a headwind, Schularick said, with Germany exporting more to Poland in summer 2023 than it did to the PRC.

Schularick expressed “severe doubts” over the ability of Germany’s auto industry to adapt quickly enough to counter the threat from Chinese competitors, with Volkswagen - whose complex governance structure makes it slow to react - serving as a metaphor for the country as a whole. (See MNI INTERVIEW: German Car Makers Have 5 Yrs To Change-Suedekum)

“A realistic scenario is that there are some parts of the Volkswagen group that do have a future and that are profitable, and that will, in one way or the other, stay in German hands, or in Germany. But it may be that under certain conditions we decide Volkswagen’s mass market business is not critical for security, and that it makes sense to find a strategic Chinese investor who will take over and make mass market cars in Germany, maybe with a VW brand,” he said.

Germany's labour market will deteriorate, although it remains to be seen how rapidly, with big job losses in the car industry supply chain potentially offset by growth in such areas as defence, and as the pool of workers shrinks due to demographic change.

“It will end up being more of a gradual drag. It's not yet my baseline that we will see unemployment rates high enough to be in and of themselves a trigger for political action - I don't think we’ll go to double-digit unemployment in Germany,” said Schularick.

ECB TOO TIGHT

On top of these problems, European Central Bank monetary policy has been "too tight for too long,” he said, adding that this increases the chances that rate-setters will panic later on.

"I don't see any reason why for the past six months the ECB has been stuck in a restrictive mode,” he said. The neutral rate of interest which is neither restrictive nor expansionary is at around 2.0-2.5%, versus the current Deposit Rate of 3.25%, he said.

“The caveat is that no-one knows what is going to happen in the U.S. elections, although a Trump victory would in all likelihood be bad for European growth."