The loss of Russian gas will force change on German industry, according to economist Oliver Holtemoeller.
Germany’s economy could perform worse than expected as interest rates rise, a leading economist told MNI in an interview, heralding difficult choices for government as it prioritises the immediate social and economic impact of rising energy prices even as the country faces a permanent loss of competitive advantage.
While a joint economic forecast by four leading think tanks sees Europe’s largest economy growing 1.4% this year before contracting 0.4% in 2023, this may be over-optimistic if the European Central Bank tightens policy more than hoped, said Oliver Holtemoeller, from the Halle Institute for Economic Research (IWH), which contributed to the projection.
“We do not have the usual business cycle fluctuation here,” he said. “We have a permanent shift in the path of GDP. GDP will be lower.” (see MNI INTERVIEW: Germany Faces Deeper Recession - Bofinger).
The forecast, which sees growth recovering to 1.9% in 2024 when inflation peaks at 8.8%, assumes ECB interest rates rise to 3.25% by the end of next year.
“It takes some time until the interest rate increase affects the real economy, so our outlook for 2024 is rather optimistic. I would still say it's balanced because there are upside and downside risks, but if monetary policy reacts more aggressively to fight inflation, this would of course, in the medium term, also have an impact on the real economic outlook and could affect the recovery in 2024 and maybe even 2025.”
LOSS OF COMPETITIVENESS
Energy prices will not return to pre-crisis levels even when the Ukraine war is over, Holtemoeller said. Nor will Germany return to importing Russian gas, dooming the cost advantage it has enjoyed in industries including chemical production.
Overall industrial performance remains solid, but structural changes will see some firms disappear. Others will shift production abroad - a process Holtemoeller, professor of economics at Martin Luther University Halle-Wittenberg, said was already evident among chemicals companies cutting production due to the gas squeeze.
“Some elements of the German chemical industry will not survive this crisis; this is something that we have to realize,” he said. “This will come with structural change in some regions that will be problematic for some households.”
But firms’ desire to retain workers beyond the current crisis should keep the unemployment rate stable at around 5.3% over the medium-term, he believes.
While the joint study does not assume gas rationing as its baseline scenario, “current demand is above the previous year, so it's still not clear whether we will have gas rationing in the winter,” Holtemoeller said.
Berlin’s announcement last week that it will spend EUR200 billion to bring down energy costs, may exacerbate some problems.
“What the German government has announced makes it more likely that we will have a shortage of gas in the winter. With all these subsidies the price signal is distorted, and this makes the worst-case scenario more likely,” Holtemoeller said.
While the decision to exempt the spending from Germany’s constitutional debt brake makes legal sense, he added, it is out of line with the instrument’s economic objective.
TECHNOLOGY A WILD CARD
Upside risks to growth do exist, he conceded, especially if technology increases energy efficiency. But energy costs will increase throughout the winter, with broad-based inflation only starting to dip by the middle of 2023.
With wage increases averaging 5% this year against inflation around 10%, a greater proportion of household incomes will be spent on utilities, weighing on consumption.
Continued euro weakness against the dollar will feed imported inflation and capital outflows, he said, though these would be potentially offset by improved exports.
Looking ahead, demographic change presents additional fiscal challenges, Holtemoeller said. With 400,000 people leaving Germany’s workforce every year, federal allocations for pensions payments face a potentially massive shortfall - in part a result of short-term crisis measures and multi-year commitments like promised boost in defence spending to 2% of GDP without raising taxes. The crisis is also testing faith in democracy, particularly in Germany’s east.
“Policy is really deeply concerned about the societal impact of what's going on,” he said. “This is what this package is about. It's a short-term instrument to give people confidence in the current system, but it neglects the long-run consequences.”