Is Germany's shrinking economy our foreland?

Industrial activity is shrinking everywhere and the German economy is in recession, although you can't say this about it. The US economy, on the other hand, is growing slightly faster than expected, with fiscal policy and monetary policy working against each other in the United States.

The industry is under pressure. That sounds like a far too generic observation. After all, you should at least indicate where that is the case. Well, the answer is: everywhere. This week, provisional figures for business confidence in May were published in an otherwise limited group of countries. My point is that the industry sub-index was below 50 in all of those countries. This implies contraction in the sector. Germany took the crown. There, the confidence index fell from 44.5 in April to 42.9 in May. Of course, Germany has a large weight in the figures for the eurozone as a whole. The figure for the euro area as a whole therefore fell from 45,8 in April to 44,6. The index also fell in the US and the UK and was also low at 48,5 and 46,9 respectively. Only in France was there a slight improvement: from 45,6 in April to 46,1 in May.

What is immediately striking, of course, is that business confidence in the service sector is much better. That sub-index is well above 50 in all countries, indicating growth. Since the service sector in our countries is much larger than manufacturing, this weighs more heavily on the economy as a whole. However, experience shows that the industry is more cyclical and often somewhat ahead of the rest of the economy.

Industrial activity is also under pressure outside the countries mentioned. I always like to look at countries like Korea and Taiwan because they are 'early cyclical'. In April, manufacturing production in Taiwan was about 20% lower than a year earlier. Admittedly, in recent years there has also been occasional exuberant growth and perhaps a normalization of production levels. However, when you look at such figures against the background of what is happening in other countries, it is difficult to be optimistic. Taiwanese export orders are also extremely weak. They are also about 20% lower than a year ago.

Now, you might think that the ever-present tension between Taiwan and China is hurting Taiwan's economy, as China may boycott Taiwan. Whether that is the case, I cannot judge. I can look at other countries in the region. Singapore is a relatively small economy, but there too industrial activity is under considerable pressure as the following picture shows.

A slightly more positive picture emerges from the figures on world trade as compiled by the CPB. These are figures that are followed by many economists in the world. Of course it is a hell of a job to compile these kinds of figures and since this is a weighted sum of national statistics, we have to take into account a considerable margin of uncertainty around these figures. Moreover, these figures are somewhat behind other figures. Despite these nuances, there is good news to report. World trade grew by 1,5% in March compared to February, according to CPB calculations. This brought the year-on-year comparison back just above 0%.

Back to Germany
In our eastern neighbours, not only the provisional purchasing managers' index for May was published as an indicator of business confidence. The Ifo Institute published the well-known proprietary Ifo index of business confidence. It showed a decline in May, after rising for six months in a row. The expectations component in particular dropped significantly: from 91,7 in April to 88,6.

The German CBS, Destatis, published a revision of the GDP figures for the first quarter. According to the previous figures, the German economy had stagnated in the first quarter, but is now contracting: -0,3% quarter on quarter. In the fourth quarter of last year, the German economy had also contracted: -0,5% quarter-on-quarter. According to the rule of thumb, a recession occurs when an economy shrinks for two quarters in a row. Now a little shrinkage is really not the end of the world. But for now there is little prospect of improvement. It is possible that the German economy will shrink again in the second quarter. Unemployment has already risen from 5,0% in March-May last year to 5,6% in April this year.

You can't say this
I am aware of sensitivities and if you say things that people don't like you risk being canceled and then ignored. But I'm going to give it a go anyway. Then what? Trying to answer the question why the German economy is clearly doing worse than many other countries. Mind you, this is not an exact science and somewhat speculative. It is quite possible that the relative (and absolute) weak performance of the German economy is related to the weight of industry. It is higher in Germany than in most other European countries. And since, as argued above, the manufacturing sector is having a much more difficult time than the service sector, it is perhaps logical that the economy with the largest industrial sector performs more moderately.

But Germany also differs from neighboring countries in another area. Energy policy is radically different. After the tsunami at Fukushima in 2011, the German government decided on the Energiewende. Nuclear reactors had to be closed and full use was made of sun and wind. As a result, energy costs in Germany have been higher for years than in most other countries. Recent developments in energy-intensive sectors show how sensitive activity is to energy prices.

What might be the message of this? You could say that the Germans are at the forefront of the energy transition with their Energiewende. If it is true that higher energy costs are gradually contributing to an erosion of industrial activity, we have something to look forward to. Now you can of course argue that it is simply no different and that we have to bite the bullet. However, I think it would be useful and fair to recognize that this is a very sour apple. The German statistical office publishes specific figures for energy-intensive sectors. It can be deduced from these figures that labor productivity in those sectors is about 40% higher than the industry average. These sectors therefore provide very high-quality employment. The loss of such jobs reduces the earning capacity of the country and inevitably and inexorably contributes to a reduction in total (material) wealth. 

Which brings me to our own prime minister. Earlier this week, he was on a talk show where he once again said that the energy transition will create a lot of jobs. In that he is right. Logical too. If you are going to convert your energy system, it will probably create jobs. But that's not the point at all. One job is not the other. The labor market is tight and we are ageing. We are not waiting for a lot of new jobs at all. What we do need is jobs with high labor productivity. I am afraid that the energy transition will not deliver that. That is not an argument not to implement that transition, but it should encourage you to think and to tell honestly how things like this work.

Biden and Powell are working against each other
As the debate on the debt ceiling continues, the US budget deficit is growing alarmingly. In the 1.940 months through April, the deficit was USD $7,5 billion, or XNUMX% GDP. This means that the deficit has almost doubled in a year's time. It is quite unusual for the deficit to increase so sharply while the economy is not in recession.

The US economy grew by 1,3% in the first quarter compared to the fourth quarter last year. Growth was previously estimated at 1,1%. This is an annualized figure, which means that the economy will grow by 1,3% if the growth rate in the first quarter continues for a year. In the usual way of measuring in Europe, growth was 0,3% quarter-on-quarter. That doesn't sound impressive. It should be borne in mind, however, that corporate destocking took more than 2 percentage points off growth. Private consumption grew by 3,8% (annualized; calculated in our way it was 0,9%). Government consumption grew by no less than 5,2% (annualized, our way 1,3%). On balance, you have to conclude that US economic growth is continuing reasonably well. We should therefore not be surprised if the Federal Reserve raises official interest rates even further. Typically, here is an example of fiscal policy and monetary policy working in opposite directions.

Closing
Economic developments continue to be confusing. The service sector seems to be doing well everywhere. Much less with industry. It seems to be shrinking everywhere. It is especially difficult in Germany. That economy has been shrinking, it now appears, for half a year. I suspect that the German economy is struggling partly because of their Energiewende. Is what is happening there our foreland in the energy transition? The US economy grew slightly more than previously calculated in the first quarter. A growth figure of 1,3% is modest, but the underlying evidence shows that the growth dynamics were quite reasonable. With fiscal policy currently providing strong impulses to activity, while the Fed is actually trying to dampen growth, the likelihood of further interest rate hikes by the Fed has increased.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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