Germany: ECONOMY

ECONOMY



Overview: Germany has a social-market economy that combines free enterprise and competition with a high level of social services. The economy is the world’s third largest, when measured at market exchange rates, and the fifth largest, when using purchasing power parity. Reflecting a social compact between employers and employees, workers’ representatives share power with executives in corporate boardrooms in a system known as co-determination, or Mitbestimmung.



The performance of the German economy is a study in contradictions, with indisputable strengths in exports and manufacturing, but also troubling weaknesses in the labor market and federal budget. Exports are responsible for one-third of total economic output, and at the prevailing dollar-euro exchange rate, no country exports more merchandise. In 2003 Germany edged out the United States in merchandise exports (US$748 billion for Germany vs. US$724 billion for the United States, according to the World Bank) and accounted for 10 percent of total world trade. In the same year, illustrating the competitiveness of its export sector, Germany posted a trade surplus. German manufacturing excels in the production of automobiles, machine tools, and chemical products.



By contrast, weak domestic demand has suppressed overall economic output, which rose by 1.7 percent in 2004 after two years of zero growth but was slowing again in 2005. In the summer of 2005, the International Monetary Fund (IMF) forecast growth of 0.8 percent during the year and 1.2 percent in 2006, 0.7 percentage points lower than the prior forecast. These projections placed Germany in last place among industrialized nations in the IMF survey. Most ominously, in March 2005 Germany’s seasonally adjusted unemployment rate increased to 12 percent, a post-war record. The unemployed totaled nearly 5.2 million people, an amount not seen since the Weimar Republic. After peaking in March, however, unemployment moderated to 11.2 percent, or 4.65 million people, in September 2005. Only one-third of the German population is employed full-time. Unemployment is linked to lagging economic development in the former East Germany, strict regulations, rigid labor market conditions, and the impact of globalization. Regarding globalization, competition from cheap labor in countries like China and India is only part of the story. The private sector needs to look no farther than Eastern Europe, particularly the neighboring countries of Poland and the Czech Republic, for an attractive investment climate and extremely low labor costs. The fall of the Iron Curtain, which accompanied German reunification, and the expansion of the European Union (EU) into Eastern Europe on May 1, 2004, have placed the livelihoods of many German workers in jeopardy.



Germany is seeking to ease labor market rigidities through a reform program known as Agenda 2010. This program is designed to reduce the overly generous and costly benefits associated with jobs (and therefore impeding the creation of new ones). These benefits include short working hours and long vacations, unemployment insurance, pension rights, paid sick leave, and comprehensive health insurance. Agenda 2010 also reduces the marginal tax rate to a maximum of 42 percent in the highest tax bracket and 15 percent in the lowest tax bracket.



Unemployment is about 18 percent in the new states in the East, where 14 years of massive investment from the West have failed to produce prosperity. This enormous inter-German transfer of wealth, which totaled US$1.6 trillion cumulatively from 1991 to 2004, or about US$130 billion per year, has exceeded the growth rate of the states in the West and thus has eaten away at the substance of the West’s economy. Furthermore, the combined impact of slow economic growth, tax cuts, and the internal wealth transfer has had a negative impact on Germany’s budget deficit, which has exceeded the 3 percent of gross domestic product limit established by the EU’s Stability and Growth Pact each year since 2002.



Gross Domestic Product (GDP): In 2004 Germany’s GDP was nearly US$2.2 trillion. Per capita GDP was US$31,992, at current exchange rates. Using purchasing power parity, per capita gross national income was US$26,220 in 2002, putting Germany in twentieth place in the world. In 2003 services constituted 70 percent of GDP; industry and construction, 29 percent; and agriculture, the remaining 1 percent.



GOVERNMENT Budget: Since 2002, Germany has run a budget deficit in excess of 3 percent of gross domestic product (GDP), in violation of the European Union’s Stability and Growth Pact. In 2004 the budget deficit was about 3.7 percent of GDP. However, some forecasters expect the deficit to decline below 3 percent of GDP in 2006.



Inflation: Inflation is under control. In 2003 consumer price inflation was only 1.1 percent.



Agriculture, Forestry, and Fishing: In 2003 agriculture, forestry, and fishing accounted for only 1.1 percent of Germany’s gross domestic product (GDP) and employed only 2.2 percent of the population, down from 4 percent in 1991. Much of the reduction in employment occurred in the eastern states, where the number of agricultural workers declined by as much as 75 percent following reunification. However, agriculture is extremely productive, and Germany is able to cover 90 percent of its nutritional needs with domestic production. In fact, Germany is the third largest agricultural producer in the European Union (EU) after France and Italy. Germany’s principal agricultural products are potatoes, wheat, barley, sugar beets, fruit, and cabbages. From 1999 to 2003, the number of agricultural holdings declined by 11 percent to 421,400, reflecting a general trend toward consolidation. As of May 2004, Germany had a total of 448,000 cattle and 726,000 pigs, both figures down about 3 percent from the previous year.



Despite Germany’s high level of industrialization, roughly one-third of its territory is covered by forest. The forestry industry provides for about two-thirds of domestic consumption of wood and wood products, so Germany is a net importer of these items. In 2003 the forestry industry’s production equaled 51.2 million cubic meters of roundwood and 17.6 million cubic meters of sawnwood. As of 2004, an estimated 31 percent of trees in Germany showed signs of environmental damage, according to an annual report by the federal government.



Germany’s ocean fishing fleet is active in the North Sea, the Baltic Sea, and the Atlantic Ocean between Britain and Greenland. The fleet, which has diminished in size in recent decades, contends with overfishing, extended exclusive fishing zones claimed by neighboring countries, and quotas imposed by the European Community Common Fisheries Policy. In 2003 the fishing industry’s total catch was 335.1 million tons.



Mining and Minerals: Coal is Germany’s most important energy resource, although government policy is to reduce subsidies for coal extraction. Coal production has declined since 1989 as a result of environmental policy and the closing of inefficient mines in the former East Germany. As of October 2001, recoverable coal reserves were estimated at 72.8 billion short tons, the largest amount of any country in the then 15-member European Union (EU). The two main grades of coal in Germany are “hard coal” and lignite, which is also called “brown coal.” Unfavorable geological conditions make the mining of hard coal economically uncompetitive, but a slight increase has occurred in lignite production since 1999. Despite its considerable reserves, environmental restrictions have led Germany to become a net importer of coal. Non-energy-related mining recovers potash for fertilizer and rock salt for edible salt and the chemical industry.



As of January 2004, proven oil reserves were 442 million barrels, a modest amount by international standards but still the fourth largest reserves in the EU. More than half of Germany’s domestic oil production is attributable to the offshore Mittelplate field along the western coast of the German state Schleswig-Holstein.



Also as of January 2004, proven natural gas reserves were 10.8 trillion cubic feet, the third largest in the EU. Nearly 90 percent of Germany’s natural gas production takes place in the state of Lower Saxony. In 2002 Germany imported 2.4 trillion cubic feet of natural gas, or 75 percent of its requirements. The most important source of natural gas imports is Russia, with a 40.8 percent share, followed by Norway at 31.5 percent, and the Netherlands at 22.3 percent.



Industry and Manufacturing: Industry and construction accounted for 29 percent of gross domestic product (GDP) in 2003, a comparatively large share even without taking into account related services. The sector employed 26.4 percent of the workforce. Germany excels in the production of automobiles, machine tools, and chemicals. With the manufacture of 5.5 million vehicles in 2003, Germany was the world’s third largest producer of automobiles after the United States and Japan, although China was threatening to displace Germany in the world rankings as early as 2005. In 2004 Germany enjoyed the largest world market share in machine tools (19.3 percent). German-based multinationals such as Daimler-Chrysler, BMW, BASF, Bayer, and Siemens are marquee names throughout the world. What is less well known is the vital role of small- to medium-sized manufacturing firms, which specialize in niche products and often are owned by management. These firms employ two-thirds of the German workforce.



Energy: In 2002 Germany was the world’s fifth largest consumer of energy, and two-thirds of its primary energy was imported. In the same year, Germany was Europe’s largest consumer of electricity; electricity consumption that year totaled 512.9 billion kilowatt-hours.



Government policy emphasizes conservation and the development of renewable sources of energy, such as solar, wind, biomass, hydro, and geothermal. As a result of energy-saving measures, energy efficiency (the amount of energy required to produce a unit of gross domestic product) has been improving since the beginning of the 1970s. The government has set the goal of meeting half the country’s energy demands from renewable sources by 2050. In 2000 the government and the nuclear power industry agreed to phase out all nuclear power plants by 2021. However, renewables currently play a more modest role in energy consumption. In 2002 energy consumption was met by the following sources: oil (40 percent), coal (23 percent), natural gas (22 percent), nuclear (11 percent), hydro (2 percent), and other renewables (2 percent).



Services: In 2003 services constituted 70 percent of gross domestic product (GDP), and the sector employed 71.3 percent of the workforce. The subcomponents of services are financial, renting, and business activities (30.5 percent); trade, hotels and restaurants, and transport (18 percent); and other service activities (21.7 percent).



Banking and Finance: By tradition, Germany’s financial system is bank-oriented rather than stock market-oriented. The process of disintermediation, whereby businesses and individuals arrange financing by directly accessing the financial markets versus seeking loans from banks acting as intermediaries, has not fully taken hold in Germany. One of the reasons that banks are so important in German finance is that they have never been subject to a legal separation of commercial and investment banking. Instead, under a system known as universal banking, banks have offered a wide range of services from lending to securities trading to insurance. Another reason for the strong influence of banks is that there is no prohibition of interlocking ownership between banks and their client companies. However, in January 2002 the government moved to discourage this practice and promote more rational capital allocation by eliminating the capital gains tax on the sale of corporate holdings from one company to another.



At the end of 2000, 2,713 out of 2,931 German financial institutions (92.6 percent) were universal banks, including 354 commercial banks, 1,798 credit cooperatives, and 561 savings banks. The non-universal banks specialized in such activities as mortgage banking and investments. The list of the six largest German banks illustrates the diversity of bank structure and ownership. Of the top six banks, ranked by total assets as of year-end 2002, four are private, but the fifth largest is public, and the sixth largest is a cooperative.



Despite the central role of banks in finance, stock markets are competing for influence. The Deutsche Börse (German stock exchange), a private corporation, is responsible for managing Germany’s eight stock markets, by far the largest of which is the Frankfurt Stock Exchange, which handles 90 percent of all securities trading in Germany. The leading stock index on the Frankfurt exchange is the DAX, which, like the New York Stock Exchange’s Dow Jones Industrial Average, is composed of 30 blue-chip companies. The other German stock exchanges are located in Berlin, Bremen, Düsseldorf, Hamburg, Hanover, Munich, and Stuttgart. Xetra is Germany’s electronic trading platform. As of the end of 2004, the total market capitalization of the German stock markets was nearly US$1.1 trillion, representing about 45 percent of gross domestic product (GDP). The shares of some 684 companies trade on the exchanges.



Recent stock market volatility has discouraged the development of an equity or shareholder culture, where individuals view stocks and mutual funds as promising alternatives to bank savings accounts or bonds as investments. In fact, by mid-2004 only 16.4 percent of the German population owned stock, down from 21 percent in early 2001. One failed experiment in the evolution of an equity culture was the Neuer Markt (New Market) exchange, which was intended to serve as the German equivalent to the United States’ technology-laden NASDAQ market. The Neuer Markt, which opened in 1997 during a euphoric period for technology investors, was designed to handle the initial public offerings of nascent German technology companies. By the fall of 2002, it had all but collapsed, having lost 96 percent of its value since the market peak. In September 2002, Deutsche Börse announced that it would shut down the niche exchange by the end of 2003. Although the Neuer Markt experience does not tell the whole story about German capital markets, the continued reliance on bank financing has negative implications for the creation of new companies and, in turn, jobs. So too, in the view of some observers, does resistance to restructuring of failing small-to-medium sized companies by foreign-run private equity and hedge funds.



Tourism: Domestic and international tourism generates about 8 percent of gross domestic product (GDP) and 2.8 million jobs. Following commerce, tourism is the second largest component of the services sector. In 2004 Germany registered 45 million overnight stays by international tourists, 9 percent higher than in the previous year and an all-time record. In 2003 Germany ranked ninth in the world in international arrivals, with 18.4 million international tourists, versus 75 million in top-ranked France. In the same year, Germany registered a net outflow in the balance of payments related to tourism, as visitors spent US$24.6 million, while German tourists outside the country spent US$68.3 million. Tourism is a factor in Germany’s net deficit in the trade of services. Two-thirds of all major trade fairs are held in Germany, and each year they attract 9 to 10 million business travelers, about 20 percent of whom are foreigners. The four most important trade fairs take place in Hanover, Frankfurt, Cologne, and Düsseldorf. Germany’s sponsorship of the soccer World Cup in 2006 presents an opportunity for the tourism sector.



Labor: The distribution of Germany’s workforce by sector is very similar to the relative output of each sector. In 2004 the workforce was distributed as follows: agriculture, 2.2 percent; industry, 26.4 percent; and services, 71.3 percent. Participants in the workforce totaled 38.87 million. In March 2005, Germany’s seasonally adjusted unemployment rate increased to 12 percent, or nearly 5.2 million people. Both statistics represented post-war records. Unemployment approached 20 percent in some states in the East, where high wages are not matched by productivity. However, by September 2005 overall unemployment had declined to 11.2 percent, or 4.65 million people. Germany has no legal minimum wage, except in construction, but the government is considering introducing one.



Foreign Economic Relations: Germany’s foreign economic relations are consistent with the policy of the European Union (EU) to expand trade among the 25 member states and also with the goal of global trade liberalization through the latest Doha Round of the World Trade Organization (WTO). Germany uses its position as the world’s leading merchandise exporter—a fact that partially reflects the strength of the euro—to compensate for subdued domestic demand. German companies derive one-third of their revenues from foreign trade. Therefore, Germany is committed to reducing trade restrictions, whether involving tariffs or non-tariff barriers, and improving the transparency of foreign markets, including access to public works projects. The fact that Germany has exceeded the EU’s Stability and Growth Pact’s 3 percent limit on the budget deficit as a percentage of gross domestic product every year since 2002 has been an irritant in relations with the rest of the EU.



In 2003 Germany conducted slightly more than half of its trade within the then 15-member EU, followed by, in order of volume, developing countries, Eastern Europe (including countries like Poland that subsequently joined the EU), the United States and Canada, non-EU Europe (Switzerland, Norway, Liechtenstein, and Iceland), and Japan. Increasing emphasis is being placed on trade with Russia and China. The 2005 Hanover trade fair devoted much of its attention to Germany’s growing economic and trade ties to Russia, particularly in the area of energy. Germany is Russia’s top trade partner. In 2002 China overtook Japan as Germany’s top trade partner in Asia, and Germany is investing heavily in that rapidly rising economic power.



Imports: In 2003 Germany imported US$601.4 billion of merchandise, while imports of goods and services totaled US$773.4 billion. Principal merchandise imports were motor vehicles (US$64.4 billion), chemical products (US$63.2 billion), machinery (US$41.8 billion), oil and gas (US$39.9 billion), and computers (US$30.5 billion). Germany’s main import partners were France (9.0 percent), the Netherlands (7.8 percent), the United States (7.3 percent), Italy (6.1 percent), the United Kingdom (6.1 percent), Belgium (4.9 percent), China (3.8 percent), and Austria (3.8 percent).



Exports: In 2003 Germany exported US$748.4 billion of merchandise, while exports of goods and services totaled US$873.3 billion. Principal merchandise exports were motor vehicles (US$145.5 billion), machinery (US$103.0 billion), chemical products (US$92.9 billion), electrical devices (US$36.2 billion), and telecommunications technology (US$35.1 billion). Germany’s main export partners were France (10.6 percent), the United States (9.3 percent), the United Kingdom (8.4 percent), Italy (7.4 percent), the Netherlands (6.2 percent), Austria (5.3 percent), Belgium (5.0 percent), and Spain (4.9 percent).

Trade Balance: In 2003 Germany posted a merchandise trade surplus of US$147 billion.



Balance of Payments: In 2003 the current account balance was a positive US$54.9 billion, or 2.2 percent of gross domestic product.



External Debt: In 2002 total public debt was about US$1.5 trillion, or 60.8 percent of gross domestic product.



Foreign Investment: In 2003 net foreign direct investment was inbound US$11 billion.



Foreign Aid: In 2004 Germany provided US$7.5 billion of foreign aid, corresponding to about 0.3 percent of gross domestic product. Germany provides foreign aid to roughly 70 nations. The majority of the aid is bilateral, as opposed to multilateral.



Currency and Exchange Rate: Germany’s currency is the euro. As of December 20, 2005, one US dollar was equivalent to 0.8406 euros. Because Germany has adopted the euro, the Bundesbank, which had been responsible for conducting monetary policy and maintaining a stable German mark, has ceded much of its previous influence to the European Central Bank.



Fiscal Year: Calendar year.