Stagnation in Germany threatens economic outlook

Ed Nusbaum calls for growth-boosting measures in eurozone

The global economy has entered another tricky phase. Growth in China slowed to (an albeit still very healthy) 7.3% in Q3, suggesting further discomfort for commodity exporters. In Japan, the shine seems to have come off Abenomics. The recently re-elected Dilma Rousseff has her work cut out to kickstart the Brazilian economy again. Meanwhile oil prices have dropped to around US$80 a barrel and could fall further next year according to Goldman Sachs.  This will adversely impact all oil producing countries, including Canada, Russia, parts of South America, and of course, the Middle East.  While manufacturers and other users of oil will benefit, new production techniques could suffer, and the US’s goal of being energy self-sufficient might be impacted.  

Of course, there are pockets of positive feelings around the world. The US is still adding jobs at a good pace, the UK is set to grow faster than any other major advanced economy in 2014 and Canadian business leaders remain optimistic.  We had our global conference in Montreal last week, and I spoke with the local Council on Foreign Relations about the prospects for growth around the world.  Interestingly, business leaders in Quebec are even more optimistic about their economy than peers in wider Canada, but they remain concerned that bureaucracy and regulatory red tape will adversely impact their operations as they become more globally integrated. 

However, the major concern is once again the eurozone. Not only is the European Union the largest single market in the world, but the 19 countries who use the euro account for approximately a fifth of global output. In the years following the sovereign debt crisis, Germany was something of a rock, posting strong growth even while its neighbours were struggling. But its economy contracted by 0.2% in Q2 and could already be in recession; business confidence dropped by more than half in Q3 according to our International Business Report (IBR). Without the support of its largest economy, net business optimism across the eurozone dropped to just 5% in Q3, the lowest since the second quarter of 2013. Only Argentina is more pessimistic than France (-42%) and Italy (-14%) globally.

The major worry across the currency bloc is now deflation and you only have to look at what happened to Japan in the 1990s to understand what this can do to an economy. Businesses and consumers stop spending in the expectation of lower prices, while negative inflation means the real cost of borrowing increases. In short, both demand and supply suffer. Just one in ten businesses across the eurozone expect to raise prices over the next 12 months (compared to one in three globally) and a majority in France  (-12%) and Greece (-4%) expect prices to fall. Prices in Poland (0%), the Netherlands (2%) and Spain (3%) are essentially flat.

The solution touted by many economists is monetary expansion - such as the quantitative easing (QE) programmes launched by the UK and US. France and Italy would like to see (and appear to have won) a relaxation of eurozone budgeting targets (which they were likely to miss anyway) to give them the space to boost growth. However Germany is resisting further interventionism by the European Central Bank and is prescribing more austerity for its single currency partners.

Germany posted its biggest budget surplus since reunification in the first half of 2014 and Christine Lagarde, head of the IMF, suggested it should use this fiscal power to boost demand across the region by investing in infrastructure. Annual investment in Germany amounts to 17% of GDP compared to 21% for its peers and infrastructure improvements would of course have the added benefit of increasing the long-term growth potential of the economy.

I will be watching the situation in the eurozone very closely over the coming weeks and months. We have seen the ripple effect of recent European data on stock markets in the US and throughout the world. The success of the Mittelstand has been synonymous with the success of Germany over recent years, but the proportion of businesses citing a lack of demand in Germany quadrupled to 23% in Q3, while a majority now expect to shed workers in the year ahead. Politicians would be wise to heed their concerns and do all they can to support the growth prospects of dynamic businesses across the region.