Germany's economy is flopping and the manufacturing sector just keeps declining — here's why recession could be around the corner

Yusuf Khan
Aug. 29, 2019, 07:48 AM

mercedes crashPolizeidirektion Ludwigsburg via Der Spiegel

  • Germany's economy has been faltering and could be in a technical recession, according to economists.
  • Data on Thursday added to Germany's woes, as new factory orders declined in July and construction was at its lowest level in five years.
  • The economy contracted in the last quarter and consumer sentiment continues to stagnate as people just aren't buying as much. 
  • The global economy is sputtering too, and Brexit and the trade war are weighing on machinery and new car orders.
  • For Europe's biggest economy, Germany's slowdown can, in turn, bring down the rest of the eurozone with it, including growing economies like France and Spain. 
  • View Markets Insider's homepage for more stories. 

Germany's economy has been stuttering in the last few months and the outlook is bleak. 

On Thursday, data showed that new orders for German manufactured goods declined by 2.7% in July on the previous month and 5.6% month on month, a major drop for a country that's economy is also 50% manufacturing. 

While construction data from IHS Markit also showed that there has been a severe slowdown in activity, falling to its slowest rate in five years.

Last week it was confirmed that the German economy had contracted in the last quarter, meaning if the same happens again, Europe's largest economy will be in a technical recession, adding to the pain. 

The economy isn't looking great right now, and although unemployment is at a healthy 39 year low, that could change if demand from Germany factories continues to drop. 

As Claus Vistesen, Chief eurozone economist at Pantheon Macroeconomics said in a report in August: "The IFO survey is clear as rain; yes, the German economy is in recession."

How did we get here? 

1. Manufacturing is slowing down. 

Germany's economy unlike most economies in Europe relies heavily on manufacturing.

In fact, 47% of Germany's GDP is made up of manufacturing, according to Andrew Kenningham, senior European economist at Capital Economics. In terms of share of an economy that's four times as much as the US.

This essentially makes Germany very fragile when it comes to softening demand from abroad for Germany goods like machinery or autos. 

"It's not just weakening demand from China and Brexit, but it's the downturn in demand for manufactured goods that's hitting Germany," said Kenningham to Markets Insider in a call in August. 

Germany relies upon other countries importing machinery. So any demand slump in the US or China, for example, would hit Germany too. 

German manufacturing levels fell to their lowest level in six years last month, mostly in part due to a drop in demand from abroad. This was backed up by fresh data from the Federal Statistics Office that showed that new orders in July fell 5.6% month on month.

Likewise, exports plunged 8% year on year in June, with non-eurozone sales falling over 6% according to Trading Economics.

Auto sector exports — Germany's biggest export — has fallen by about 13% in the three months to June, said Kenningham.

He added that much of this is down to political uncertainty, such as Brexit, which has weighed down on UK imports. 27% of Germany's exports to the UK are vehicles.  

Kenningham said in a note that crashing out of the European Union without any deal in place "would further reduce German exports to the UK," which were equivalent to 2.5% of German GDP last year.

German exports to the UK would fall by around 10% for six months, he said, which would trim 0.25% points off German GDP on an annualized basis.

2. Germans just aren't spending as much.

German spending contracted sharply in the second quarter of 2019. According to Pantheon Macroeconomics, it rose by 0.1% quarter on quarter, reversing the "jump" in Q1 of 0.8%. 

But Germans actually have more money in their wallets than before this current downturn.

"Real incomes have been increasing rapidly," according to Kenningham, and "employment has been rising."

However, the Capital Economics economist explains that consumers are being much more cautious in spending. 

"People have been more pessimistic, and you can see that with a rising savings rate as people are more concerned about the future. It's not surprising when on the news they see that the economy continues to struggle," Kenningham said. 

The savings rate currently is at around 10.5%, compared to the US at 8%.

3. There aren't many viable policy options to fix this.

"There isn't much of a policy response available for Germany," explains Kenningham.

"Normally a central bank would loosen policy or cut taxes to increase spending. There has been some loosening of policy, but nothing substantial." 

On August 29, Bloomberg reported that Germany had plans to bring corporate tax down to 25%, and recently there were also plans to bring a change in income tax to help boost spending. But how much that'll change things is debatable. 

Germany's central bank has already pledged it would help fight recession, and pump billions into the economy to revive it, if it does fall into decline. 

Meanwhile, the European Central Bank's interest rate is currently below zero, at -0.4%, so even if Mario Draghi does lower interest rates in September as expected, the effect most likely won't be able to pull Germany out of recession.

See more: Germany's central bank just warned a recession could be coming. Its government is prepared to spend $55 billion to fight it.

Germany is now in a peculiar position.

Wages are rising, and employment is high, but the economy is on the brink of a recession. 

The consensus is that if Germany does enter a recession, it will not be as bad as the euro crisis in 2012. But given Germany's weight in the eurozone, if it does, the risk is it could pull down countries like Spain and France — economies that have been performing well. 

If this happens, then Europe could well be in trouble. 


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