HQ TrustSeptember 28 2020

HQ Trust on German economic activity: Upturn with risks

6 mins read

Written by Michael Heise, Chief Economist HQ Trust at HQ Trust GmbH

To view this article in German please click here.

Although recovery in the Germany economy has been stronger than many anticipated, the corona pandemic has left a considerable mark. And Michael Heise perceives risks for 2021 too. Consequently, he calls for an improvement of the general economic framework.

Four letters are in the running: Will the recovery of the German economy take a V, U, W or L form? At present, many indicators suggest the optimistic version: the V, as official figures show that, in the second quarter, the real gross domestic product is down 9.7 % on the first quarter. However, as a consequence of the easing of the pandemic-related restrictions, overall economic output in the current quarter is likely to increase significantly. Therefore an increase of the magnitude of up to 7 % appears realistic for 2021.

Deutschland: Output & Incoming Orders

Output in manufacturing industry (index values, 2015=100, adjusted for calendar and seasonal effects)

Output & incoming orders in industry (index values, 2015=100, adjusted for calendar and seasonal effects)

Production in the manufacturing industry rose again by a total of 16.9 % between April and June, therefore lying this month around 8.2 % above the average level for the second quarter. In terms of the volume of incoming orders in industry, this backlog increased further with a figure of 20.5 % following a strong increase in June (up 27.9 % on the previous month). The improved results in export expectations in the manufacturing industry (ifo) and the assessment of incoming orders among purchasing managers also indicate that the order situation continues to improve and that the economy is setting a smart pace in the current quarter.

Germany: Foreign trade

IFO Anticipated exports 

(manufacturing industry, balances, seasonally adjusted)

IFO Anticipated exports: current data

(manufacturing industry, balances, seasonally adjusted)

The individual indicators to date do show signs of a V-shaped recovery which most commentators had regarded as the least likely development. At the time of the unprecedented crash, it was difficult to imagine a sudden reversal. But ultimately there were good reasons for it. The economy had been placed in an induced coma; the closure of sales outlets (department stores, car showrooms, for example) and service areas meant that consumer wishes could not be satisfied. 

As the online trade was unable to pick up the slack, in particular in the area of durable goods, the level of savings in private households rose significantly in the months of lockdown. With the easing of restrictions, consumption began reviving of its own accord. Over the coming months too, the catch-up effect in consumption will continue to be effective. Support was also provided by the economic policy measures which, up to now, have been able to prevent widespread insolvency and – thanks, for example, to the short-time working benefit – loss of income in the private sector. 

(Real retail sales Chart)

Rising infection figures are a risk

However, the figures for new infections which are rising in many countries, or rising even further, constitute a considerable risk for economic activity in the further course of the year and in 2021: Should the pandemic begin spreading at an accelerated rate in Germany or one of its major partner countries, making restrictive state measures necessary, a renewed downturn in growth can hardly be prevented. In the extreme case of a second lockdown with a partial shut-down in business and renewed contact restrictions, a repeat crash would have to be anticipated. In this event, a kind of W-shaped recovery of economic activity, known as a double dip, would have to be expected. In view of the enormous economic costs, it is believed that a widespread lockdown will not be considered. Nor would it be defensible, given the low death rate and the current relatively low number of serious cases of infection. 

Even relatively moderate specific measures to combat the pandemic will slow down the trend towards economic recovery. Higher costs incurred to comply with regulations as well as restrictions on larger events will place a burden on numerous branches. Furthermore, the recovery of consumption rates would also slow down as a result of measures to combat the pandemic. The reduction of unemployment and short-time work models will take even longer, particularly as the pandemic has led to a structural shift towards digital business models as well as other transport and travel concepts and fewer deep and automated production chains. The demands made of those in employment are changing as a consequence and require effective retraining and qualification measures. 

How are the most important trading partners doing?

Just how quickly a higher rate of employment can be reached depends furthermore on developments among the most important trading partners. The stabilisation of Chinese economic activity, which has already returned to pre-crisis levels, is of considerable significance for German companies. But with regard to developments in other important customer countries, the prospects remain very uncertain. In the US, for example, while the daily infection rate is dropping, it is still at a very high level and leads to an anticipation of lasting restrictions for the local population. The UK, the fifth largest export market for Germany, has experienced a massive downturn and is likely to recover only very slowly. Similarly, the euro zone is marked by the pandemic. Travel restrictions for Spain or rising numbers of cases in France could limit the economic recovery dynamic in the coming months.

The risk of slipping into a further phase of economic weakness following the first resurgence of economic output is therefore not insignificant. This would result in new challenges for economic policy. German financial policies already supported the economy with huge sums and the associated sharp rise in the national debt in the first wave. A renewed economic slow-down would make further economic-policy measures necessary. Initial decisions were taken during the last few days with the extension of the short-time working benefits or the special regulations with regard to the obligation to file for insolvency.

Improving general framework for business

Supporting companies and the self-employed who are hit particularly hard by the pandemic, and in some case face doubt with regard to their continued viability, is the right thing to do. However, this strategy, while right in itself, represents a tightrope walk for the policymakers, as a long-term reduction of capacity and market exits in some branches will be unavoidable, and have to be permitted in a market-based system. Considering the distinct drop in demand in some branches, the extension of the short-time working benefits to 31 December, 2021 is in some respects undoubtedly at the limits of what can be reasonably justified. 

Just a few days ago, the French government announced policies aimed specifically at increasing the competitive capacity of companies. The plan, funded in part with EU resources, focuses primarily on lowering non-profit-dependent taxes by 20 billion, significantly ramped up the investment programme in a range of future-oriented sectors and granting businesses major subsidies for vocational education and advanced professional training. 

By contrast, the German approach has concentrated more strongly on the demand side with the reduction of VAT rates and the granting of a bonus payment for children. The drawback here is that the expensive temporary drop in VAT only stimulates consumer activity in the current half-year. The return to the higher rates at the beginning of 2021 will result in a retarding effect and – possibly at the most inopportune time – trigger a downturn in consumer spending. Germany too should also give regard to the factors influencing competitive capacity such as high taxes and social contributions, pandemic-related cost increases and a slump in output as well as high energy prices. Some items in the last German economic stimulus package addressed these points such as improvements in loss accounting, less stringent rules relating to depreciation or state subsidies allocated for renewable energy.

Factors weakening competitive capacity

But the fact remains that Germany places a heavy tax burden on lower and middle incomes, and is well above the international average for corporate and business tax rates; the solidarity supplement for many sole traders and partnerships remains in place and the energy costs for production remain high in Germany and are set to rise further as a result of the climate package. All of these are no longer counterbalanced by excellent infrastructure which may have been considered Germany’s hallmark many decades ago but which, in the meantime, has been equalled or indeed outstripped in many other countries. The investment measures in the context of the economic stimulus package will not be able to affect speedy changes, particularly as the slow progress in infrastructure development may not be the result of a lack of funding but rather of the long-drawn-out planning and approval processes. 

The current trend in many political sectors is not to consider reducing income tax or corporate tax or other special facilities, rather proposes imposing even higher taxation on income or introducing more rigid regulations with regard to the labour, commodities and housing markets. This would weaken the economy’s competitive capacity and, in the long term, result in a lower level of investment and fewer jobs. This approach will not lead to successful consolidation of the national debt. This would require a long-term policy not concentrating solely on developing demand, but rather focussing strongly on the economy’s competitive capacity. 


The recovery of the German economy since the easing of the restrictions put in place to curb the corona virus pandemic is stronger than many anticipated. However, the spread of the virus represents a major risk for the coming months and for 2021. It is now essential to keep up the momentum of the economic recovery process, on the one hand by means of specific and economically-justifiable measures to combat the pandemic, on the other hand by means of economic policies which strengthen the economy’s competitive capacity. 

The shrinking of some sectors will then be counterbalanced by growth in other areas.

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