Recession in Germany. Short or Long?

Germany's economy may contract by 0.4% in 2023, followed by a 0.5% recovery in 2024. The recovery is not certain. The country was in a short-term recession on the eve of 2023, but the situation stabilized in the summer, given the saturation of the energy market with alternative sources. Akin dynamic has given some hope for a quick recovery of the German economy. Despite positive expectations, Berlin entered a new recessionary wave at the end of 2023. One of the factors behind the decline is the decrease in households' effective demand.

For example, German household spending in the third quarter of 2023 fell by 0.3%. Interestingly, this decline is almost commensurate with the rate of decline in the country's GDP. This is because the effective demand factor is key in the economic growth model of modern economic systems. In particular, private consumer spending in Germany accounts for 70% of the GDP. Interestingly, in the second quarter, consumer spending grew by 0.2%. 

Why the dynamics are so uneven? Why is Germany among the weakest EU economies by growth rates, and why are the Greeks now mocking the Germans, suggesting: "sell the islands"?

First of all, the German government's ability to stimulate the economy was significantly affected by the decision of the country's Constitutional Court, which blocked a €60 billion package of financial incentives for the economy. The package was supposed to be used to: 

• Create a hydrogen sector (45 companies in 35 regions of Germany). 

• Produce carbon-free steel (6 billion euros from the Climate Fund, 20 thousand jobs).

• Implement approximately 31 projects in the microelectronics sector (4 billion euros of investment). 

• Produce chips. Germany planned to become the primary chip producer in the EU (two large plants of TSMC and Intel in Magdeburg and expansion of Infineon's production in Dresden). 

• Produce batteries for electric vehicles (20 billion euros of investment). 

• Invest in renewable energy (15 billion euros of investment and 500 thousand new jobs). 

However, the German government promised to find ways to solve this problem. 

That is, one may observe an economic triad. It includes modernizing existing production facilities, such as microelectronics and metallurgy. We can also see the creation of new production clusters: batteries and chips. A new energy profile featuring hydrogen and renewables supplements the above aspects. 

Given the Constitutional Court's blocking of the government's financial plans to invest in the projects for the development of the German economy, the Bundesbank announced a possible recession in the fourth quarter of 2023.

The German Purchasing Managers' Index (PMI) recorded a further contraction of the country's economy, implying risks of continuing the declining trend in 2024.

A Lifeline for Households 

To cushion the crisis, the German government is partially restricting fiscal and liberal pricing models in the market for social goods and services, including energy. Starting in October 2023, the cost of natural gas for households will decrease as the government has reduced two gas charges to zero euros: the energy control fee (currently 0.57 euros per kWh) and the conversion fee (0.038 euros per kWh).

Overall, this implies savings for households of approximately 60 euro cents per kilowatt hour. As a result of these reductions, the average German household will pay 5% less for energy. In absolute terms, this shall save 130 euros per year for a family that consumes 20,000 kilowatt-hours annually. 

The Average German Household Will Pay 5% Less for Energy as a Result of These Easing Measures

Small households with a consumption of 5,000 kilowatt-hours will save up to 33 euros per year, while medium-sized households with a consumption of up to 12,000 kWh will save up to 78 euros per year. The amount of compensation is relatively small, but on a national scale, it amounts to saving billions of euros used to increase the effective demand of the population and fuel the economy.

For households that use fuel oil, liquefied natural gas, firewood, and other fuels for heating, the government provides a state subsidy of up to EUR 2,000 per heating season per household (the minimum subsidy amount is EUR 100).

Another aspect of the negative impact on living standards is the ECB's tight monetary policy, which consists of increasing base interest rates (currently, the rate has risen to a record high of 4.5%).

This leads to a rise in the cost of both business and consumer loans. For example, the cost of so-called student loans (which Germans take out to pay for higher education) has grown from 7.6% to 8%.

At the same time, total net household income in Germany increased to a record €591 billion in the second quarter of 2023 (the previous maximum figure was €520 billion). It happened, among other things, due to the inflation factor. 

Now, the price growth factor has begun to decline gradually: in October, consumer inflation fell to 3.8% compared to 6% in August 2022. That is, a decline in the economy and high interest rates is a necessary, albeit heavy, price for the stabilization and minimization of inflationary risks in the future.

There Is a Way Out

One of the reasons for the current situation is the unexpected, almost force majeure structural adjustment of the German economy that began in 2022.

Germany planned to gradually transition from fossil energy resources, including nuclear power, to renewable sources by 2050. Key reforms in the energy sector were to be completed by 2030.

At the same time, according to the authors of the reforms, including all politicians who shaped the Green Transition concept, traditional energy-intensive industries (e.g., chemicals) were to be replaced by new industries and sectors of the economy adapted to the parameters of the sixth technological mode.

This process was supposed to reach the finish line by 2040. 

At the same time, the outbreak of Russia's full-scale war against Ukraine caught Germany unprepared for a quick adaptive response: the external shock unfolded during the initial structural adjustment in key sectors of the German economy, including the energy sector.

Russia's full-scale invasion of Ukraine added an external shock to the transition.

As a result, the Green Transition in the energy sector has not been completed, and alternative industries that could replace energy-intensive production have not been activated. The process requires Germany to intensify the Green Energy Transition, accelerating it from 10-15 years to 5 years. The emergence of alternative economic sectors should replace the chemical industry and metallurgy much earlier than in 2030.

Now, Germany needs sales markets, sources of skilled labor, liquid assets for investment, and raw material platforms. Naturally, the above factors cannot materialize in their pure form. We are talking about combinations and various options for merging them, with an emphasis on one or more priorities. For example, there is a growing reliance on Central European countries. They are seen as investment targets and partly as markets and sources of labor, but the first factor is the key one. 

Ukraine is just becoming the focus of German investment policy and is not yet a raw material platform that can play any significant role in the German market. At the moment, the predominant factor is only the export of labor from Ukraine. However, it's worth noting that Germany is well aware of Ukraine's economic importance and potential but cannot clearly define what to do with it.

This means that the format of Ukrainian-German trade relations is a soft, not yet hardened clay from which you can either mold a practical vase or leave it as a frozen, shapeless mass.

What conclusions one may draw for Ukraine in this context? Paradoxically, the conclusions are optimistic. Kyiv needs to integrate into logistics routes between Europe and Asia. The Berlin-Kyiv-Delhi strategic axis could become a logistics route, with the growing Indian economy becoming a market for German goods instead of Russia and China. In this model, Ukraine will be able to fulfill not only transit opportunities but also investment and production opportunities.

However, for this to happen, it is necessary to resolve the security factor - to end the war with Russia's surrender.