The news about the German economy is not encouraging. Various survey measures show that expectations are declining to levels last seen years ago and the actual growth rate was just above zero for the last quarter.
Germany is supposed to represent the powerhouse of Europe. One would thus expect that if Germany sneezes, the rest of Europe catches a cold. However, this is not the case. Most other European economies are slowing down less than Germany. The exception is, of course, Italy. But the slowdown in Italy has many domestic, politically induced, reasons.
Why hasn't German consumption driven GDP? It has something to do with immigration
Domestic demand has been solid, but not spectacular, contributing about 1.5-2.0 % to GDP growth, on average, over the last years. A key component of domestic demand is domestic consumption, which constitutes the bulk of domestic demand growth. The other components of domestic demand, public expenditure and investment appear rather stable. What is surprising is that the contribution to growth from private consumption has declined recently (2018/9).
This is difficult to explain against a backdrop of steadily increasing wages and employment. In the US, which also has a booming labor market, the contribution of private consumption to GDP growth is more than twice as large. One reason for the relative weakness of domestic consumption might be due to the fact a large part of the additional employment generated in Germany goes to immigrants. In 2018 more than one half of all the new jobs created were filled by foreigners. Only a small part of these were refugees who are slowly being integrated into the labor market. Most of the foreign workers are EU nationals, especially from Eastern and Southern Europe who are attracted to the country by the high number of job openings which cannot be filled by Germans, whose number is declining.
This high degree of labor mobility has two macro-economic effects. First of all, it diminishes the pressure on the German labor market, thus reducing wage increases. But there is a second effect, in that most of these newly arrived workers have a low propensity to spend, or at least a low propensity to spend in Germany. Many of the EU-workers in the country have not immediately brought their family (understandably given the tight situation of the housing market); they are thus likely to save a large part of their earning, and to send a substantial part home – thus supporting demand in their home countries.
What about German productivity?
Another reason for the underlying weakness of consumption in Germany might be the weakness of productivity growth. Over the last years, employment has increased by almost as much as GDP. This makes for a booming labor market (and high tax revenues), but it also implies that expectations of future growth must be limited as the domestic labour force is currently almost fully employed. Consumers tend to spend more than their current income if they expect high growth and thus a high future income. Wages can increase on a sustained basis only if productivity does as well. As long as productivity growth does not accelerate, domestic demand is likely to remain weak.
Germany would not be close to a recession if this relative weakness of consumption had not been aggravated by a negative contribution from the external sector of 0.7 % of GDP this year. The weakness of German exports is thus another central reason for the present slowdown. However, global trade started to slow down already last year. The impact on the German economy was delayed by a high built up in inventory (worth 0.6 % of GDP last year). It seems German exporters were over-confident last year, producing for inventories. They now make up for this error by reducing production and investment.