Hamish McRae: Europe and demographic decline may yet drag Germany down

Germany is financially strong, but as Angela Merkel has said, her strength is not infinite

Well-sealed windows. When Angela Markel was asked by the German newspaper Bild what feelings Germany awakened in her, she famously replied: “I think of well-sealed windows! No other country can make such well-sealed and nice windows.”

She is right, of course. The words she used were “dichte und schöne”, literally “dense and beautiful”, but well-sealed and nice catches it better. If it is quality German engineering that has managed to seal the country from the worst ravages of economic recession, it has been her quality leadership that has insulated the country from the political chaos around it. Certainly at the moment the German economy bestrides Europe. She will be confirmed by today’s elections as one of the few EU leaders to survive recession – with Germany joining Sweden and Poland, both of which had “good recessions”, in this elite club. Everywhere else, leadership has changed.

So electorates are disposed to reward good economic stewardship. But Germany’s ability to seal itself from European underperformance will I think become more difficult over the next ten years than it has over the past.

The success story first. Start with the right-hand graph. It shows the number of core jobs in Germany –that is jobs that pay social security contributions. As you can see, these have risen strongly since 2005, with hardly a blip in 2008 and 2009 during the recession. In that sense Germany has achieved an even stronger job recovery than we have in the UK. Unemployment is low, inflation is low, and the budget is in surplus.

But look at something else. Prior to 2005, when the labour market reforms proposed by a commission led by Peter Hartz, VW’s personnel director, took full effect, Germany was dubbed ‘the sick man of Europe’. You can see the collapse of employment that took place from unification onwards. Britain has more people in work now than ever before in our history. Germany has fewer than it did 20 years ago.

In the short-term there is no real problem. German business is cheerful, as the positive findings from the surveys of the IFC Institute in Munich show. These should be a lead indicator for the real economy. The left-hand graph plots business opinion against GDP and as you can see the upward kick in the former suggests that the latter will recover this year. Consensus Economics, which tracks the projections of the main economic forecasters, suggests a rise of 0.5 per cent in GDP this year, increasing to 1.7 per cent next.

In the longer-term, however, problems loom. Three push their way forward. One is simply that the very success of German economic policy will make the country complacent. The economics team at Berenberg has just put out a paper headed “German elections: jobs miracle at risk?” noting the pressure for Germany to adopt a minimum wage and other social legislation, and there is certainly evidence that many workers in so-called mini-jobs face such low wages that they have to have more than one job to make ends meet.

The second is that the rest of Europe will pull Germany down. Slow-growing neighbours mean slow-growing exports. The country is a great exporting machine and is diversifying away from Europe but what is happening on its borders create headwinds. The consensus forecast for growth in the eurozone this year is minus 0.4 per cent, and only 0.9 per cent next year. There is a cyclical upswing but it is weak, and could be derailed by a re-run of the sovereign debt crisis.

The third problem is population. Projections vary, but mainstream forecasts suggest that Germany’s population will fall to around 72 million from its present 82 million by 2050. The country’s working-age population is already in decline and the question is to what extent the country will encourage immigration to fill the gap. At the moment Germany is sucking in young and well-qualified people from southern Europe. Greeks and Italians are flocking to language schools to learn German. So it may be that migration will fix Germany’s population decline, but at the cost to southern Europe of losing its most energetic and well-educated young people.

My own instinct is to be cautious in dismissing the ability of Germany to cope with its problems. These looked desperately serious ten years ago, but Germany reformed. The eight years of Angela Merkel’s chancellorship have seen this transformation happen, though the reforms were pushed through by her predecessor Gerhard Schröder.

My biggest concern is not about Germany’s ability to reform itself but rather the burden it is having to take on in Europe. The sovereign debts of the weaker eurozone countries are in practice guaranteed by the European Central Bank, and Germany is its largest shareholder. Germany is financially strong but as Angela Merkel herself has said, her strength is not infinite. Anyone can do the maths. Italy has a larger national debt than even Germany and an even worse demographic profile. Germany is not strong enough to guarantee Italian debt.

For the moment the problem has been parked and a bit of growth will ease pressure further. At some stage, though, it mounts again – the problem doubtless for Angela Merkel’s successor, whosoever he or she may be. The trouble with well-sealed windows is you don’t realise how bad the storm outside has become.