Search

 

Cablegate: Forecast for Germany: Moderate Growth, High

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 FRANKFURT 008717

SIPDIS

SENSITIVE

STATE FOR EUR PDAS, EB, EUR/AGS, AND EUR/ERA
STATE PASS FEDERAL RESERVE BOARD
STATE PASS NSC
TREASURY FOR DAS LEE
TREASURY ALSO FOR ICN COX, HULL
PARIS ALSO FOR OECD
TREASURY FOR OCC RUTLEDGE, MCMAHON

E.O. 12958: N/A
TAGS: ECON EFIN EUN
SUBJECT: Forecast for Germany: Moderate Growth, High
Deficits; Clear, Consistent Reform Efforts Still the Key


T-IA-F-04-0023

This cable is sensitive but unclassified. Not/not for
Internet distribution.

1. (SBU) Summary: Our forecast for Germany shows moderate
real GDP growth of 1.7% in 2005 after 1.8% in 2004. The
government deficit should top 4% of GDP this year, then
decline to 3.5% in 2005, based on current policies.
Persistent joblessness in western Germany, and even more so
in the East, is a strong Government concern. Typically
German recovery is fueled by export growth that feeds back
into investment, then employment, then consumption. The
investment link is the weakest this time around.
Supplementary labor costs borne by enterprises, relatively
high tax rates, and burdensome regulations are among
impediments to investors. These drawbacks seem to have
become relatively more pronounced as investment options in
central European countries continue to improve. Fiscal
policy has not produced the demand side effects anticipated,
despite a deficit well beyond "restraints" of the EU
Stability and Growth Pact. Perhaps a partial answer lies in
the quality of public expenditure, which is consumed by
social and financing costs and not investment. Spending
smarter while cutting taxes or social charges through
coherent, consistent, and comprehensive reforms could help
boost both investment and the government's bottom line.
There is German public support for reform, but the discord
among the country's political leaders as well as the round
of state and local elections in the run-up to the 2006
national campaign is sapping the government's will and
ability to make the long-needed reforms. End Summary

Forecast: Moderate Growth in 2004 and 2005
------------------------------------------

2. (SBU) Our recent forecast points to German real GDP
growing by 1.7% in 2005 after an increase of 1.8% this year.
Growth in both years will be mainly driven by exports.
Softer growth in the Euro area next year will be compensated
by a pick up in German domestic demand.

Consumer Demand to Pick Up
--------------------------

3. (SBU) In a typical German economic recovery, export
growth triggers higher investment, raising employment,
consumer confidence and retail sales. The recovery we see
this time around will by pass strong investment growth.
Private consumption has been stagnating in 2003 and 2004 due
to a slow rise in disposable income and a noticeably higher
savings rate, up from 9.6% in 2000 to 11% in 2004. Consumer
confidence has been soft, employment declining, unemployment
raising and high contributions to social security systems
continuing. Businesses blame uncertainty over Germany's
economic outlook and confusion over the course of reforms
for causing Germans to boost their already high level of
savings. There may be a moderate up tick in 2005 consumption
stemming from stronger growth in disposable income caused by
lower income taxes (the last step of the income tax reform)
and higher self-income. However, current consumer behavior
makes this more difficult than usual to predict. Next
year's boost to consumption should stem from stronger growth
in disposable income caused by lower income taxes (the last
step of the income tax reform) and higher self-employed
income.

Investment Weakness a Puzzle
----------------------------

4. (SBU) Investment continues to be a partial puzzle. The
prolonged drag on overall investment by the construction
sector, which accounts for 50% of all investment, will not
disappear next year. Machinery and equipment investment
will rise 4.6% -- much better than recent years, barely
pushing growth in overall investment activity past the 0.5%
mark. Recent en vogue explanations for poor investment
performance include "credit crunch" and "outsourcing."
Bundesbank officials argue that the rise in German overseas
investment, which does not register in the available
statistics, is financed by capital German firms are raising
outside the Federal Republic.

5. (SBU) The Bundesbank makes a credible argument that
demand for loans is what is lacking, not supply. With
respect to outsourcing, it is true that share of imported
materials in German exports has risen from around 30% in
1995 to almost 39% in 2002. This phenomenon has generated a
heated debate on whether Germany has become a "bazaar
economy," with industrial production hollowed out as
investors make needed inputs in other countries. A lower
share of industrial output in overall economic activity,
however, does not necessarily mean a decline in overall
output. That is, unless workers cannot find new jobs in
other, equally or higher productive jobs such as in the
service sector. Unfortunately, that seems to be the case
according to a McKinsey report cited by USB Warburg research
economists. While for each euro of outsourcing, the German
economy gains only 79 cents, for each dollar of outsourcing
the U.S. economy realizes 1.13 dollars. The difference is
that nearly 70% of the displaced workers in the U.S. found
new jobs with higher productivity within six months. In
Germany only 40% do.

6. (SBU) There are some bright spots on the horizon that
support even our modest pick up for investment in equipment
and machinery. Real interest rates stand at historically
low levels, bank profitability is going up (suggesting a
possible increased emphasis in lending to the less marginal
credit cases) and wage rounds have yielded labor cost
increases of only 1.5%. Government efforts to reduce some
of the institutional rigidities will help next year with
labor market reform (Hartz IV, i.e., the merger of
unemployment and social aid programs) and loosening of
firing restrictions for small and medium-sized enterprises.
Recent labor agreements add to some cautious optimism,
resulting in longer hours and more flexible tariff wage
contracts. These can help constrain unit labor costs,
bolstering Germany's price competitiveness. These trends
will be working against the headwind of managers doubting
that the global recovery will continue next year, as
suggested by recent sentiment indicators.

Budget Deficits Continue
------------------------

7. (SBU) A best-case scenario for 2005 puts the government
deficit at 3.5% of GDP, more than spitting distance from the
3% Maastricht mark. The Finance Minister's "Project 3%"
will be working full tilt to avoid the European Commission
from cranking up the Stability and Growth Pact again - this
time taking up Eichel on his own November 2004 pledge to get
the deficit below 3% in 2005.

8. (SBU) The 2005 budget is encumbered with several risks.
Among these are high-expected revenues from planned
privatization (15.5 billion euros) and the still-to-be-
proven heavy truck highway toll (3 billion euros). The
costs of merging the unemployment benefit and social welfare
systems is probably underestimated. One welcomed feature
for 2005 should be that the social security programs are
unlikely to have to draw on the budget.

9. (SBU) For 2004 the deficit is likely to top 4%. Poor
revenue performance from weak domestic demand is the primary
reason. Also, rosy revenue scenarios have not panned out as
dreamed for the highway toll for heavy trucks (zero instead
of 2.8 billion euros), Bundesbank profit (only 248 million
euros instead of 3.5 billion euros) and tax amnesty (3-400
million euros rather than 5 billion euros).

Lower Prices and Gains In Employment
------------------------------------
10. (SBU) German inflation will decline, despite current
energy and raw material price rises, as no administrative
price or tax hikes are expected and assuming oil prices
moderate. Labor market statistics will be difficult to
interpret as 900,000 recipients of social welfare will have
to register as unemployed to get the new unemployment
benefits. No reliable estimates exist as to how many of
these are already so registered. Some estimates suggest
that the number of unemployed might increase by 300,000.
Employment should increase slightly. The unemployed should
be attracted by mini-jobs that will allow them to boost
their net income by retaining government benefits plus the
earned income and should be deterred by the prospect of
losing benefits if they do not accept a job offer.

Investment and Government Demand Side Policies: A Closer
--------------------------------------------- -----------
Look
----

11. (SBU) Investment weakness, a prominent feature of this
forecast, deserves a bit of a closer look. Recent wage
settlements have highlighted the gulf between what workers
contribute to production and what employers pay. USB
Warburg economic research estimates that for the engineering
industry in 2003 pay for value-added labor was 30,425 euros.
The firm then paid an extra 37.4% for non-working days (paid
holidays) and bonuses (the "thirteenth month"). Compulsory
contributions to social security added another 27.2%,
pension schemes and other supplementary costs accounted for
another 13.2%. Total wage costs amounted to 50,095 euros or
177.8% of the pay for value added labor. Wage agreements
and government reforms could help close a portion of this
divide that contributes to make Germany a relatively less
attractive investment location.

12. (SBU) The recent OECD Survey of Germany also points to
high corporate taxes. It cites a study by the German
Council of Economic Experts based on 2003 tax codes showing
that Germany has the highest average effective taxation of
returns of investment.

13. (SBU) Some recent commentators have suggested the
government could do more to help simulate demand. The
government's tax reform, a remarkable achievement in its
time, has dropped the top income tax rate from 53% to 42%
beginning in 2005. In 2004 and 2005 together this should
add 1% of GDP back into consumer's pockets, according to
OECD estimates. Other fiscal charges or administered price
increases have eaten away some of those gains offered in
previous stages of the income tax cut. Some of gone into
the higher savings rate, as noted above.

14. (SBU) Another part of the answer could lie in the
quality of the government's expenditures. 57% of the
government's expenditures in 2003 went to social welfare
programs and only 3% to investment. In the 1980's the
government spent 48% of its budget on social systems and 5%
on investment.

15. (SBU) Transfers amounting to around 4% of GDP to the
new states are increasingly ineffective in promoting growth.
The OECD judges that subsidies to enterprises in the new
states have not increased productivity but have increased
dependence on the government and decreased adaptability to
market forces. The OECD also estimates that more than half
the transfers for infrastructure are used for government
consumption (culture, central administration), with the
number of government employees per inhabitant in the new
states exceeding the ratio in financially weak western
states by 25%.

16. (SBU) Tax subsidies for construction have contributed
to overcapacity in office and residential housing that
continue to weigh against investment. Government
procurements, which account for 17% of GDP, are highly
complex, often broken into small contracts administered at
the state level and not subject to open competition at the
EU level, according to an OECD analysis.

17. (SBU) One theme that runs through discussions on
investment and government budget policies is "confidence,"
or lack thereof. Uncertainty about global demand,
employment, and reforms feed into this lack of confidence.
Confidence can work wonders. In that bellwether year for
German growth, 2000, the business community was optimistic
about the future when the tax reforms were adopted, only to
turn sour when new policies were adopted that were not so
favorable for economic growth.

18. (SBU) The European Commission points to research
suggesting that even as a government reduces its budget
deficits through structural changes, consumers' and
investors' expectations can, and have, improved if they
sense that the government will pass the gains on through
lower taxes (or no tax increases). Consumption goes up and
investment goes up if there is a clear, consistence
comprehensive and credible reform plan. A recent survey for
the German Financial Times suggested that the majority favor
reforms. Confidence could follow. Less and smarter
government spending is something that most would understand.


Forecast for Germany

2003 2004 2005

Percent Avg. Annual Growth
GDP -0.1 1.8 1.7
of which
Consumption 0.0 0.0
1.4
Investment -2.2 -2.8
0.6
-construction -3.3 -4.1 -2.6
-machinery & equipment -1.4 -1.9
4.6
Net Exports -11.2 36.7 8.8

Consumer Price Index 1.0 1.7 0.9

Employment -1.0 -0.3 0.4
Unemployment Rate (%) 10.5 10.6 10.6
Fiscal Balance (%GDP) -3.8 -4.1 -3.5


19. (U) This message coordinated with Embassy Berlin

20. (U)POC: James Wallar, Treasury Representative, e-mail
wallarjg2@state.gov; tel. 49-(69)-7535-2431, fax 49-(69)-
7535-2238

Bodde

© Scoop Media

 
 
 
World Headlines

 


Myanmar: Military Must Stop Murdering And Jailing Protestors – Bachelet

UN High Commissioner for Human Rights Michelle Bachelet on Thursday said security forces in Myanmar must “halt their vicious crackdown on peaceful protestors,” following another day of deadly violence across the country on Wednesday... More>>

Syria: Economic Decline, Rising Hunger And Surging Humanitarian Needs

Syria’s fragile economy has “suffered multiple shocks” over the past 18 months, with its currency plummeting and joblessness swelling as people struggle to cover their basic needs, the UN Emergency Relief Coordinator told the Security Council ... More>>

OECD: Final Quarter Of 2020 Shows Continued Recovery In G20 International Merchandise Trade

G20 international merchandise trade continued to rebound in the fourth quarter of 2020 ( exports up 7.2% and imports up 6.8%), following the sharp falls seen in the first half of 2020, as lockdown measures affected trade globally. Although growth ... More>>


Focus On: UN SDGs


UNFCCC: Greater Climate Ambition Urged As Initial NDC Synthesis Report Is Published

UN Climate Change today published the Initial NDC Synthesis Report, showing nations must redouble efforts and submit stronger, more ambitious national climate action plans in 2021 if they’re to achieve the Paris Agreement goal of limiting global temperature rise by 2°C—ideally 1.5°C—by the end of the century... More>>


2021: Critical Year To ‘reset Our Relationship With Nature’ – UN Chief

During this time of “crisis and fragility”, the UN chief told the United Nations Environment Assembly on Monday that human well-being and prosperity can be vastly improved by prioritizing nature-based solutions. Painting a picture of the turmoil ... More>>


Paris Agreement: UN Secretary-General António Guterres To Mark U.S. Reentry With Envoy For Climate John Kerry

Watch live at webtv.un.org UN Secretary-General António Guterres will join U.S. Special Presidential Envoy for Climate John F. Kerry at an event marking the United States’ reentry into the Paris Agreement this Friday. The discussion with the Secretary-General ... More>>