Joint Economic Forecast Spring 2021: Pandemic Delays Upswing – Demography Slows Growth

In Germany, the first year of the coronavirus pandemic was marked by extreme fluctuations in economic activity and a massive paralysis of the domestic economy. The strong recovery process following the end of the shutdown last spring came to a standstill overall in the course of the second wave of infection over the past winter half-year, with major differences in economic activity between industry and service providers. The leading economic research institutes expect gross domestic product to increase by 3.7 percent in the current year and by 3.9 percent in 2022.

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Strong Exports Support the Economy

Following the dramatic slump in spring 2020, German foreign trade regained its footing in the second half of the year. The recovery in exports will continue in the first half of 2021. Incoming orders from abroad were already well above pre-crisis levels in January.

Unlike in previous crises, private consumption is not a stabilizing factor this time around, but rather is partly responsible for the sharp fluctuations. The main reason for this is that infection control measures are hampering numerous contact-intensive business models, especially in the consumer-related service sectors, so that private households are unable to spend as usual. As a result, economic activity in these sectors to date has reacted strongly to the pandemic. In 2020, private consumer spending fell more sharply than ever before in Germany’s post-war history. In their forecast, the institutes assume that the current shutdown will continue for the time being and that the most recent measures easing restrictions will be largely withdrawn. Further easing is not expected until the middle of the second quarter, with restrictions being lifted by the end of the third quarter. In the wake of the easing of restrictions, a strong expansion of economic activity is expected for the summer half-year, especially in the service sectors, which were particularly affected by the pandemic. On the consumption side, private consumption will play the main role. To the extent that vaccination progress is also made in other countries, cross-border trade in services will revive, too.

In view of the anticipated easing of restrictions, the recovery in employment is also likely to gain momentum in the summer half-year. On average for the year, employment is expected to rise by 26,000 people in 2021. The increase next year is expected to be 539,000 people, reaching pre-crisis levels in the first half of the year. In the wake of the relaxation of infection control measures starting in May, the number of unemployed will also fall more sharply. However, the unemployment rate is expected to be 5.7 percent this year and 5.2 percent next year – still above the pre-crisis level of 5 percent.

Public budgets are expected to run a deficit of EUR 159 billion in 2021, slightly higher than in the previous year. It is true that tax revenue is already increasing again due to the economic situation. However, spending on vaccinations and tests is causing social benefits in kind to rise sharply. Government investment activity is also likely to expand further, in particular due to the funds available in investment programs. As a percentage of GDP, the general government budget deficit is expected to remain roughly constant at 4.5 percent in 2021 and fall sharply to 1.6 percent in 2022.

The coronavirus pandemic is leaving its mark on production potential. According to the current estimate, it is likely to be around 1.1 percent lower on average in the years 2020 to 2024 than the level estimated before the coronavirus crisis. In addition, the consequences of demographic change in Germany are drawing ever closer. With the baby boomers reaching retirement age, the working population will shrink in a few years and the proportion of older people will rise significantly. The consequences for potential growth are considerable: by 2030, the annual potential growth rate is expected to decline by around one percentage point.

Infographic, Real gross domestic product in Germany, Joint Economic Forecast Spring 2021

Economic Policy: Overcoming the Crisis

Economic policy responded to the economic crisis swiftly and with extensive measures. This is likely to have helped secure the continued existence of many companies that have been affected by the crisis. In total, Germany’s federal government alone has pledged aid amounting to more than EUR 1 trillion. The anatomy of the crisis argues in favor of instruments that act quickly and in a targeted manner and are also self-dosing. These include the option of tax loss carryback, which is already being used, but is limited to profit income for 2019 and capped at EUR 10 million. Extending these regulations to the years 2018 and 2017 could strengthen the liquidity of companies hit by the crisis without further review. Admittedly, separate programs are needed for young and start-up companies. To encourage the creation of new companies, one option would be to further develop the start-up subsidy, for example.

Sound public finances are an important prerequisite for being able to respond appropriately to macroeconomic crises. This is another reason why a structurally balanced budget makes sense in normal times. However, demographic change is weighing on growth prospects in the medium and long term. To achieve a structurally balanced budget, this means either consolidation on the expenditure side or strengthening the revenue side. The tax ratio in Germany is already at an all-time high – the need for substantial additional spending, especially in the area of investment, has been identified. Against this backdrop, a higher retirement age is gaining more attention, as it would strengthen the revenue side of pension insurance and also increase production potential. Such a step would thus result in a double return.

Global Economy Continues to Expand

The international economy should pick up rapidly as soon as the spell of the pandemic has lifted. However, different regions of the world are recovering at different times. In China, the economy was in full swing at the turn of the year, and lower purchasing managers’ indices again point to a moderate slowdown in the spring. At that time, fiscal stimulus and the success of the vaccination campaign will ensure a very strong economy in the US. Due to the pandemic, the eurozone continues to lag behind, with production expected to actually fall significantly in the first quarter. This also applies to the UK, where important trade with the EU is also suffering from the consequences of Brexit. The decline in production in Europe is also reflected in a slower expansion of global output at the start of the year. In the summer half-year, the European economy should increasingly gain momentum, faster in the UK than in the EU. By contrast, the economic outlook in most emerging and developing countries is clouded by the fact that the majority of the population will remain unvaccinated until 2022.

All in all, global production is expected to increase by an annual average of 6.3 percent in 2021, following a decline of 3.6 percent in 2020. For 2022, the institutes expect another fairly strong increase of 4.1 percent.

Infographic, Real gross domestic product in Euro Area, Joint Economic Forecast Spring 2021

Infografik, Real gross domestic product in the world, Joint Economic Forecast Spring 2021

Risks

Downside risks: Pandemics continue to pose a major downside risk to the economy, as do future bankruptcies. Trade policy also remains a downside risk, as the Biden administration is basically pursuing the same economic policy goals as the previous administration.

Upside risks: In the international arena, the combination of strongly expansionary economic policy and high pent-up savings could lead to a surge in consumption. In Germany, the purchasing power that private households have stored up during the pandemic poses an upside risk. If private households were to draw more heavily on their savings, GDP would expand much more strongly. In this case, consumer prices would also rise significantly more.