The need for speed

The full note is available at: https://davidskilling.substack.com/p/the-need-for-speed

Across advanced economies, national growth models need to adapt to a rapidly changing world.  Patterns of global flows and the locations of competitive advantage are shifting rapidly in response to geopolitical rivalry, competitive industrial policy, higher energy prices, and so on.  

Many growth models are being placed under increasing strain.  Change needs to happen fast. 

Reflections from Germany & the UK

I have been in Germany this week, reminding me of the structural challenges facing Europe’s largest economy.  From the unreliability of Deutsche Bahn, to airport delays and patchy internet, the under-investment in Germany’s core infrastructure was evident.

More fundamentally, Germany illustrates the deep challenges caused by global economic and geopolitical dynamics.  From around 2000, Germany generated strong export-led growth on improved competitiveness and a presence in high growth industrial sectors.  Germany grew its exports/GDP share from ~30% in 2000 to ~45% by 2012, holding its global export share steady.  China was an important part of this growth story, with Germany’s goods exports to China reaching ~3% of GDP. 

But Germany’s core industrial strengths are exposed to structurally higher energy prices as well as geopolitical frictions with China.  And some of the commanding heights of the German economy (notably its auto sector) are under sharp competitive pressure from China: China has just become the world’s largest car exporter, with particular strengths in electric vehicles.

Germany is now in technical recession, with a GDP contraction of 0.3% qoq in Q1 following -0.5% qoq in Q4.  Energy intensive industrial production (chemicals, steel, glass) has been hit hard by higher energy prices after Russia’s invasion of Ukraine, down 12.9% in the year to April (while overall industrial production expanded by 2.7%). 

Germany’s GDP is about the same as it was in 2018, and the outlook is weak on concerns about energy prices, demographics and labour shortages, as well as sector-specific challenges.  Export growth (including exports to China) is under increasing pressure.

In response, Germany is taking out the cheque book.  It is investing tens of billions in subsidising energy costs for energy intensive firms, accelerating the green transition, and attracting investment (including up to €10 billion to support Intel to build a semiconductor plant).  But a more fundamental revamp is required.  Germany’s growth model needs to be adapted to new realities, as was the case with Germany’s structural reforms 20 years ago.

This is also part of the backdrop to Germany’s uneven approach to China: Germany has a deep exposure to China, which is now challenged by the growing strategic rivalry.  China is an important source of earnings and growth for many German firms, and they continue to allocate capital to China.  The Mercedes Benz CEO spoke for many German corporates when he recently said that cutting ties with China would be ‘unthinkable’.  In advance of the China/Germany summit in a couple of weeks, the governing coalition remains split on how hawkish to be on China…