Corona and coal exit affect East German economic development
After a kind of hibernation, possibly even prolonged by a second wave, will we continue to operate more or less as before the crisis? Or are we going to experience a new state after the crisis that doesn’t have much in common with the old one?
It is obviously too early for a final answer to this far-reaching question. All of the world’s major economies are struggling with massive economic collapses – the exact extent of which is still widely disputed – not to mention the appropriate handling of medical challenges and humanitarian tragedies. On closer inspection, however, the clear economic downward trend is not spread across all players and regions alike. In this we can see the first tendencies for the period during and especially after the pandemic – in Europe, the US, China, and beyond.
Let’s focus on the US and China first. Even before the crisis, the major American and Chinese tech companies with their market capitalization were among the most valuable companies in the world and clearly overshadowed German and European companies: Apple, as a single company on the stock exchange, is valued higher than the sum of 30 German DAX companies, i.e., the crown jewels of the German economy. Tesla is rated higher than BMW, Daimler, and Volkswagen combined.
Looking at the development of these companies over the first nine months of the year, several points are striking: Firstly, the share prices of these companies have outperformed over the past few weeks. In the coronavirus crisis, we experienced the fastest stock market crash ever and, at the same time, the fastest recovery. However, the current catch-up movement is not a general reflection of the macroeconomic situation, but primarily reflects the development of a particular part of the economy. The upward trend in equity markets is mainly driven by companies with particularly high growth prospects, also referred to as growth stocks in the financial markets. While companies with favorable valuation and solid fundamentals, in contrast, classified as value stocks, often remain in a clear minus since the beginning of the year, growth values have actually risen on average. The US equity markets especially benefit from this.
The S&P 500 increased slightly over the course of Q1-3 of 2020, and the NASDAQ technology index almost reached an all-time high. On the other hand, leading European indices such as the DAX and even more clearly in other European countries that are particularly characterized by value companies, have lost ground despite the interim recovery.
Secondly, the turnover of technology giants has continued to grow rapidly. For example, Microsoft and Facebook recorded sales growth of 13 and 11 percent respectively in the second quarter of 2020 compared to the same quarter of the previous year. The trading giant Amazon anticipates sales growth of 40 percent, which is not surprising in the face of global lockdowns and the associated tailwind for online orders. The two highly-rated Chinese companies Alibaba (+34 percent) and Tencent (+29 percent) also significantly increased their sales between April and June – probably because China already saw the first economic restrictions in late January. Customers who have become accustomed to online consumption are expected to retain it even when the situation returns to normal.
Thirdly, the major American tech companies Google, Amazon, Facebook, Apple, and Microsoft have embarked on a big shopping tour. While many companies around the world are struggling to survive and only keep a perspective through government rescue packages, these companies are bursting with strength. According to Handelsblatt, these tech giants have bought more companies this year than they have done in many. In this way, they are manifesting their market position in the longer term — and even expanding it.
European companies will need to find strategic answers on how to deal with the increasing global dominance of these selected American and Chinese companies. This concern has been fueled since the term “decoupling” became popular. A politically driven unbundling of the Chinese and American economies would mean a complete reversal of the economic integration of the two major powers, which had been progressing until the recent past. “Decoupling” goes hand in hand with the fear of European companies that one day they will have to decide where they stand – on the side of Washington or Beijing? Or whether they have to “split up” in order to perform with largely separate companies in China and the US. The consequences could be devastating in both cases: significant reductions in sales and declining efficiency, with both effects likely to reinforce each other. Thus, European policy must also find answers if the success of companies in China and the US is to be based on better conditions, such as larger internal markets with- out barriers, and political claims are increasingly derived from this economic success – especially from nation states whose values do not always coincide with those of Europe. Here too a European response is urgently needed.
Germany already weathered the crisis better than the other major European economies such as France, Italy, or Spain. For years, this situation led to massive demands on Germany to finally move more state funds and increase public investments. The hope of these demands was that the higher investments in Germany would help to reduce cur- rent account deficits worldwide and revive other countries’ economies. Behind closed doors, however, one wondered for a long time whether these demands could achieve the desired goal. Above all, the question was raised whether Germany’s companies could not become even more competitive and thus more dominant via the state investments demanded at the time, such as an expansion of infrastructure or improved depreciation options for research and development – in other words, whether the desired reduction in the current account deficit would ultimately result in its widening.
As soon as the crisis struck, one could hear precisely this criticism publicly. Aid packages in Germany are followed abroad with eagle eyes, because there is always the perceived danger that a state with sound public finances, such as Germany, can mercilessly play this advantage over other states during a crisis and give its companies a sustainable competitive advantage. This criticism finds further fuel because the economic decline is unevenly distributed across Europe this year.
According to the European Commission’s growth forecasts in July 2020, the slumps hit southwest Eu- rope particularly strongly, especially France, Italy, and Spain. The further you move to the northeast, the lower the expected slump in economic performance – even though their absolute size still represents the strongest slump for most countries since the end of World War II. In view of these divergences, the German government is acting correctly and wisely by pushing for European solutions to cope with the crisis.
Description of macroeconomic development
So the answer to the question asked at the beginning cannot be called interruption or disruption, but rather acceleration. Existing developments before the coronavirus crisis will be significantly accelerated by it and will shape our lives in the years to come. Such a development is a question of what further macroeconomic development is to be expected.
Over the past few months, economists have repeatedly tried to describe macroeconomic development in letters. The optimistic variant is the letter V, in which a sharp downturn is followed by a rapid and equally strong recovery process. The pessimistic variant is best described with the letter L, that is, a permanent significant loss of prosperity. In the middle are the letters U, in which the recovery process is strong but only takes effect after some time, and the letter W, which involves further setbacks after an initial economic recovery, for example, in the form of a second wave of the pandemic. How could the acceleration outlined above be best summarized in the form of a letter? It is appropriate to use the letter K, which describes a stronger spread in the form that some eco- nomic actors are suffering lasting damage from the crisis, while others are only really starting out. Such acceleration can, in the worst case, lead to division if business and government do not react appropriately and with a global view on the extent of current developments.
Situation in East Germany
In East Germany, the downturn of the economy as a result of the pan- demic is likely to be slightly weaker than in Germany as a whole. Contributing to the fact is that infection numbers are significantly lower in the East than in the West. This is probably one reason why, according to the ifo Business Climate Index, the East German retail sector does not currently rate its situation as bad as the German whole. In addition, manufacturing enterprises reported a capacity utilization rate in the spring that was low but significantly higher than in Germany as a whole. At play here is that East German companies produce more strongly than companies in West Germany for the internal market, which is generally more stable in downturns than export markets. Finally, the East German economy is less susceptible to economic activity than that in the West, because the manufacturing sector particularly affected by the slump has a lower weight of about 16 percent than in Germany as a whole (23%). The public service sector plays a major role in the East, with a share of 25 percent, and its production is likely to remain fairly stable (share in Germany as a whole: 18%). Overall, overall economic output in eastern Germany is expected to fall by 3.2 percent in 2020 (Germany as a whole — 5.1%). Expansion of 2.4 percent is expected for the year 2021. Unemployment: 6.4 percent in 2019, 7.8 percent in 2020, and 7.9 percent in 2021.
Coal exit – the phase-out of fossil fuels
According to analyses carried out by the Halle Institute for Economic Research (Leibniz-Institut für Wirtschaftsforschung Halle, IWH), the lignite (brown coal) industry, with around 21,000 employees in 2014, is a secondary factor in Germany. However, the average compensation of employees (gross annual salary plus employer social security contributions) of €68,000 is almost twice as high as the German average of €35,000. The IWH, therefore, expects a noticeable reduction in the average wage in the three directly affected regions of Rhineland, Central Germany, and Lusatia because of coal exit. In the course of the lignite phase-out, suppliers are also affected and regional incomes will decrease overall, so that a €4.2 billion reduction in compensation of employees in the final year of the projection (2040) is expected in Germany as a whole, compared to a non-accelerated exit. From a macroeconomic perspective, the effects are small, which is why Oliver Holtemöller concludes: “From a macroeconomic perspective, Germany can afford a faster exit from lignite-based power generation.” However, the regional effects are quite considerable.
According to the 2019 final report “Climate Protection and Coal Exit: Policy Strategies and Measures until 2030 and Beyond” by the Federal Environment Agency, lignite mining has decreased altogether from 411 million tons in 1989 to 178 million tons in 2015. According to the report, since the mid-1990s, the Lusatian region is no longer the largest lignite production region in Germany, rather the Rhenish region is. Consequently, the installed capacities of 9.8 gigawatt-hours (GWh) were also highest in the Rhenish region, followed by 7 GWh in the Lusatian region and 3 GWh in the Central German region (as of end of 2017). It is also noted that in the Rhenish region, with 79 terawatt-hours (TWh), the electricity produced is also higher than in the Lusatian region (49 TWh) and the Central German region (17 TWh) (as of 2015). The population density also varies in the regions, with the Rhenish region (770 inhabitants per square kilometer) most densely populated. The Central German region follows with 222 inhabitants per square kilometer and the Lusatian region with 106 inhabitants per square kilometer. In contrast, the proportion of those over 50 years of age is highest in the Lusatian region with 55 percent, followed by the Central German region with 48 percent, and then the Rhenish region, which corresponds to the nationwide average with a share of 43 percent. Economic activity in 2014 in the identified regions accounts for around 12 percent of Germany’s total gross value added. The proportion of the mining, energy, and water supply sector is the largest of the three regions in Lusatia with 15 percent.
Glimmer of hope
According to Dalia Marin of the Technical University of Munich, East Germany is on its way to becoming Europe’s center for electromobility. As proof of this, she lists the production of the electric car ID.3 from Volkswagen in Zwickau and Dresden and the production of the electric car i3 from BMW in Leipzig. In addition, the Chinese company CATL produces EV battery cells for BMW at a plant near Erfurt in Thuringia. Another Chinese company, Farasis Energy, will produce EV battery cells for Mercedes-Benz in Saxony-Anhalt in the future. In addition, there are Tesla’s announcement and major steps towards the production of electric cars and batteries in a new “Gigafactory” near Berlin.
Halle Institute for Economic Research e. V. (IWH). 2019. “Pressemitteilung 1/2019: Schneller Braunkohleausstieg hat deutliche Folgen in betroffenen Regionen [Press release 1/2019: Rapid coal exit has significant consequences in affected regions].” Halle Institute for Economic Research e. V. (IWH), January 15, 2020.
Marin, D. 2020. “Eastern Germany’s New Growth Engine.” Project Syndicate, October 2, 2020. www.project-syndicate. org/commentary/eastern-germany-electric-cars-new-growth-engine-by-dalia-marin-2020-10 (accessed October 9, 2020).
Oei, P. et al. 2019. Klimaschutz und Kohleausstieg: Politische Strategien und Maßnahmen bis 2030 und darüber hinaus [Climate protection and coal exit: Policies and measures until 2030 and beyond]. Dessau Rosslau: Federal Environment Agency. www.umweltbundesamt.de/publikationen/ klimaschutz-kohleausstieg-politische-strate- gien (accessed October 9, 2020).
Translated from the original German presentation by ESMT Berlin President Jörg Rocholl to the Deutsche Bank Advisory Board Meeting East on October 7, 2020.