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The leading research institutes have drastically reduced their economic forecasts for the German economy. Gross domestic product is expected to increase by only 0.1 percent this year. In the fall they had predicted growth of 1.3 percent. Professor Dr. Stefan Kooths, director of the Economic Cycle and Growth Research Center at the Institute for the World Economy (IfW) in Kiel, classifies this.

Mr. Kooths, is Germany’s weak growth proving to be more persistent than expected? Yes, overall the sluggish overall economic development is slower than expected six months ago. There is always an interplay between economic and structural factors. From an economic point of view, it must be said that there was no recovery in the winter half of the year. On the contrary: the overall economy has slipped into underutilization. Therefore, this drastic downward revision reflects the weak past half-year rather than the expectations for the following quarters. Because the overall economic picture hasn’t changed that much. We continue to assume that we will receive a boost from private consumption because private purchasing power will increase, and that export business will also gradually pick up again. This is now delayed and also a little weaker.

Do you cite a phase of economic weakness and dwindling growth forces as the reason for the downward correction? Can you explain this in more detail? In economic terms, we have to see that the consistently high order backlogs in industry have apparently not supported production as much as we could have expected six months ago. This is also due to the weak international economy for goods in which Germany is traditionally very strong in exports, namely capital goods. So it’s more the economic weakness. Structurally, we have to see that production options in this country are now 2.2 percent lower than expected before the pandemic.

The joint forecast speaks of more headwinds than tailwinds. What does that mean? The expected economic boost did not come from the international environment. And domestically, uncertainty has contributed to investments remaining even weaker than we had already estimated. And that certainly also has to do with the uncertainty about economic policy, where it is unclear to investors what they are getting into when they invest in Germany. This may also have had an impact on consumers, who held back more.

Which factors would stimulate domestic investment again? By concentrating precisely on the general conditions and not doing what currently characterizes economic policy: namely, taking a very interventionist course, where one tries to attract individual companies, particularly through subsidies. Instead, the general location conditions should be improved more, starting from the infrastructure through the education system to regulation. This seems to me to be an important factor: increasing high bureaucratic burdens and, in some cases, high taxation. In international comparison, Germany has fallen behind everywhere. Politicians should therefore generally improve the general conditions instead of trying to lure individual companies or sectors to Germany with subsidies.

Did the federal government’s more restrictive financial policy also contribute to the reduced forecast? The reaction to the Karlsruhe judgment on the debt brake has of course slowed down financial policy somewhat more. But that is not the main reason for the revision. We estimate the influence to be more like one to two tenths of a percent for 2024. But overall, financial policy in the current year would be more geared towards brakes anyway, because it has to cut back again with a view to the financing scope. She is coming out of a crisis mode, and that cannot continue forever. I would rather speak of a normalization of financial policy. Of course, it also slows down the economy to some extent, but it is not the main reason for the downward revision.

What does your forecast mean for tax revenue? There are rules of thumb according to which one percentage point less GDP means around €10 billion in reduced revenue. One cannot simply draw conclusions about tax revenue from the weak economy. Unlike the tax estimate based on financial statistics, we look at the national accounts, which are more relevant to the economy. Part of the state’s slowing effects also comes from the fact that it is withdrawing tax relief – for example in the catering industry or for the supply of gas and district heating. Higher taxes or CO2 levies are therefore revenue improvements that, on the other hand, dampen the economy. We expect state tax revenues to increase by just over four percent in 2024 and 2025.

Are the Federal Finance Minister’s savings plans for the next budget justified in light of the forecast? Everything is still a bit in the balance. We think it is possible that, with existing leeway, we can just manage the 2025 budget year. In 2026, it will be difficult for the government to stay within the then permissible financial framework. Certain budget leftovers that can now be carried forward to 2025 will then definitely be used up.

You spoke of a boost for the economy over the course of the year. Can you provide some reassurance to uncertain citizens? It is important that we read the forecast correctly. This mini-growth of 0.1 percent on average for the year represents the economic dynamics in 2024 as worse than they actually are. We assume that a recovery will begin in the spring – initially through consumption and then more strongly through exports. This year the momentum will increase by just one percent. This 0.1 percent says more about the weak winter months behind us than about further developments. Whenever you have a weak start to the year, it has a major impact on the annual result. Further development is significantly cheaper.

Recently, weak consumer sentiment has also put a lot of pressure on the economy, which contributes heavily to GDP. What does the outlook look like here? There looks to be a significant improvement for consumption and thus also the consumer-related economic sectors. This is because more purchasing power is now coming back into the hands of private households as a result of the wage agreements, which are gradually reacting to the high rates of price increases – and also among those who have a higher propensity to spend. Overall, this should significantly stimulate private consumption. This year and next, consumption will be the key driver – 2025 with improved exports.

How is value creation in industry recovering? We will only be able to expect more significant increases from the middle of the year. Both the manufacturing sector and the construction industry will have another half of a weak year. It will take a little longer for the construction industry to pick up again because the construction industry is going through a very deep trough, especially when it comes to residential construction.

What are the stronger brakes? Prices for construction have inflated much more than for consumption. At the same time, with the change in interest rates, we have a situation where new construction projects are currently hardly profitable at the prices charged for construction services. This has to correct itself again before things can improve. We see that land prices are reacting to higher interest rates and that existing property prices have already fallen significantly. When it comes to new construction, however, we have seen a very significant price increase over the past three years, and that is currently making building too expensive.

How do the institutes assess the development of inflation? The good news is: the phase of high price increases is behind us. But we’re not quite there yet where the central bank’s target is when we expect 2.3 percent this year. As far as consumer prices are concerned, we are returning to calmer waters. However, if we exclude the energy price effects, which have a dampening effect in both years, the remaining price inflation is still above the Bundesbank’s 2 percent target. This is mainly because service prices are still catching up.

When can an interest rate cut be expected – and also the effects on economic dynamics? Not only among the institutions, but largely also by market players, it is expected that the central bank will reduce interest rates from the middle of the year. And because there is this expectation, the longer-term interest rates have already reacted, which are ultimately relevant for investment decisions. Therefore, a certain countermovement has already occurred. It typically takes one to two years for this to have an economic impact. That will take some time, especially since we actually still have a very high price level for construction, which probably needs to be corrected first.

A risk factor for the economy is the social climate – right-wing extremism is considered poison. Have you assessed this influence in the future? In general, every form of social division, every form of extremism and exclusion is poisonous for economic development, because our free system is built on mutual trust. And when societies become involved in internal wars, this is also detrimental to economic activity. This is not a factor that we have included prominently in this forecast.

Let’s look at the global economy. German exports fell despite increasing global economic activity. Global economic activity remains on a stable upward trend, as in the last half of the year. The only problem was that their composition – because it was consumer and service-heavy – was unfavorable for German products and exporters. The German economy is more exposed to capital goods and intermediate services. We expect global economic activity and industrial production to develop on a par again – and that should also stimulate German exports.

You are also more confident about 2025, where you expect an upturn of 1.4 percent. Which risk factors could lead to a downward correction again? The year will be stronger economically, but this recovery phase will also almost come to an end – i.e. it will become weaker again. The economic pattern will level off again somewhat in the second half of next year. The growth rates that we expect from the middle of the current year are above the growth rates of production capacities. This means that the overall economic capacity utilization is increasing, and when we get towards normal capacity utilization, the buoyant forces become weaker.

Where are the limits of production possibilities? For decades, we were used to economic output increasing by an average of one to three percent year after year. That was the old normal. Now we are entering a situation where we can expect just half a percent on average year after year. This is now the new normal. And measured against this 0.5 percent that the capacity increase provides, we then have to assess the actual economic development. And here we are reaching our limits more and more quickly, largely due to demographic developments.

So a lack of skilled workers and qualified immigration as a brake on growth? Decarbonization is also likely to have a dampening effect. Bizarrely, even repairing the infrastructure will temporarily put a strain on production capacity in Germany for several years. The more construction sites you have, the more you have to reroute trains and have traffic jams. So even the stronger investment activity by the state will temporarily but inevitably have a somewhat dampening effect on capacity.

What does this tell us about the debt brake? We want to make the discussion more objective. The prosperity and woe of economic development does not depend on a reform of the debt brake. We can imagine moderate, sensible reform. But politicians should not assume that easing the debt leeway would resolve the economic area’s actual problems. Unfortunately, that is not to be expected; we actually have to push forward with reforms – in the labor market, regulation, bureaucracy, and immigration. These cannot be solved by giving the state more fiscal leeway.