Despite economic growth in Germany: why the cake is smaller than we think

Created: 2022-11-12 09:09

By: Prof. Dr.

Timo Wollmershauser

Prof. Dr.

Timo Wollmershäuser is Head of Business Cycle Research and Forecasts at the ifo Institute in Munich.

© N. Bruckmann/M.

Litzka/dpa

The German gross domestic product (GDP) should increase in the current year despite the Ukraine war and the energy crisis.

But is there more to distribute and are we really better off because of that?

Ifo economics expert Prof. Timo Wollmershäuser on the pitfalls of the most widely observed economic indicator and the question of what loss of income we are threatened with in the next few years.

Munich – A country's real gross domestic product measures the size of the cake baked by all of a country's inhabitants.

This could be one of the first sentences of an introductory book on economics.

In the summer of this year, this cake grew by 0.3 percent.

Real GDP: Poor indicator of wealth gains and losses

Many economic analysts had actually expected a decline in real gross domestic product (GDP).

The high energy prices should have caused private consumption and industrial production to shrink.

But even after deducting the high price increases, both components of the gross domestic product probably increased.

Apparently the German economy is more robust than expected.

But are we really better off because the pie has gotten bigger?

Do we have more income in our pockets than we did in spring?

And can we Germans therefore afford more?

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GDP: Bad indicator in times of crisis

In times like these, the change in real gross domestic product is only a poor indicator of the prosperity gains and losses of Germans.

It does measure the change in the total value of the goods and services produced in Germany (after deducting the inputs required for production) and thus whether the pie has gotten bigger or smaller.

And it also shows whether the incomes of private households and entrepreneurs have increased or decreased.

However, it does not take into account the fact that part of the income generated goes abroad to settle the sharply increased bill for imported natural gas and oil.

Germany is an open economy and connected to the rest of the world through many relationships.

The current energy crisis is having a particular impact on Germany, as it obtains almost all of its crude oil and natural gas from abroad and, until shortly before the outbreak of the war, Russia was one of the most important source countries.

As a result of falling crude oil and natural gas deliveries from Russia, the prices of these energy sources and thus the German import bill have risen sharply.

It is true that the higher prices for imported energy are at least partly passed on to other countries by companies, which creates additional domestic income through the sale of export goods.

However, since energy has so far only made up a small part of the production costs, export prices are likely to rise far less than import prices and the terms of trade, which relate the two foreign trade prices to one another, should therefore deteriorate.

A good part of the higher prices for imported energy should therefore be borne by domestic end consumers.

They can afford less from their income and suffer a real loss of income.

With the so-called real value of the gross domestic product, an alternative measure of income is available,

Energy crisis leads to loss of real income in Germany

The current rise in energy prices began even before the Russian attack on Ukraine.

Starting with exceptionally low prices for natural gas and oil during the corona crisis in 2020, the price of imported energy rose sharply last year.

The deterioration in the terms of trade was accompanied by a loss of domestic real income of 35 billion euros or 1.0 percent of gross domestic product.

Accordingly, the recovery in the year after the corona crisis, measured in terms of the real value of the gross domestic product, was noticeably weaker at 1.6 percent than the increase in the price-adjusted gross domestic product of 2.6 percent suggested.

In March of this year, the rise in prices accelerated noticeably again.

Even if the highs in natural gas and oil prices have now been exceeded and prices have been falling since the summer, they are unlikely to return to their pre-crisis levels in the foreseeable future, since Russia is unlikely to be available as an energy supplier any longer.

This year, therefore, the gap between the two measures is likely to widen further as the terms of trade deterioration accelerates.

While the price-adjusted gross domestic product will probably increase by 1.4 percent according to the most recent forecast by the joint economic forecast, the purchasing power of the economy as a whole, measured in terms of the real value of the gross domestic product, is likely to fall by 0.3 percent.

The difference corresponds to a real income loss of 1.8 percent in relation to gross domestic product, or 64 billion euros.

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With the gradual stabilization of energy prices in the coming year assumed by the joint forecast, the real income losses will also come to an end.

Economic output is likely to fall compared to the previous year, measured both in terms of price-adjusted gross domestic product (−0.4 percent) and in terms of the real value of gross domestic product (−0.7 percent).

If this projection proves to be correct, the energy crisis would result in a real income loss of around 3 percent of the economic output generated in Germany in the years 2021 to 2023.

Only during the second oil price crisis from 1979 to 1981 were these losses even higher, totaling 4 percent of economic output.

The cake is smaller than we think

The quantification of real income losses to other countries is important in all distribution discussions.

They represent the piece of the overall economic cake created in Germany, which has to be given abroad and simply cannot be distributed domestically.

In wage negotiations, for example, it must be taken into account that the high prices for goods and services produced in Germany are not the result of a boom that is making company profits soar.

Above all, they reflect the high costs that have to be paid abroad for imported energy and primary products.

The income to be distributed between employees and entrepreneurs must therefore be corrected for these real income losses.

Government support measures cannot change the size of the pie.

They can only influence the share that individual population groups have to give up from their individual pie.

And they can shift the piece of the pie to future generations over time if the measures are funded, say, by debt or less investment.

However, as long as Germany imports energy from abroad and the price for it remains high, we will have to pay part of our income abroad to settle the import bill.

The cake is smaller than we think.

About the author: Prof. Dr.

Timo Wollmershäuser has been head of economic research and forecasts at the ifo Institute