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June 4, 2014
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With the dream start into 2014 we have lifted our GDP forecast to 1.8% (from 1.5%). For 2015 we maintain our 2% call, as we expect that the only temporary increase in the sum of gross wages resulting from the introduction of the minimum wage will be offset by more cautious investment spending. [more]
Focus Germany: Strong domestic economy to suffer from good intentions Current Issues Business cycle 2014 German GDP growth revised up to 1.8% . Although 0.3 pp of the 0.8% qoq increase can be attributed to favourable weather conditions, the underlying momentum did pick up further (Q4 GDP: 0.4% qoq). In Q2 we expect some pay- back. With the dream start into 2014 we have lifted our GDP forecast to 1.8% (from 1.5%). For 2015 we maintain our 2% call, although downside risks have increased due to domestic policy settings. Minimum wage of EUR 8.50 per hour: Grand Coalition on the wrong track. The general minimum wage of EUR 8.50 per hour is likely to be introduced from January 1, 2015 with only a few exemptions. The objectives of a more equal distribution of income and the easing of the burden on the public purse are, however, likely to be missed by a long way. The minimum wage will probably have a major negative impact on the employment of problem groups in particular, make (re)entry into the labour market much more difficult and drive up structural unemployment with pronounced negative fiscal effects. Reducing the inequality of gross pay distribution will be achieved at the cost of squeezing out workers who are the least productive. Spotlight on Germany's export surpluses: Who's the "bad guy" in Euroland? Germany's current account surplus versus the EMU countries has already more than halved to 2% of GDP. If one wants to "blame" one single party for the result of bilateral trade relations, China would be the more appropriate addressee. Since 2010, China has recorded higher surpluses than Germany in bilateral trade with the southern peripheral countries of the euro area, which have declined only slightly since then. Also, given the similarity of the product ranges, China is an almost overwhelming competitor in third markets and is increasingly also crowding out local producers in their domestic markets. European Elections: Implications and trends. In the European Elections Conservatives took the lead as strongest political group in the EP despite significant losses. The election results will bring another grand coalition of the established parities in the EP which has been well proven in the last term already and reflects political relations in some member states. Populist influence should remain limited despite successful campaigning: Given their fragmentation and lack of common political narratives, their extent of influencing should remain limited even if a new political group should be formed under the French far-right. With the relative loss of the conservatives and the liberal forces, market-friendly orientation in some dossiers could come under pressure. Political Germany is currently discussing on how to deal with the eurosceptic AfD. Particularly within the CDU this could lead to controversial discussions – particularly with regard to the elections in three German states later this year. Author s Bernhard Gräf +49 69 910-31738 bernhard.graef@db.com Nicolaus Heinen +49 69 910-31713 nicolaus.heinen@db.com Heiko Peters +49 69 910-21548 heiko.peters@db.com Oliver Rakau +49 69 910-31875 oliver.rakau@db.com Stefan Schneider +49 69 910-31790 stefan-b.schneider@db.com Editor Stefan Schneider Deutsche Bank AG Deutsche Bank Research Frankfurt am Main Germany E-mail: marketing.dbr@db.com Fax: +49 69 910-31877 www.dbresearch.com DB Research Management Ralf Hoffmann Content Page Forecast tables ...............................................2 2014 German GDP growth revised up to 1.8% ...........................................................3 Minimum wage of EUR 8.50 per hour: Grand Coalition on the wrong track .................7 Spotlight on Germany's export surpluses: Who's the "bad guy" in Euroland? ................. 21 European Elections: Implications and trends ........................................................... 26 Chart of the month ........................................ 30 Chartbook ..................................................... 31 Event calendar .............................................. 38 Data calendar ............................................... 39 Financial forecasts ........................................ 40 Data monitor ................................................. 41 June 4, 2014 Focus Germany Strong domestic economy to suffer from good intentions Focus Germany 2 | June 4, 2014 Current Issues Economic forecasts DX Real GDP Consumer Prices* Current Account Fiscal Balance (% growth) (% growth) (% of GDP) (% of GDP) 2013F 2014F 2015F 2013F 2014F 2015F 2013F 2014F 2015F 2013F 2014F 2015F Euroland - 0.4 1.1 1.5 1.3 0.8 1.3 2.4 2.4 2.1 - 3.1 - 2.5 - 2.1 Germany 0.4 1.8 2.0 1.5 1.2 1.7 7.5 7. 1 6.8 0.0 0.2 0.1 France 0.4 1.0 1.4 1.0 1.0 1.1 - 1.7 - 1.5 - 1.3 - 4.3 - 3.6 - 3.1 Italy - 1.8 0.3 1.1 1.3 0.7 1.2 1.0 1.2 1.2 - 3.0 - 2.9 - 2.6 Spain - 1.2 0.7 1.5 1.5 0.5 1.1 0.8 2.1 2.5 - 7.1 - 5.8 - 4.5 Netherlands - 0.8 0.9 1.4 2.6 0.5 1.2 10.4 10. 5 11.0 - 2.5 - 3.1 - 2.9 Belgium 0.2 1.4 1.6 1.2 1.1 1.5 - 1.6 - 2.0 - 1.0 - 2.6 - 2.5 - 2.6 Austria 0.3 1.4 1.8 2.1 1.5 1.7 2.7 3.6 3.7 - 1.5 - 2.8 - 1.5 Finland - 1.4 0.3 1.4 2.2 1.6 1.8 - 1.1 0.0 0.3 - 2.1 - 2.1 - 1.6 Greece - 3.9 1.0 2.2 - 0.9 - 0.8 0.1 0. 8 1.0 1.5 - 12.7 - 1.6 - 0.9 Portugal - 1.4 1.4 1.1 0.4 0.3 0.9 0.5 1.0 2.0 - 4.9 - 4.2 - 3.0 Ireland - 0.3 1.8 2.2 0.5 0.5 1.2 6.6 7.0 7.0 - 7.2 - 4.7 - 2.6 UK 1.7 2.9 2.2 2.6 1.6 1.8 - 4.4 - 2.7 - 2.6 - 5.8 - 4.7 - 3.8 Denmark 0.4 1.4 1.5 0.8 1.4 1.8 7.3 6.5 6.5 0.0 - 1.5 - 2.0 Norway 2.1 2.5 2.6 2.1 1.9 2.1 10.6 11.5 11.5 7.6 9.5 10.5 Sweden 1.6 2.7 3.0 0.0 0.5 1.8 6.2 5.6 5.5 - 3.6 - 1.6 - 0.8 Switzerland 2.0 1.8 2.0 - 0.2 0.4 0.8 12.5 12.5 12.5 0.4 0.0 0.0 Czech Republic - 0.9 2.0 2.5 1.4 1.0 2. 0 - 1.4 - 1.5 - 1.4 - 1.4 - 2.6 - 2.5 Hungary 1.1 2.1 2.2 1.7 0.7 2.9 2.9 1.5 1.1 - 2.2 - 2.9 - 2.7 Poland 1.6 3.0 3.7 0.9 1.2 2.1 - 1.3 - 2.0 - 1.8 - 4.4 4.3 - 3.1 United States 1.9 2.3 3.8 1.5 2.0 2.3 - 2.3 - 2.5 - 2.6 - 4.0 - 2.9 - 2.6 Japan 1.6 1.3 1.5 0.4 2.7 1.7 0.7 0.3 1.5 - 9.2 - 6.9 - 5.8 World 2.8 3.3 3.9 3.2 3.5 3.6 *Consumer price data for European countries based on harmonized price indices except for Germany. This can lead to discrepanc ies compared to other DB publications. Sources: National Authorities, Deutsche Bank Forecasts: German GDP growth by components, % qoq, annual data % yoy DX 2013 2014 2011 2012 2013 2014F 2015F Q1 Q2 Q3 Q4 Q1F Q2F Q3F Q4F Real GDP 3.3 0.7 0.4 1.8 2.0 0.0 0.7 0.3 0.4 0.8 0.2 0.5 0.4 Private consumption 2.3 0.8 0.9 1.3 1.6 0.3 0.7 0.3 - 0.3 0.7 0.4 0.4 0.4 Gov't expenditure 1.0 1.0 0 .4 0.8 0.5 0.0 - 0.2 0.7 - 0.3 0.4 0.2 0.2 0.2 Fixed investment 6.9 - 2.1 - 0.8 5.5 3.8 - 1.4 1.2 1.3 0.7 3.2 0.4 1.0 0.9 Investment in M&E 5.8 - 4.0 - 2.4 7.0 5.1 - 1.4 0.5 0.1 1.4 3.3 1.5 1.5 1.5 Construction 7.8 - 1.4 - 0.2 5.4 3.2 - 1.5 1.7 2.1 0.2 3.6 - 0.5 0.5 0.5 Inventories, pp - 0.1 - 0.5 0.1 0.5 0.0 0.5 - 0.4 0.2 - 0.2 0.7 - 0.2 0.1 0.0 Exports 8.0 3.2 0.9 4.7 6.8 - 0.7 2.5 - 0.1 2.5 0.2 1.4 1.2 1.5 Imports 7.4 1.4 1.5 6.5 7.2 0.2 1.5 0.8 1.3 2.2 1.5 1.5 1.8 Net export s, pp 0.7 0.9 - 0.2 - 0.5 0.3 - 0.5 0.6 - 0.5 0.7 - 0.9 0.0 - 0.1 - 0.1 Consumer prices* 2.1 2.0 1.5 1.2 1.7 1.5 1.5 1.6 1.3 1.3 1.2 1.1 1.2 Unemployment rate, % 7.1 6.8 6.9 6.6 6.6 6.9 6.9 6.8 6.9 6.8 6.7 6.6 6.5 Industrial producti on 7.3 - 0.4 0.0 4.2 3.0 Budget balance, % GDP - 0.8 0.1 0.0 0.2 0.1 Public debt, % GDP 80.0 81.0 78.4 75.2 72.0 Balance on current account, % GDP 6.8 7.4 7.5 7.1 6.8 Balance on current account, EUR bn 178 199 206 201 198 *Inflation data for Germany based on national definition. This can lead to discrepancies to other DB publications. Sources: Federal Statistical Office, German Bundesbank, Federal Employment Agency, Deutsche Bank R esearch Focus Germany 3 | June 4, 2014 Current Issues 2014 German GDP growth revised up to 1.8% — As expected, the upside risks to our Q1 GDP forecasts have materialised. As 0.3 pp of the 0.8% qoq increase can be attributed to favourable weather conditions, the underlying momentum did pick up further (Q4 GDP: 0.4% qoq). — In Q2 we expect some pay-back. However, as the construction sector – where these weather effects were concentrated – is operating at full tilt, the relapse should be limited. Still, business surveys also provide some evidence that the underlying momentum will at least not accelerate further. — With the dream start into 2014 we have lifted our GDP forecast to 1.8% (from 1.5%). For 2015 we maintain our 2% call, as we expect that the only temporary increase in the sum of gross wages resulting from the intro- duction of the minimum wage will be offset by more cautious investment spending. Q1 GDP boosted by mild weather conditions The growth rate of 0.8% qoq (2.5% yoy) – the highest since Q1 2011 – shows that the German economy is on a robust, domestically driven expansion course. However, Q1 growth was overstated by seasonal factors (construction spending 3.6% qoq), causing some pay-back in Q2. Still, with the weather effect estimated at 0.3 pp of GDP the underlying momentum inched up further in Q1. Growth was broad-based in Q1 with all domestic components contributing. Only net exports subtracted from growth (-0.9 pp), fully reversing the unusually strong showing in Q4 (0.7 pp). The main story was construction, though. At 0.4 pp, construction was responsible for half of Q1’s expansion as the mild winter allowed construction projects to be moved forward. A drop back to the high level seen in H2 2013 would produce a decline of 3.6% and arithmetically deduct around 0.3 pp from the underlying GDP momentum. A positive surprise was the strong acceleration in investment in machinery & equipment. It rose by 3.3% qoq following expansion of 1.4% in Q4 after having contracted or shown only miniscule growth in the preceding 8 quarters. This shows that – despite global uncertainties – rising capacity utilisation is slowly forcing companies to carry out at least some replacement investments. Private consumption continues to be a bright spot, thanks to decent employment & wage growth. Rising by 0.7% qoq, consumption growth accounted for half of Q1’s GDP increase and compensated for the unusual weakness in Q4 (-0.3% qoq). From an income perspective, growth continues to be tilted towards wage income. Gross wages were up 3.6% yoy in Q1 (net: 3.1%) thanks to rising employment. Wages per employee were up only 2.5% yoy, supporting our expectations for decent hourly wage growth in the range of 2 ½% to 3% in 2014. Growth of property and entrepreneurial income stood at 5.8% yoy. The saving rate (Q1: 9.9%) remained range-bound over the last four quarters. Net exports provided a – not completely surprising – disappointment in the Q1 GDP release. Exports showed a meagre growth rate of 0.2% qoq (Q4: 2.5%; goods exports even fell in Q1), while imports rose strongly (2.2% qoq vs. 1.3% prev.). Thus, net exports subtracted 0.9 pp. This is more than a full reversal of Q4’s 0.7 pp contribution and in line with the generally weak global backdrop in Q1. In yoy terms, though, exports (5.5%) and imports (6.2%) accelerated further. Both PMI new export orders as well as ifo export expectations do not suggest that export growth is going to pick up meaningfully in the next few months. Especially PMI new export orders have come down appreciably - 2.0 - 1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 - 1.0 - 0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 10 11 12 13 14 % qoq (left) % yoy (right) % qoq, sa (left); % yoy, nsa (right) Sources: Federal Statistical Office, DB Research Q1 2014 – substantial growth acceleration 1 - 1.5 - 1.0 - 0.5 0.0 0.5 1.0 1.5 2.0 2.5 11 12 13 14 Private consumption Machinery & equipment Construction Net exports Rest Growth contribution to real GDP growth, qoq, pp Sources: Federal Statistical Office, Deutsche Bank Research Construction & consumption main drivers in Q1 20 14 2 80 90 100 110 120 130 140 12 13 14 Construction H2 '13 avg. Q4 '13 avg. Q1 '14 avg. Source: Federal Statistical Office Construction spending (industrial production component), 2010=100, seasonlly adjusted Drop to H2 level would imply modest Q2 2014 GDP growth 3 Focus Germany 4 | June 4, 2014 Current Issues compared to their high Q4/Q1 levels, providing for a mixed outlook over the short run. Revisions of the growth composition of previous quarters support our cautious outlook for private consumption and exports. Especially the revisions to Q4 are worth noting, with private consumption falling even more than initially reported (-0.3% qoq vs. -0.1%). Construction was revised down as well (0.2% vs. 1.2%). Finally, the initially reported strong net export contribution (which looked odd anyway) has been lowered (0.7 pp vs. 1.1 pp) while inventories provided less of a drag on growth (-0.2 pp vs. -0.8 pp). In essence (final) domestic demand was weaker at the end of 2013 than previously reported, which – taken together with the strong Q1 – makes for decent but not spectacular momentum. Over the last 5 quarters domestic demand added about 0.5 pp to quarterly growth, while net exports were on average a small drag (-0.1 pp). Survey data paints a more mixed picture for Q2 The May ifo index fell from 111.2 to 110.4 – the lowest level in four months. The decline was driven by a downturn in expectations (106.2 vs. 107.3 prev.) in combination with a modest drop in the assessment of the current situation (114.8 vs. 115.3 prev.). Except for the situation in manufacturing both components declined in all sectors to a varying degree. This not only reversed April’s unexpected increase but has brought sentiment levels generally below their relatively weak March levels. The correction in the manufacturing PMI (52.9 after 54.1 in April) was even more pronounced. However, the services PMI rose again by 1.7 points to stand at 56.4, so the composite PMI remained unchanged at 56.1 (0.6 of a point above its Q1 average). At face value the levels of the ifo and the PMI index still point to quarterly growth rates between ½% and 1% for Q2. But given the pay-back of Q1’s weather boost, we are expecting a qoq increase of ¼%. With quarterly growth rates of close to ½% in H2 the economy should muster an annual growth rate of 1.8% in 2014. Domestic demand the exclusive growth driver in 2014 Leading indicators show that labour demand should continue its broad-based acceleration in coming months. We expect the unemployment rate to fall by 0.3 pp to 6.6% in 2014. Although profit and property income will likely remain rather subdued, nominal disposable income should expand by around 2 ½% in 2014 – courtesy of solid employment and wage growth – allowing for a 1.3% increase in real private consumption. This is one of the highest rates in the last decade and partly due to the weak inflation environment. Investment spending growth should decelerate somewhat in the coming quarters as the impetus from domestic and foreign demand is not yet strong enough to give a material boost. In addition, corporates probably also remain cautious given some geopolitical uncertainty as well as the ongoing question marks over global trade. Policy (introduction of a minimum wage in 2015 and pension reforms) seems to have started leaving its imprint in animal spirits. A recent investment survey conducted by the DIHK found that 45% of Germany’s industrial companies are investing abroad in 2014, with the balance (of higher or lower investment) rising from 16 to 20. Moreover, for the first time since 2008 more companies mentioned cost savings as a reason for foreign investment, although the increase was just 1 point, to 21%, compared with 36% back in 2008. In a similar survey compiled by EY, 20% of the companies said that they want to shift production abroad, breaking an 8-year downward trend (2013: 11%). Our forecast is for investment in machinery & equipment to grow by 7.0% - 2.0 - 1.5 - 1.0 - 0.5 0.0 0.5 1.0 1.5 2.0 2010 2011 2012 2013 Private consumption Government consumption Real, sa, % qoq Source: Federal Statistical Office Q1 consumption made up for Q4 weakness 4 - 15 - 10 - 5 0 5 10 08 09 10 11 12 13 14 Disposable income Employee compensation Property and entrepreneurial income % yoy, nominal Source: Federal Statistical Office Income growth range bound over last few quarters 5 70 80 90 100 110 120 130 08 09 10 11 12 13 14 Climate Situation Expectations ifo index: Situation and expectations fell in May 6 Index, 2005=100 Sources: ifo Focus Germany 5 | June 4, 2014 Current Issues in 2014 (2013: -2.4%) largely thanks to the strong Q1 and carry-over effects from 2013. In H2, construction spending should continue to be well supported by rising housing demand (immigration, urbanisation). Permits were up 15% yoy in Q1. Thus – despite some pay-back in Q2 – construction investment should increase by 5.4% in 2014 (2013: -0.2%) and be an important growth pillar. The export outlook has – at least compared to some months ago – become less promising. Since November, global trade has been on a downward trend, standing at a meagre 1.8% yoy in March. Given disappointing Q1 GDP data in the US, China and EMU we have cut our global GDP forecast for 2014 to 3.3%. As a result we have marked down our 2014 export forecast from 5.8% to 4.7%. Imports should still expand by 6.5%. Net exports (-0.5 pp) will, therefore, be a drag on overall growth now, while we had still expected a slightly positive contribution before. Policy headwinds to become more visible during 2015 We believe that over the course of 2015 economic sentiment will start to fray and underlying momentum is going to slow. The marginal increase in the yoy rate to 2% is solely due to a positive calendar effect. Immigration is likely to slow eventually as the boost from lower legal barriers to immigration from Eastern Europe runs out and migration flows from the peripherals normalise in the context of economic recovery. Secondly, and more worrisome, corporates are going to start adjusting to economic policies currently being finalised or already passed in Berlin. Specifically, a high nation-wide minimum wage with very limited exceptions, a lower pension age for some and higher pension levels mostly for some mothers will raise labour costs and weigh on medium-term employment prospects and the fiscal outlook. The new government has also made less progress on energy policy than initially hoped, which continues to weigh on investment prospects for energy-intensive companies. With the introduction of the minimum wage in 2015 we believe the employment build-up will stall over the course of the year. At EUR 8.50 per hour, Germany will have one of the highest minimum wages in Europe and it will not be that far off from French levels, when compared to the median wage. Especially in the still structurally weaker eastern part of the country it has the potential to damage labour market prospects. Given the high labour force utilisation the negative employment effects might not show up immediately. In addition, corporates will - 15 - 10 - 5 0 5 10 15 20 - 6 - 4 - 2 0 2 4 6 8 10 11 12 13 14 % qoq (left) % yoy (right) % qoq (left), % yoy (right) Source: Federal Statistical Office Investment in machinery & equipment: 2nd solid increase 7 - 40 - 30 - 20 - 10 0 10 20 30 07 08 09 10 11 12 13 14 Investment Dom. Invest. goods orders, 1Q lag Real, % yoy Source: Federal Statistical Office Orders point to about 4 - 5% investment growth 8 60 65 70 75 80 85 90 95 100 93 97 01 05 09 13 Sources: ifo, Deutsche Bank Research Capacity utilization slightly above average 9 - 1.0 - 0.5 0.0 0.5 1.0 1.5 2.0 - 4 - 2 0 2 4 6 8 10 11 12 13 14 Net exports (contr. in pp, right) Exports (left) Imports (left) Real, sa, % qoq Source: Federal Statistical Office Net exports: Very volatile over the last few quartes 10 - 2.0 - 1.5 - 1.0 - 0.5 0.0 0.5 1.0 1.5 2.0 - 30 - 20 - 10 0 10 20 30 10 11 12 13 14 Merchandise exports (lhs) PMI new export orders (lagged by 3 months, rhs) ifo export expectations (lagged by 3 months, rhs) % yoy (lhs), Standardized values (rhs) Sources: Deutsche Bundesbank, ifo, Markit Surveys point to continued sideways trend for exports 11 Focus Germany 6 | June 4, 2014 Current Issues probably initially try to pass on their higher labour costs, which might delay the adjustment. We believe that employment (growth) will be lowered by about 300,000 in 2015 (around 0.7% of total employment). Still, in 2015 the minimum wage might still add ½% to the sum of gross wages as rising wages for those retaining their jobs will overcompensate the negative income effect of the job losses. As a result, the growth rate of private consumption will probably peak at around 1 ¾% in 2015. In the longer term, however, negative employment effects will prevail. Already in 2015 we see the unemployment rate being 0.2 pp higher (6.6% instead of 6.4%) than in a scenario without a minimum wage, with job losses increasing thereafter. Cumulatively, we fear that 800,000 jobs could be lost/not created over the medium term. A full discussion of the effects of the minimum wage on important economic variables will follow in the next article. Oliver Rakau (+49 69 910-31875, oliver.rakau@db.com) Stefan Schneider (+49 69 910-31790, stefan-b.schneider@db.com) 0 10 20 30 40 50 60 2000 2003 2005 2007 2009 2011 2013 Foreign production to save costs Foreign production to open up market Sales and customer service Purpose of foreign investment by German industrial firms 12 % (no survey of foreign investment plans conducted in 2002) Source: DIHK survey: Auslandsinvestitionen in der Industrie 2014 Focus Germany 7 | June 4, 2014 Current Issues Minimum wage of EUR 8.50 per hour: Grand Coalition on the wrong track — Fundamental changes are unlikely to be made to the draft legislation regulating a general minimal wage. The general minimum wage of EUR 8.50 per hour is likely to be introduced from January 1, 2015 with only a few exemptions. — This represents a complete about-turn following the labour market reforms implemented in the mid-2000s. The creation of a low-wage sector has improved markedly the integration opportunities for problem groups. The barriers to their entry will once again become much higher. — The objectives of a more equal distribution of income and the easing of the burden on the public purse are, however, likely to be missed by a long way. The minimum wage will probably have a major negative impact on the employment of problem groups in particular, make (re)entry into the labour market much more difficult and drive up structural unemployment with pronounced negative fiscal effects. Reducing the inequality of gross pay distribution will be achieved at the cost of squeezing out workers who are the least productive. — Our analysis reveals that the minimum wage is likely to have a negative impact on employment in 2015 – primarily in the service sector, in agriculture and retailing – affecting around 300,000 people and thus probably stopping jobs from being created. — In the medium to long term, the introduction of the minimum wage is likely to cost some 800,000 people their jobs or prevent them from finding a job and over the near term, to reduce potential growth by several tenths of a percentage point. — Although the introduction of the minimum wage can probably no longer be stopped, it could at least be amended so that precisely those people with few integration prospects will not be permanently denied access to the labour market. Unfortunately, the chances of this happening are probably remote. Back in November 2013, in our Standpunkt Deutschland publication “Minimum wage at EUR 8.50: The wrong policy choice”, we already warned of the considerable negative effects of the introduction of a standard national statutory minimum wage of EUR 8.50 per hour. In the meantime, draft legislation was drawn up by the labour ministry and was approved by the Federal cabinet in early April 2014. It is unlikely that fundamental changes will be made before the legislation is finally passed in autumn 2014. Based on the bill and the current data from the socio-economic panel (SOEP) we shall go into greater detail with our analysis of the introduction of the minimum wage. In the medium to long term the introduction of the minimum wage is likely to mean that 800,000 people will either lose their jobs or be prevented from finding a job. The intended objectives of reducing inequality and easing the burden on the public purse are, however, likely to be missed by a long way. Instead of jeopardising the positive labour market development since the mid-2000s by introducing the relatively high minimum wage, action should be taken to reduce structural unemployment and further improve the quality of work. If the political will to introduce a minimum wage does indeed exist, then it should be introduced at differing levels – for example dependent on qualification, age and region – and impinging relatively little on the wage structure. Focus Germany 8 | June 4, 2014 Current Issues Massive interference in the wage structure by the minimum wage can probably no longer be prevented In early April, the cabinet approved the bill for regulating a general minimum wage (MiLoG) as part of the Law to Strengthen Free Collective Bargaining, which also regulates the reform of the Collective Agreement Act and the Posted Workers Act. 1 The deliberations in the Bundestag will probably be concluded before the summer break. The bill is then likely to be submitted to the Bundesrat in September and the law should then come into effect as of January 1, 2015. Despite widespread criticism – not only from the employer side – it is unlikely that the grand coalition will make major amendments to the bill. From January 1, 2015 a general, statutory minimum wage of EUR 8.50 per hour is to apply to virtually all workers 2 (§ 1 (2) MiLoG). For industry-specific minimum wages in accordance with the Posted Workers Act and the Employee Transfer Act a transitional regulation applies until December 31, 2016 (§ 23 MiLoG). At the moment there are sector-specific minimum wages – mostly at different levels for west and east Germany – for 3.8 million employees in 13 business segments. The minimum wage will also apply to these workers from January 1, 2017. The first amendment to the minimum wage will be made on January 1, 2018. This amendment is to be determined by a minimum wage commission by June 10, 2017(§ 9 (1) MiLoG). 3 When setting the minimum wage, the Commission is to retrospectively use the development in collective pay as a guide (§ 9 (3) MiLoG). According to comments by Federal Labour Minister Andrea Nahles, the minimum wage is intended to ensure greater fairness and help some four million people to “finally receive a fair day's pay for a fair day's work”. 4 The objectives are not only a fairer distribution of primary income, but also an easing of the burden on the public purse. With an eye on potentially negative employment effects, the draft legislation states: “the level of the minimum wage is appropriate with respect to its impact on employment. Also against the backdrop that Germany has already managed to gather experience of the impact that sector- specific minimum wages have on employment, no significant employment effects are to be expected.” Starting level of EUR 8.50 per hour politically motivated No detailed argumentation is supplied as to why a minimum wage of precisely EUR 8.50 per hour should be the ideal level to achieve the objectives. Our assessment is that the intended objectives of introducing a minimum wage will not be attained, and that in fact the outcome will be the opposite of what was intended. The government's objectives are more likely to be achieved by the tried and tested negotiation of the entire wage structure by employer and employee 1 German Federal Government draft legislation (2014). Bill to Strengthen Free Collective Bargaining. 2 Those exempt are trainees, young people under 18 who have not completed vocational training, those doing compulsory work experience, voluntary workers and long-term unemployed receiving reintegration allowance in the first six months (§ 22 MiLoG). 3 The Commission will be appointed for five years and will then decide annually about adjustments to the minimum wage. It will be made up of one chair, six more permanent members with voting rights and two members from business without voting rights (§ 4 MiLoG). Decision will be made by simple majority. Should the voting be tied, the chair will then use his casting vote (§ 10 (2) MiLoG). The lead organisations of the individual unions and the employers' associations will each propose three members for appointment by the German government (MiLoG, S. 42). 4 Federal Ministry of Labour and Social Affairs (2014). Press release (in German only) “Der Mindestlohn kommt”, April 2, 2014. Focus Germany 9 | June 4, 2014 Current Issues representatives. Free collective bargaining to negotiate wages and the decentralisation to company level are probably the main reasons for the improvement in German companies' competitiveness since the mid-1990s. 5 In addition, German firms in the past decades have made extensive use of the opportunities presented by the opening-up of emerging nations – especially in eastern Europe and Asia – to cut their average wage costs by establishing global value chains. In order to evade the relatively high wage level in Germany and the strict labour market regulation, there has been outsourcing particularly of the parts of the production chain with relatively high labour inputs and low skill requirements. 6 Ignoring all concerns, the grand coalition has decided to introduce a minimum wage of EUR 8.50 per hour. However, the improved situation of those who will remain employed following the introduction of the minimum wage stands in contrast to the worse situation for those who will either lose their jobs or not be hired because of the minimum wage. This trade-off should be communicated clearly by politicians. As is shown in the following, the major state intervention in German wage-setting will probably have marked negative employment effects and thus result in a negative overall effect. International experience with minimum wages The employment impact of a binding minimum wage cannot be theoretically determined unequivocally. According to neo-classical labour market model (no friction, perfect competition, compensation on the basis of marginal productivity) a binding minimum wage has clearly negative employment effects, as all jobs that create less value than the minimum wage are eliminated. Positive employment effects could be produced by a monopsonistic labour market model. With market power in the setting of wages residing with the employer, the wage could be too low from a macroeconomic point of view. The introduction of a binding minimum wage with a moderate “bite” then generates higher income and higher employment. Furthermore, in search markets there can also be positive employment effects, as companies can fill vacancies quicker and the tenure at the company is likely to be longer. Whether and under which circumstances minimum wages result in a negative employment effect must therefore be determined empirically. A comprehensive international compendium of relevant literature covering 102 reports since the early 1990s was compiled by Neumark and Wascher (2007) 7 . The range of the estimated elasticities extends from decidedly negative to positive. An overwhelming majority of the studies – around 2/3 and if we restrict ourselves to the most meticulously conducted studies the figure rise to no less than 85% – points towards negative employment effects. Positive employment effects were found in fewer than 10% of reports. In the more recent reports about the US a relatively great deal of public debate was focused on the report by Dube et al. (2010) which found negative employment effects when looking at regional heterogeneity. Neumark et al. (2013), however, questioned the empirical methodology and found negative employment effects. 8 5 Dustmann, C. et al. (2014). From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy. Journal of Economic Perspectives, 28 (1), 167-188. 6 Peters, H. (2013). Global value chains secure competitive advantages for German companies. Deutsche Bank Research. Focus Germany. July 1, 2013. 7 Neumark, D. and Wascher, W. L. (2007). Minimum Wages and Employment. Foundations and Trends in Microeconomics, 3 (1-2), 1-182. 8 Dube, A. et al. (2010). Minimum Wage Effects across State Borders: Estimates using Contiguous Counties. The Review of Economics and Statistics, 92 (4), 945-964. Neumark, D. et al. (2013). Revisiting the Minimum Wage-Employment debate: Throwing Out the Baby with the Bathwater? NBER Working Paper Nr. 18681. FR GB US - 40 - 30 - 20 - 10 0 10 20 30 20 40 60 80 100 x - axis: Kaitz index*, y - axis: annual change since year of introduction (percentage points) *Year of minimum wage introduction or oldest value Sources: OECD, Eurostat, national statistics, Deutsche Bank Research Increase in minimum wages was disproportionately low when the introductory level was high 1 Focus Germany 10 | June 4, 2014 Current Issues Overall, the literature regarding minimum wages points clearly towards negative employment effects. The decisive feature when a minimum wage is introduced is its bite into the wage distribution, which is often high for the problem groups in the labour market – even when the minimum wage is relatively low. That is why frequently exemptions are made or a lower minimum wage is set for these groups. The usual tool for measuring the bite of a minimum wage is the difference between the minimum wage and the mean or median wage of a full-time employee (Kaitz index). In an international comparison there are serious differences between the bite of minimum wages. 9 When, however, a relatively high level was chosen initially, the increases in the minimum wage were usually lower than the increase in median wages. As a consequence the Kaitz index for these countries is lower than in the year that the minimum wage was introduced. Conversely, the minimum wage in countries with an initially relatively low level was raised by more than the median wage. The international comparison provides a benchmark for the level of the minimum wage in Germany that would probably give rise to only few negative employment effects. There are analyses of the US and the UK that find no 9 There is a minimum wage in roughly 50% of the countries around the globe. See ILO (2013). World of Work Report 2013: Repairing the economic and social fabric, Geneva, p. 50. Minimum wages as % of wage of full-time employee in 2012 2 2012 vs. ... %Rank%RankEUR per hour Recently amended Introduction%RankPercentage point Turkey38.41372.512.1701 Jan 20141936 (data from 1970)96.41-23.9 France49.8261.529.5301 Jan 2014197038.22023.3 New Zealand51.3159.938.4801 Apr 2013198334.82325.1 Slovenia48.3359.544.5601 Jan 20141995 (data from 2005)51.2118.3 Portugal39.6957.752.9201 Jan 20111974 (data from 1975)70.02-12.3 Hungary39.6953.961.9701 Jan 2014198837.42116.5 Australia44.0552.7711.8801 Jul 20131966 (data from 1985)65.25-12.5 Latvia38.01450.981.9301 Jan 20141991 (data from 1997)39.61911.3 Germany45.6450.2108.5001 Jan 2015201550.213 Belgium43.0750.799.1001 Dec 2012197554.89-4.1 Lithuania35.71747.8111.7601 Jan 20131991 (data from 1997)54.410-6.6 Ireland43.7647.6128.6501 Jul 2011200067.53-19.9 United Kingdom38.81247.2137.4301 Oct 2013199942.4174.8 Slovak Republic36.81647.0142.0201 Jan 2014199158.86-11.8 Netherlands41.2846.9159.1101 Jan 2014196965.54-18.6 Poland37.91546.5162.3101 Jan 20141990 (data from 1991)40.0186.5 Romania31.22245.2171.1401 Jan 2014199049.314-4.1 Canada39.6945.1187.4401 Jan 20141918 (data from 1965)47.415-2.3 Spain34.91844.2193.9101 Jan 2013198056.17-11.9 Greece29.52543.4203.3501 Mar 2012199155.18-11.7 Korea34.51942.4213.5801 Jan 2014198829.32513.1 Luxembourg34.51942.02211.1001 Oct 2013197335.8226.2 Japan33.32138.3235.8901 Jan 20141959 (data from 1975)27.62610.7 United States27.22637.8245.4624 Jul 20091938 (data from 1960)46.916-9.1 Czech Republic30.62336.0251.9501 Aug 2013199151.012-15.0 Estonia30.02435.7262.1301 Jan 20141991 (data from 1999)32.0243.7 MeanMedianMinimum wageMedian Sources: OECD, Eurostat, WSI, national statistics, SOEP, Deutsche Bank Research 30 35 40 45 50 55 60 65 70 74 78 82 86 90 94 98 02 06 10 FR GB US Kaitz index (median) Sources: OECD, Deutsche Bank Research Minimum wage grow more rapidly in France than in the US and the UK 3 Focus Germany 11 | June 4, 2014 Current Issues statistically significant negative employment effects. 10 In both countries the bite of the minimum wage is however relatively low. In the UK, there are exemptions for workers in the early stages of their working lives. 11 In the US, there are in addition to the national minimum wage also alternative provisions at the state level. Washington was where the highest state-level minimum wage was set (26% higher than the national minimum wage). By contrast, a minimum wage with a similar bite to that currently in force in France would give rise to an extremely difficult situation especially for problem groups. While the minimum wage was introduced at a relatively low level with a Kaitz index of under 40% the above-average increases since then led to the impact in France being the strongest in the advanced economies with a Kaitz index of more than 60% in 2012. In the process, problem groups were increasingly forced out of the labour market. The minimum wage is particularly problematic for those starting their working lives as it frequently denies them access to the labour market and has therefore sent youth unemployment soaring. 12 The negative impact of the minimum wage is, however, masked in France by the extensive wage subsidies. 13 When a firm employs someone at the minimum wage rate, the subsidy is 26%. The subsidisation of wages of up to 1.6 times the minimum wage is scaled back depending on the level of the wage. Nearly half of all jobs are thus subsidised at huge fiscal expense to the French public purse. The experience gathered to date with sector-specific minimum wages – relevant studies in Germany frequently find only a slight negative employment effect and a hefty compression of the wage structure – does not allow any conclusions to be drawn about the impact of a universal minimum wage. The taking of evasive action in other sectors, which tends to dampen the negative impact of sector- specific minimum wages, is no longer possible when a universal minimum wage applies. 14 At the moment in Germany minimum wages apply in 13 sectors with 3.8 million employees. In 85% of cases, however, a lower minimum wage has been negotiated for east Germany. The minimum wage in 40% of cases in east Germany is less than EUR 8.50 per hour. Minimum wages range from EUR 6.50 per hour in the hairdressing business in east Germany to EUR 13.95 per hour in the construction sector in west Germany. Since for sector-specific minimum wages the exemption from the minimum wage legislation applies until the end of 2016, the minimum wages in 5 sectors will also remain below EUR 8.50 after January 1, 2015. Minimum wage level derived from international experience The summary of international experience gained with minimum wages showed that the starting level should be chosen with care. If it is set too high, then there is a risk of considerable employment losses. 10 Knabe, A.; Schöb, R. and Thum, M. (2014). Der flächendeckende Mindestlohn. Freie Universität Berlin. Diskussionsbeitrag 2014/4. 11 Compared to the general minimum wage, the reduced rate for trainees is roughly 40%, for under- 18s just 60% and for 18-to-20-year-olds the rate is 80%. 12 Cahuc, P. et al. (2013). Youth unemployment in old Europe: the polar cases of France and Germany. IZA Journal of European Labor Studies, 2-18. 13 The combination of minimum wage and wage subsidy means that when the minimum wage is raised labour costs only increase for wages that are roughly the same as the previous minimum wage level. For wages above that level labour costs actually drop due to the increased subsidy. For example, in 1997 the minimum wage increase of 10% resulted in the negative employment effect of the minimum wage hike of 290,000 persons being more than offset by the positive effect of the wage subsidy of 500,000 persons. See Laroque, G. and Salanié, B. (2000). Une décomposition du non-emploi en France. Économie et Statistique 331 (1), 47-66. 14 Sachverständigenrat – German Council of Economic Experts (2013). Jahresgutachten 2013/2014. Wiesbaden. 5 10 15 20 25 83 87 91 95 99 03 07 11 FR DE GB US Sources: Eurostat, Deutsche Bank Research Unemployment rate of under 25s, % Youth unemployment high in France 4 6.50 7.00 7.50 8.00 8.50 9.00 10 11 12 13 14 15 16 17 Industrial cleaning (wage group 1), east Germany Nursing care, east Germany Laundry services, east Germany incl. Berlin Temping, east Germany incl. Berlin Hairdressing, west Germany Hairdressing, east Germany EUR per hour Sources: Federal Ministry of Labour and Social Affairs Sector-specific minimum wages below EUR 8.50 after 2015 5 Focus Germany 12 | June 4, 2014 Current Issues A minimum wage with an impact comparable to that in the US and the UK – measured using the Kaitz index – would range between EUR 5.10 per hour and EUR 8.00 per hour for Germany. On account of the pronounced difference that still exists between the economic potency of west and east Germany, at the very least, regionally differentiated minimum wages would be essential. For east Germany, the range of a minimum wage based on the US and the UK of EUR 4.20 to EUR 6.50 per hour is well below the range for west Germany (EUR 5.30 to EUR 8.40 per hour). Furthermore, it would be advisable to create additional exemptions for groups with fewer prospects in the labour market – above all the low-skilled. Since it is difficult to estimate in advance the precise impact of introducing a minimum wage on account of institutional peculiarities of the German tax/transfer system it would be advisable for the initial minimum wage to be set at the lower end. This would then be slightly above EUR 5 per hour for Germany (west Germany: EUR 5.30 and east Germany: EUR 4.20 per hour). Should there be no major adverse employment effects, the minimum wage could be raised cautiously and by differing amounts in a “discovery process”. An independent institution should evaluate the impact and decide about changes. Minimum wage of EUR 8.50 per hour bites massively into wage distribution The intensity of the impact of the planned general statutory minimum wage of EUR 8.50 per hour is consequently relatively strong with considerable effects on the labour market. We examine this more closely below with an analysis based on SOEP data for 2012. This is an annual household survey of more than 20,000 people regarding income, employment, education and health. 15 One consequence of pay increases is that every year some people rise above the minimum wage threshold. That is why we have extrapolated hourly wages from 2012 using an average increase of 2.5%. 16 The share of workers affected by the introduction of the minimum wage in Germany thus falls from 15% to 13%. The share in east Germany of 20% is much higher than in west Germany (11%). The Kaitz index in east Germany averages 62%, which is much higher than in west 15 For a detailed description of the data see Rahmann, U. and Schupp, J. (ed., 2013). SOEP Wave Report 2012 and Wagner, G. G. et al. (2007). The German Socio-Economic Panel Study (SOEP) – Scope, Evolution and Enhancements. Schmollers Jahrbuch 127 (1), 139-169. 16 Gross hourly wages were calculated using gross monthly wages and weekly hours extrapolated for the month. In calculating the weekly working hours a variety of details were used to prevent temporary overtime from causing distortions. If no overtime was worked, or overtime worked was paid or nor remunerated, the usual number of hours worked per week was used. If, however, overtime is booked into working time accounts or can be reduced by taking time off in lieu, the contractually agreed working hours were used. See Brenke, K. and Müller, K.-U. (2013). Gesetzlicher Mindestlohn – kein verteilungspolitisches Allheilmittel. DIW Wochenbericht Nr. 39. Hypothetical minimum wage with comparable impact as in the US and the UK 7 Kaitz index Germany West East % EUR per hour US Mean 27.2 5.10 5.30 4.20 Median 37.8 6.40 6.70 5.20 GB Mean 38.8 7.20 7.60 5.90 Median 47.2 8.00 8.40 6.50 GB - Year of minimum wage introduction (1999) Mean 35.6 6.60 6.90 5.40 Median 42.4 7.20 7.50 5.80 Sour ces: OECD, SOEP, Deutsche Bank Research Cumulative distribution of gross hourly wages in west and east Germany 8 y-axis: Cumulative gross hourly wage distribution; x-axis: EUR per hour Sources: SOEP, Deutsche Bank Research 0 10 20 30 40 50 60 70 80 5 6 7 8 8.5 10 12 15 20 SOEP - 2012 Forecast distribution when minimum wage is introduced Sources: SOEP, Deutsche Bank Research Impact of continuation of trend in wages until introduction of the minimum wage 6 Share of persons with gross hourly wage of less than EUR … (%) Focus Germany 13 | June 4, 2014 Current Issues Germany (48%) and is roughly on a par with France. Mecklenburg-Western Pomerania has the highest level of 70%. The impact of the minimum wage is thus relatively high and causes a marked compression at the lower end of the wage distribution. The level of wage elasticity of labour demand of the companies is decisive in estimating the employment effect. Existing estimates of wage elasticity for the relevant low- wage segment range from -0.2 to -0.9. The study in which the smallest effect was found only examined the manufacturing sector. Since the more wage- sensitive service sector was excluded this probably underestimates the macroeconomic effects. 17 We assume a middling wage elasticity of -0.5 for the rest of the assessment. Also, uncertainty exists about how many business sectors will still have sector-specific wages when the minimum wage is 17 Ragnitz, J. and Thum, M. (2008). Beschäftigungswirkungen von Mindestlöhnen – eine Erläuterung zu den Berechnungen des ifo Instituts. ifo Schnelldienst 61 (1), 16-20. Negative employment effects of minimum wage introduction mainly in east Germany 9 Minimum wage of EUR 8.50 per hour as % of median wage of full-time employee Sources: SOEP, Deutsc he Bank Research Focus Germany 14 | June 4, 2014 Current Issues introduced. We assume that there will continue to sector-specific wages for 13 sectors and 3.8 million employees. Under these assumptions the introduction of the minimum wage would affect 4.4 million workers who would earn an average gross pay of EUR 6.36 per hour. The introduction of the minimum wage would send wages rising by an average of 34%, so that – assuming an elasticity of -0.5 – companies would reduce their staffing levels or their planned hiring of new staff by 800,000 people or 2.3% in the medium to long term. If instead the minimum wage were to be introduced at a lower starting level of EUR 5 per hour, the adverse employment effect would be much lower at less than 200,000. The 3.6 million workers who would remain employed on the minimum wage would receive an average 22% increase in hourly wages. 18 The number of recipients of supplementary unemployment benefit would, however, change only slightly as a result. In addition, a portion of unemployment benefit II would be replaced by payments of housing benefit and child supplement. 19 The hourly wages of all workers would thus undergo a one-off increase of 2.6%. Since workers on low incomes typically work fewer hours per work, the average working hours of the economy as a whole would also increase by 0.5% due to this group's exit from the labour market. This underlines that the introduction of the minimum wage constitutes a massive trade-off between the improvement in the income situation of those persons who remain employed and the job losses triggered. Minimum wage blocks labour market access for people with low integration prospects The introduction of the minimum wage is likely to primarily drive those people out of the labour market whose integration prospects are already relatively remote. Compared with other countries it is mainly the low-skilled in Germany who are particularly frequently affected by intractable unemployment. Around 20% of people without training are unemployed. 20 The intensity of the impact is greater than average for workers who have no vocational qualification, were unemployed for longer periods, work in east Germany, are not in their main working age, are foreign nationals and are atypically employed. The negative employment effects will probably be the greatest for the marginally employed and those with so-called “mini-jobs”. Some 60% of workers in these types of employment earn about 30% less than EUR 8.50 (see table 23 at the end for details). 18 The assumption made here is that workers at the bottom end of the wage distribution were dismissed. 19 Bruckmeier, K. und Wiemers, J. (2014). Die meisten Aufstocker bleiben trotz Mindestlohn bedürftig. IAB Kurzbericht 7/2014. 20 Konle-Seidl, R. et al. (2014). Arbeitsmärkte im europäischen Vergleich: Erwerbslose und Inaktive in verschiedenen Sozialsystemen. IAB Kurzbericht 8/2014. Introduction of the minimum wage has a negative overall effect 11 Wage elasticity of Employment Hourly wage Working hours '000 persons % % % - 0.2 - 300 - 0.9 1.9 0.1 - 0.5 - 800 - 2.3 2.6 0.5 - 0.9 - 1300 - 3.7 3.6 1.0 Sources: SOEP, Deutsche Bank Research -6 -5 -4 -3 -2 -1 0 4 6 8 9 11 13 15 17 Sources: SOEP, Deutsche Bank Research x-axis: Number of persons, million y-axis: EUR per hour Employment losses by level of minimum wage 10 0 20 40 60 West East Male Female Germans Non - Germans Aged 25 and under Aged 25 - 55 Aged 55 and older Unemployed > 1 year Without qualification Vocational qualification University degree Full time Part time Normal Fixed - term employees Part - time (≤ 20 hours) Temps Minijobs Midijobs Minor Civil service Private sector Red (green): share above (below) the German average of 13% % of respective group Sources: SOEP, Deutsche Bank Research Share of workers with gross wages below EUR 8.50 per hour 12 0 5 10 15 20 Germany West East Men Women Germans Non - Germans Younger people (15 - 25) Older people (55 - 65) Long term Without training* Vocational training* University* % of all members of the civil workforce (2013; *2012) Red (green): Share above (below) nationwide average of 6.9% Sources: Federal Employment Agency, Deutsche Bank Research Unemployment rates by criterion 13 Focus Germany 15 | June 4, 2014 Current Issues Introduction of minimum wage will halt increase in employment in 2015 In the short term, the elasticity should be markedly lower as corporate adjustments to the changes in cost structures will probably take place only relatively slowly and the protection against dismissal has to be taken into consideration. As the introduction of minimum wage comes as no surprise to companies, however, they are likely to take adjustment measures (reduced increase in employment) rather soon. With regard to the effects in 2015, we suppose that companies' reactions will correspond to the lower elasticity (roughly -0.2). The minimum wage is thus expected to have a negative employment effect of roughly 300.000 persons. The 4.1 million workers who remain employed for the time being will initially benefit from an average increase in gross hourly wages of close to 30%. As a result of the dismissal of employees with the lowest productivity, who in addition have fewer working hours, the average labour productivity and working time increase. This largely offsets the negative employment effect on GDP growth so that in 2015 GDP growth as a result of the introduction of minimum wage should be only 0.1 pp lower. The forecast of the labour market performance will change considerably as a result of the introduction of the minimum wage, however. Instead of expanding markedly again in 2015 as previously forecasted, employment growth should come to a halt – despite net immigration on an elevated level and solid economic growth. As some of those who lost their jobs are likely to withdraw from the labour market completely, the unemployment rate should remain constant at 6.6% in 2015 instead of falling further to 6.4%, in line with our previous forecast. The personnel costs of companies are expected to rise by roughly 2% as a result of the increase in labour costs. As the share of personnel costs amounts to 15%, total costs increase by 0.3% or EUR 17 bn. As long as the competitive situation permits, companies should try to pass on a largest possible share of the increased labour costs to prices. Especially for companies facing fierce competition, this should be difficult and thus in most cases, weigh on corporate earnings, not least because of weaker global demand and considerable international overcapacities. In this respect, smaller and medium-sized companies are facing bigger challenges than larger companies, as the bite of the minimum wage, the increase in labour costs and the share of personnel costs are higher. The passing-on of higher labour costs to prices should raise 2015 CPI by some tenths of a percentage point. The economic sectors where the reduction of employment is likely to be most pronounced are the service segment due to its higher wage sensitivity and in agriculture and retailing as a result of the huge bite of the minimum wage there. At over 10%, the largest increase in personnel costs will be in agriculture. In addition, personnel costs in retailing are likely to rise above average. The smallest increases in personnel costs are expected in the energy and financial sectors. As a result of the differing shares of personnel costs, which range from below 4% in the energy sector to 33% in corporate services, the effect on total costs varies. The highest price increases are thus expected in agriculture and the service sector. - 0.8 0.2 Employed individuals Hours worked Labour productivity Real GDP pp. vs base case scenario Sources: SOEP, Deutsche Bank Research Moderately negative effect of minimum wage on 2015 GDP growth 14 0 10 20 30 40 Energy Trade Total Manufacturing Transportation Construction Business services Sources: Deutsche Bundesbank, Deutsche Bank Research Personnel costs as % of overall performance Personnel cost share highest in services and construction sectors 15 0.0 0.5 1.0 1.5 2.0 2.5 3.0 0 2 4 6 8 10 12 Energy Financial sector Construction Manufacturing Services Transportation Total Trade Agriculture Personnel costs (left) Total costs (right) Cost increase , % Sources: SOEP, Deutsche Bank Research Personnel costs to rise most strongly in agriculture and retailing 16 Focus Germany 16 | June 4, 2014 Current Issues In the medium term, the negative labour-market effects will unfold with full force In the medium term, companies will probably try to replace the factor labour via capital, by buying abroad those intermediate products that have become more expensive domestically, and to accelerate integration in global value chains. 21 This should continue to speed up the shift in demand away from low-skilled workers to the highly qualified due to factor-distorting technological change and advancing globalisation and increase structural unemployment. In the medium term, the negative employment effect will probably increase to 800,000 persons. For the most unproductive members of the labour force it will be especially difficult to find follow-up employment due to their deteriorated integration opportunities. The increase in structural unemployment will have considerable negative fiscal effects. The structural unemployment in EU countries with minimum wages is not only higher but has risen more strongly than in countries without minimum wages since the mid-2000s. As part of the labour force likely to withdraw from the labour market completely, the potential workforce and thus potential growth will temporarily decline by a few tenths of a percentage point. This is happening at a time when potential growth is dampened by demographic change anyway. For the longer-term development, it is crucial how strong the increases in the minimum wage will be from the year 2018. If the average wage increase is established as reference point, this would, compared to the previous years when the lower wage groups tended to record below-average increases, result in a markedly stronger wage increase at the lower end of the wage distribution and increase the bite. Furthermore, the orientation of the minimum wage commission to the downstream tariff development as prescribed in the draft is critical: at the beginning of a downswing and especially in a recession, it increases the bite of the minimum wage further and thus has an additional negative effect on employment. Minimum wage: Turnaround of the successful labour market policy of the mid-2000s The introduction of a minimum wage is a complete turnaround of the labour market policy since the mid-2000s. Whereas via the creation of a low-wage sector and thus a diversification of wages at the lower end, the integration opportunities of problem groups were improved, the introduction of minimum wages stand in the way again. The number of unemployed has fallen from its peak of close to 5 million in 2005 to just below 2 million. The number of long- term unemployed has also fallen sharply. Problem groups will in the future be excluded from participating in the labour market. Just as critical is the planned restriction of atypical unemployment forms, which have strongly increased the external flexibility of companies in the last few years and made it possible for numerous difficult-to-place unemployed people to even (re)enter the labour market. For example, with regard to temporary work, over 50% were unemployed before the commencement of employment and roughly 10% had never been employed before. 22 21 As further evasive reactions, illegal work, unpaid overtime or (pseudo) self employment may be considered as further evasive reactions. It should frequently be difficult for the customs to detect these offences. 22 Gräf, B. (2014). Temporary work: Success story with an uncertain outcome . Deutsche Bank Research. Focus Germany. February 28, 2014. 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 10 20 30 40 50 60 70 80 90 Sources: SOEP, Deutsche Bank Research % yoy (mean of gross hourly wage increases since 2005) Higher increases in hourly wages in upper half of the distribution 17 0 2 4 6 8 10 12 2005 2013 with minimum wage without minimum wage Sources: European Commission, Deutsche Bank Research Structural unemployment lower in EU countries without minimum wage 18 Rates*, % *Unweighted mean of the EU countries - 30 - 20 - 10 0 10 20 30 07 08 09 10 11 12 13 14 Long - term unemployed workers Short - term unemployed workers Total % yoy (3M mov. avg.) Sources: Federal Employment Agency, Deutsche Bank Research Reduction of long - term unemployment becomes more difficult 19 Focus Germany 17 | June 4, 2014 Current Issues Nationwide minimum wage would go down the wrong track Instead of jeopardising the positive labour market development since the mid- 2000s by introducing a relatively high minimum wage, action should be taken to reduce structural unemployment, for example, by intensive support and training and further improve the quality of work. Here, measures are crucial to improve the individual upward mobility and thus, the transition from a relatively poorly paid and unstable form of employment to a more stable and better paid occupation. This could happen by expanding the further training of employees and providing more intensive support following the placing by the employment agency. A change of employer could under certain circumstances improve the individual position as well. 23 However, the measures presuppose that the labour market is indeed open to workers with relatively low productivity. The differentiation of the wage structure and the noticeable increase in movement processes since the mid-2000s have crucially contributed to the fact that opportunities to find an employment have improved, especially for problem groups. The minimum wage will probably have a major negative impact on the employment of problem groups in particular, make (re)entry into the labour market much more difficult and drive up structural unemployment with pronounced negative fiscal effects. Reducing the inequality of gross pay distribution will be achieved at the cost of squeezing out workers who are the least productive. Thus the targets of a fairer distribution and a reduction of burdens on public finances are likely to be missed completely. The inequality of gross wage distribution is already to a large extent reduced via the tax and transfer system, so that the inequality of net wage distribution is markedly lower. By international standards, German income inequality after tax and transfers is relatively low. In addition, it would be completely wrong to offset the negative employment effects via direct wage subsidies to companies. As in France, this would result in considerable rent-seeking effects and enormous fiscal costs. The creation of a state-directed "second" labour market is unlikely to be expedient, either. 23 Walwei, Ulrich (2014). Curing the sick man: The German labour market on the way to good health? IAB Current Issue. April 15, 2014. 0 5 10 15 20 25 Without qualification Vocational qualification University degree Total East DE West EUR per hour (median) Sources: SOEP, Deutsche Bank Research Gross hourly wages following course completion 20 0.25 0.30 0.35 0.40 0.45 1992 1995 1998 2001 2004 2007 2010 Post taxes and transfers Before taxes and transfers Gini coefficient Source: OECD Tax/transfer system reduces income inequality in Germany enormously 21 0.20 0.25 0.30 0.35 0.40 0.45 0.50 0.55 SI IS DK CZ NO BE SK FI AT SE LU HU DE CH NL KR FR NZ PL AU IT EE CA JP ES GR IE PT GB IL US RU TR MX CL Post taxes and transfers Before taxes and transfers Source: OECD Gini coefficient Income inequality after taxes and transfers relatively low in Germany 22 Focus Germany 18 | June 4, 2014 Current Issues There is still the possibility to stop the introduction of minimum wages or at least to alter them by reducing the level and differentiation between minimum wages by region and qualification level, to ensure that precisely the large number of people who already have fewer employment opportunities are not permanently denied access to the labour market. Regrettably, the chances of this occurring are likely to be low. Heiko Peters (+49 69 910-21548, heiko.peters@db.com) Focus Germany 19 | June 4, 2014 Current Issues Degree of intervention of minimum wage and necessary wage increases by structural features 23 Persons earning hourly gross wage below EUR 8.50 (% of the respective group) Average wage increases to the minimum wage (%) DE West East DE West East All 13 11 20 34 33 35 Form of employment Full - time 7 4 14 29 33 24 Part - time 25 23 37 36 33 46 Standard employment relationship 7 4 15 28 30 26 Fixed - term employees 25 23 33 36 36 36 Part - time (≤ 20 hours per week) 37 34 59 38 34 62 Temporary agency work 28 26 35 27 25 35 Minijob 61 58 79 42 37 80 Midijob 37 31 60 17 14 33 Marginally employed persons 58 55 76 44 39 73 Qualification No vocational qualification 28 26 40 37 36 42 Vocational qualification 13 10 24 32 3 2 33 University degree 7 6 9 36 34 40 Nationality Germans 13 10 20 34 34 34 Non - Germans 20 - - 32 - - Total unemployment > 1 year 26 20 36 33 29 39 Age groups ≤ 25 35 35 36 39 40 37 > 25 and < 55 11 9 18 31 30 33 ≥ 55 15 12 23 38 38 38 Gender Male 9 7 16 35 37 33 Female 17 15 24 33 32 36 Public sector 6 5 8 27 27 27 Private sector 16 13 25 35 34 36 Economic sector Agriculture 31 20 42 54 67 48 Energy 3 0 10 27 0 27 Manufacturing 10 7 20 31 29 34 Construction 7 5 13 36 36 36 Trade 25 22 37 35 33 39 Transport 16 13 23 31 30 34 Bank,Insurance 4 3 8 20 - - Services 11 10 15 30 31 29 Focus Germany 20 | June 4, 2014 Current Issues Continuation 23 Persons earning hourly gross wage below EUR 8.50 (% of the respective group) Average wage increases to the minimum wage (%) DEU West East DEU West East Company size ≤ 2,000 employees 16 13 23 35 34 36 > 2,000 employees 6 5 10 28 29 26 Federal state Baden - Württemberg 8 27 Bavaria 11 36 Hesse 9 31 Lower Saxony 12 41 North Rhine - Westphalia 12 32 Rhineland - Palatinate 11 28 Saarland 20 36 Schleswig - Holstein 15 45 Berlin 10 22 Brandenburg 18 42 Mecklenburg - Western Pomerania 26 39 Saxony 20 27 Saxony - Anhalt 18 52 Thuringia 23 35 Sources: SOEP, Deutsche Bank Research Focus Germany 21 | June 4, 2014 Current Issues Spotlight on Germany's export surpluses: Who's the "bad guy" in Euroland? — According to the critics of Germany's high current account surpluses, Germany is flooding Europe's southern periphery in particular with its goods and savings and has thus massively contributed to these countries' debt problems. — True, prior to the euro crisis Germany had registered current account surpluses vis-à-vis the EMU members which peaked at 4.5% of GDP. However, the current criticism focuses on the wrong country. — For one thing, Germany's current account surplus versus the EMU countries has already more than halved to 2% of GDP. For another, if one wants to "blame" one single party for the result of bilateral trade relations, China would be the more appropriate addressee. — Since 2010, China has recorded higher surpluses than Germany in bilateral trade with the southern peripheral countries of the euro area, which have declined only slightly since then. Also, given the similarity of the product ranges, China is an almost overwhelming competitor in third markets and is increasingly also crowding out local producers in their domestic markets. — Far-reaching reforms and adjustment processes to boost competitiveness are therefore all the more necessary in the southern periphery – and a narrowing of Germany's current account surplus will do little to achieve this. Germany with its back to the wall in public debate As a result of its persistent current account surpluses, Germany continues to be faced with strong criticism. Not only government officials, e.g. from France, Italy or the US and the European Commission, but also some members of the German government are pointing to macroeconomic imbalances which allegedly contribute to a destabilisation of the European and the global economy. 24 Moreover, the question is being discussed especially within the euro area – and with a great deal of polemics – to what extent Germany is partly responsible for the disastrous economic situation of several peripheral countries. 25 Among this circle of countries voices have grown louder recently blaming Germany for the debt crises, due to its high claims on foreign countries which result from large- scale trade surpluses, and denouncing Germany as the "bad guy of Europe". In Germany itself, the massive export surpluses – which have tended to rise further in the last few years – are largely seen as a sign of the enormous international competitiveness of German products, which also has a positive impact on our European trade partners as Germany imports some of the required inputs. Along these lines, Germany's surpluses are to be reduced on a longer-term horizon by means of higher domestic investment activity, which is also increasingly called for by some academic experts. 26 Whether or not Germany actually is the "bad guy" of the euro area is to be established in the following by means of an analysis of its trade surpluses versus the peripheral countries. We found that Germany still records a considerable but noticeably declining trade surplus with these countries, while 24 See European Commission (2014). European Economy. Macroeconomic Imbalances – Germany 2014. 25 See Peters, H., Schneider, S. (2013). Criticism of Germany's CA surpluses largely unfounded. Standpunkt Deutschland. December 12, 2013. Deutsche Bank Research. 26 See DIW (2013). Investitionen für mehr Wachstum – Eine Zukunftsagenda für Deutschland. In: DIW Wochenbericht, June 24, 2013. Deutsches Institut für Wirtschaftsforschung. External imb a lances A country's balance of payments provides the statistical records of all business transactions between its residents and foreigners within a certain period of time. The balance of payments is basically composed of the current account (movements of goods and services) and the capital account (movements of capital) and is, by definition, always in equilibrium as each transfer of goods is offset by the respective transfer of capital (double - entry accounting). When economists talk of external imbalances, they usually refer to a country's current account. A country's cumulative current account surpluses therefore correspond to its outstanding claims vis - à - vis its trade partners, whereas cumulative deficits represent debt owed abroad . Simplified depiction of the balance of payments Balance of payments Current account Trade balance Services balance Income balance Transfer balance Balance of capital transfers Capital account Capital account (direct investment, securities tr ansactions) Foreign - exchange account / changes in forex reserves Errors and omissions Source: Deutsche Bank Research - 2.0 0.0 2.0 4.0 6.0 8.0 10.0 - 50 0 50 100 150 200 250 00 01 02 03 04 05 06 07 08 09 10 11 12 13 EUR bn (left) % GDP (right) Germany: Current account 1 EUR bn (left), % GDP (right) Source: Eurostat Focus Germany 22 | June 4, 2014 Current Issues the countries of the periphery are increasingly registering trade deficits versus non-European partners. A particular case in point is China, which since 2010 has achieved larger surpluses in trade with the periphery than Germany has. In contrast to Germany, however, direct product competition between the GIPS countries and China is much more intensive, which makes the high and widening trade deficits particularly problematic. Hence, competition is not only heating up in third markets, but the peripheral countries are also increasingly being crowded out of their domestic markets by Chinese exports. External imbalances: Massive changes First and foremost, it should be noted that external imbalances are fairly common and, moreover, do not represent a problem per se if they go hand in hand with the opening of an economy and thus are a reflection of dynamic yet temporary deviations from an overall economic equilibrium. Accordingly, there have always been surpluses and deficits in trade balances, and they will continue to exist in the future. Current account deficits and potentially CA surpluses as well only turn into problems if the underlying imbalances regarding costs, consumption and savings are not reduced. Persistent external deficits increase a country's external debt, exacerbate existing national weaknesses and render an economy more vulnerable, for instance via fluctuations of private capital inflows, which makes financing CA deficits more difficult, as witnessed in Greece. 27 What is striking is the enormous increase in global external imbalances prior to the global financial crisis. Global current account deficits widened from just under USD 600 bn to roughly USD 1,600 bn between 2001 and 2008. Following a strong decline in the imbalances to less than USD 1,000 bn in 2009 as a result of the global economy's massive downturn, the sum of the world's CA deficits rose again in the following years and currently stands at approx. USD 1,200 bn. If one looks at the development of current account balances measured by GDP within the European Monetary Union, a very mixed picture emerges. Prior to the financial crisis it was the peripheral countries in particular, such as Greece, Portugal and Spain, which recorded massive CA deficits, peaking at 15% of GDP in Greece and at roughly 10% in both Spain and Portugal. The incentives underlying such wide deficits were based on favourable funding conditions in the peripheral countries. A combination of low nominal interest rates in the monetary union and high inflation rates led to substantially lower real interest rates in the periphery than in Germany. However, since 2007/08 these countries' annual current account deficits have been on the decline and have meanwhile either disappeared or even turned into slight surpluses. Apart from the successful export sectors this is due mainly to the slump in import demand in the course of the deep recession. By contrast, Germany's current account surpluses have steadily grown since 2009 and in 2013 reached 7.5% of GDP. These developments in the member states have led to a situation where the EMU area's CA balance measured against GDP in aggregate was subject to only very slight fluctuations and lately even registered a surplus thanks to the improvement in the periphery. The regional structure of Germany's current account surplus has changed considerably over the last few years. Germany's persistently high surpluses are increasingly due to trade with countries outside the monetary union. While the 27 See Weidmann, J. (2014). Außenwirtschaftliche Ungleichgewichte im Euro-Währungsgebiet. Speech on the occasion of the Kieler Konjunkturgespräche. Kiel Institute for the World Economy, and Raschen, M. (2014). The problem of external deficits KfW Economic Research. Fokus Volkswirtschaft. -140 -120 -100 -80 -60 -40 -20 0 20 40 60 2001 2003 2005 2007 2009 2011 2013 Q3 Greece Ireland Italy Portugal Spain Germany % GDP Net external position 2 + = Net external assets, - = Net external debt Sources: Federal Statistical Office, IMF - 2500 - 2000 - 1500 - 1000 - 500 0 500 1000 1500 2000 2500 99 01 03 05 07 09 11 13 Japan & Germany USA China & Emerging Markets Oil - exporting countries Other industrial countries Other countries Trade balance 3 USD bn, annualised Source: IMF - 20 - 15 - 10 - 5 0 5 10 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Ireland Spain Greece Portugal Italy France Germany EMU Current account balances in EMU 4 % GDP Source: Eurostat Focus Germany 23 | June 4, 2014 Current Issues surpluses in trade with EMU member states contributed almost 70% to Germany's CA surplus in 2009, the figures had fallen to only about 30% in 2013. A sober look at the data ... A look at bilateral trade flows between Germany and the individual peripheral states allows a more differentiated assessment of Germany's CA surpluses. At this juncture, an analysis of the trade balance is sufficient as not only the services balance but also the income account (earned and investment income) as well as current transfers are of lesser importance for Germany's current account, and trade balance and current account developments only differ slightly in the peripheral countries. Moreover, the development of the trade balances vis-à-vis Germany is very similar to that of the countries' current account balances. In the following analysis, we include the southern peripheral countries of Greece, Italy, Portugal and Spain und refer to them as the GIPS countries. We deliberately left out Ireland, which is sometimes included in the peripheral countries, because of its special situation within this group. For instance, Ireland – unlike the GIPS countries – boasts a trade surplus with Germany. Since 2000 the GIPS countries have narrowed – in some cases drastically – their widening trade deficits vis-à-vis Germany. This applies particularly to Spain, Portugal and Italy, whose trade deficits with Germany narrowed by more than 70%, while the bilateral Greek-German trade deficit "only" halved. 28 While in the case of Greece declining imports from Germany were the sole driver of the bilateral trade balance improvement (which even overcompensated the drop in Greek exports to Germany), the narrowing of bilateral trade deficits in the remaining GIPS countries was driven by both decreasing imports and higher exports. For instance, Spanish exports to Germany rose by an average 4% p.a. between 2009 and 2013, whereas Spanish imports from Germany shrank by approx. 5% each year. Imports from Germany were down in almost all peripheral countries, which can be explained by weak domestic demand in those countries in the course of their economic crises, while higher exports were attributable to Germany's robust business activity. In addition, the sharp drop in unit labour costs from their peak in 2009 has probably contributed to the solid export performance. Unit labour costs have fallen by 10% in Portugal and by 7 ¾% in Spain. The reasons behind the disappointing export performance in Greece – despite the fact that, according to the European Commission, unit labour costs fell by over 13% – are probably rooted in the goods structure. One-third of all exported goods are agricultural products. As these goods usually have a lower price- income elasticity, they hardly benefitted from rising incomes in Germany and lower costs. Exports from the other peripheral countries react much more sensitively in this respect, as they boast significantly higher shares of industrial higher-quality products such as motor vehicles (e.g. Spain and Portugal). Hence the share of machinery and transport equipment in exports to Germany is over four times higher in Spain and even five times higher in Portugal than in Greece. ... reveals other drivers, too So is Germany the only villain and responsible for the difficulties encountered by the peripherals? Probably not. In all four GIPS countries there are high structural trade deficits versus the traditional energy suppliers such as Russia and Saudi 28 See Peters, H. (2013). Decline in bilateral trade imbalances: Change of drivers In: Focus Germany, October 1, 2013. Chart of the month. Deutsche Bank Research. - 3 0 3 6 9 95 00 05 10 EMU Non - EMU Germany: Current account 5 % GDP Source: Federal Statistical Office - 250 - 200 - 150 - 100 - 50 0 50 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Current account Trade balance GIPS: Trade balance & current account 6 EUR bn Sources: IMF, National central banks - 60 - 50 - 40 - 30 - 20 - 10 0 10 00 01 02 03 04 05 06 07 08 09 10 11 12 13 ES IT PT GR IE EUR bn Sources: IMF, Deutsche Bank Research Trade balance vis - à - vis Germany 7 Focus Germany 24 | June 4, 2014 Current Issues Arabia, but also vis-à-vis several North African states, which is attributable to historically developed structures. Besides, direct geographical neighbours frequently contribute to the deficits. For instance, more than two-thirds of Portugal's overall trade deficit has its roots in trade with Spain. China frequently overlooked Almost unnoticed, China has turned into a major supplier for the peripheral countries. To be sure, exports by the GIPS countries to China have grown disproportionately strongly in the past few years. Between 2000 and 2013 they rose by roughly 13% while total exports only grew by 4%. However, the share of exports from the GIPS countries to China only amounts to slightly more than 2% of total deliveries. Considerably more important for the GIPS countries, however, are imports from China which expanded by almost 10% in the period mentioned (compared with just under 3% for all the imports of the GIPS countries), so the share of imports from China grew two and a half times to almost 6%. As the GIPS countries' imports from China were three times as high on average as their exports to China, the bilateral trade deficit has widened enormously since 2000. From a GIPS point of view, though, trade with Germany has been extremely positive. Exports from the GIPS countries to Germany rose by 2.3% p.a. between 2000 and 2013, i.e. more strongly than imports from Germany, which added 1.5% p.a. Accordingly, the share of imports from Germany and of exports to Germany in total GIPS imports and exports declined by about 2.5 percentage points to approx. 13.5% and 11.5%, respectively. GIPS: Higher deficits in trade with China than with Germany Since 2010 already, China has achieved higher surpluses in trade with the peripheral countries than Germany has and has thus probably become the main problem for the crisis countries. 29 Germany's trade balance with the four GIPS countries had fallen to EUR 15 bn by 2013, while China's surplus vis-à-vis these countries was nearly twice as high (just over EUR 26 bn). Among the GIPS countries, bilateral trade with China is particularly important for Spain. In trade with China, Spain in 2013 registered a deficit of EUR 10.5 bn which accounted for almost half of Spain's overall trade deficit; the deficit vis-à-vis Germany came to just under EUR 7 bn or approx. 30% of the total. And even Ireland, which recorded a surplus of a good EUR 2 bn in trade with Germany last year, regularly has a deficit in trade with China, which in 2013 amounted to just under EUR 1 bn. Chinese exports: A growing problem for the periphery The fact that Germany's trade surpluses with the GIPS countries have fallen dramatically as a result of the economic slump in these countries, while the Chinese surpluses only declined slightly over the medium term, could be an indication of a fundamental difference in their goods structure. While imports from Germany are mainly capital goods and inputs, China mostly delivers consumer goods. Hence German and Chinese exports to the GIPS countries differ in terms of their potential competition to domestic production in the respective countries. 29 See Nauschnigg, F. (2013). Leistungsbilanzungleichgewichte im Euroraum. China als Hauptproblem für Krisenländer. In: Wirtschaftsdienst. Vol. 12. 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% GR ES PT IT Food Crude materials Mineral fuels Animal & vegetable oils and fats Chemical products Manufactured goods Machinery & transport equipment Miscellaneous manufactured articles Share, % Source: UN Structure of goods exports to Germany 8 - 12 - 10 - 8 - 6 - 4 - 2 0 2 4 6 GR IT PT ES Imports Exports Trade with Germany (2009 - 2013) 9 Sources: IMF, Deutsche Bank Research Average annual change, % - 60 - 50 - 40 - 30 - 20 - 10 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 DE CN RU EUR bn Sources: IMF, Deutsche Bank Research GIPS trade balance vs Germany, Russia & China 10 Focus Germany 25 | June 4, 2014 Current Issues While German imports are to a certain degree essential for the economies of these countries, as they cannot be produced by local industry but are of decisive importance for its future growth potential, this is only partly true of Chinese goods. These goods are mostly substitutes for local production in the GIPS countries. Textiles are an impressive case in point: textile imports from China virtually exploded between 2000 and 2011 (Greece: +372%, Portugal +706%, Spain +635% and Italy +485%), and in the same period local production in these countries was dealt a severe blow (Greece -55%, Portugal -11%, Spain -25% and Italy -10%). In this context, it must be noted though that this is not attributable to China alone and that the dramatic increase in textile imports from China started from a very low level. Similar trends were witnessed in other sectors, too, albeit with sometimes marked differences between individual countries. This applies for instance to electrical engineering but also to chemical and plastic products. 30 A particularly significant factor in this context is the fact that once production has been abandoned it is extremely difficult to restart it at a later date. 31 This crowding-out process probably contributed to the drop in employment in the GIPS countries. The size of this effect, however, is hard to gauge given the in some cases dramatic cyclical employment losses as well as the deep structural changes, as witnessed for instance in the Spanish construction industry. In addition to the fact that local production in the European periphery is crowded out, Chinese products have become increasingly important and often overpowering competitors in third markets due to the similarity to the GIPS countries' range of goods. This has noticeably dampened the GIPS countries' export performance and contributed to widening trade deficits. 32 Conclusion: When looking for reasons, blinkers are not very helpful Over the last few weeks and months, public debate about the debt crisis in the peripheral countries and Germany's export surpluses has been characterised mainly by one-sided accusations by the parties involved and less by economic facts. In most cases, the role played by China was ignored. Since 2010, China has achieved higher, and growing, surpluses in trade with the peripheral countries than Germany has. In addition, Chinese products are fierce competition in third markets for the range of goods produced in the peripheral countries and also crowd out local production, especially in the consumer goods segment. Hence, in light of the pressure exerted by the Chinese competition, it is all the more important for the countries of the periphery to pursue far-reaching reforms and adjustment processes in order to achieve a sustainable increase in competitiveness. In this context, reducing the German current account deficit will hardly help. Bernhard Gräf (+49 69 910-31738, bernhard.graef@db.com) Martin Iseringhausen (martin.iseringhausen@uni-muenster.de) 30 See Mikkelsen, U. and Perez Ruiz, E. (2012). The Trade Impact of China on EMU: Is It Even Across Members? IMF Working Paper. 31 See Heymann, E. and Vetter, S. (2013). Europe's re-industrialisation: The gulf between aspiration and reality. In: EU Monitor, November 4, 2013. Deutsche Bank Research. 32 See Benkovskis, K. et. al. (2013). Crowding-Out or Co-Existence? The Competition Position of EU Members and China in Global Merchandise Trade. ECB Working Paper Series. See Chen et al. (2012). External Imbalances in the Euro Area. IMF Working Paper. 0 5 10 15 20 25 30 35 40 45 50 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Trade with Germany Trade with China Spain: Trade balance 11 Contribution to trade deficit, % Sources: IMF, Deutsche Bank Research - 60 - 50 - 40 - 30 - 20 - 10 0 10 00 01 02 03 04 05 06 07 08 09 10 11 12 13 ES IT PT GR IE EUR bn Sources: IMF, Deutsche Bank Research Trade balance vs China 12 0 5 10 15 20 25 95 97 99 01 03 05 07 09 11 GR ES PT IT Textile industry 13 Source: Eurostat Share of gross value added in manufacturing, % Focus Germany 26 | June 4, 2014 Current Issues European Elections: Implications and trends The European Elections showed the conservative EPP winning over the socialdemocratic S&D with a lead of 25 seats (214 vs. 189). The conservatives suffered a loss of around 20% of their share compared to 2009, though. The Liberals came in as third strongest political group followed by the Greens. The majority dynamics will not allow decision-making without involvement of the two large groups, the conservatives and the social democrats, in the EP. Such a de facto grand coalition has been well-proven in the last term with the two parties to collaborate in 70% of the roll-call votes in the parliament. It will allow to prevent any gridlock resulting from a more fragmented and more polarised assembly. It also follows a "centrist convergence" in politics that can be observed in some EU member states with a broad consensus on fiscal and economic issues and social welfare. The average voter turnout of 43.1% is more or less unchanged compared to 2009. This has dashed hopes of the EP to obtain greater legitimacy through the new electoral procedure, i.e. to present lead candidates for the political families who should stand for next Commission president. It will not help the EP to strengthen its role in the European institutional triangle of Commission, Council and EP. On a member states basis, though, voter turnout has been higher in a number of countries such as Germany, France, Greece or UK (see chart). This can obviously be traced to a higher mobilization of populist parties. Populist parties on the rise Most populist parties could successfully position themselves with particularistic opinions along national eurosceptic narratives and clear-cut counter-positions against their national governments. Populist eurosceptic parties substantially increased their share in seats compared to the 2009 elections. Depending on the definition they achieved around 20% across all political camps. The strong victory of the right-wing Front National in France and UKIP in the UK has attracted public attention – and distracted most observers from the fact the results of most other populist parties remained at the lower end of pre-election polls. It remains particularly doubtful whether eurosceptic parties will be able to keep their unity when being required to cooperate (see box). Moreover, the improved showing of the populist parties will affect national-level politics and, in turn, the position of governments towards Brussels. Where mainstream parties have the most at stake and populist parties consolidated their positions domestic tensions are likely to increase. Reform processes already under way or envisaged will be put into question and structural reforms and consolidation will be delayed. Election results in France will prevent constructive work on the euro area's institutional framework. Given that UKIP is the strongest party in the UK, relations between the UK and its EU partners are likely to become even more difficult. The increase of populist votes will fuel the debate on a potential competence review of the European Union which is already on the political agenda of the next legislative period. Established parties which consider themselves as "pro- European" will have to pursue a tightrope-act between respecting the constructive criticism from their electorates on the one hand while keeping distance from populist forces on the other hand and respecting the interests of their euro area peers. Three factors which deter mine the future power of populist parties 2 National feedback effects are certain. The strong results of populist forces in some countries could lead to feedback effects on national political attitudes. Thus, they can be expected to use speeches in the plenary primarily to raise their profile in their home country which is certain to have repercussions on the national level. In respect of future intergovernmental negotiating rounds – say on an overhaul of the ESM or EU treaties – this could lead to exten sive opt - out clauses, delays in the negotiations and thus to inconsistent negotiating results. Successful formation of a political group: Highly likely. In the EP, creation of a political group needs a quorum of least 25 MEPs from 7 countries. It remains to be seen whether the right - wing French Front National will be able to unite parties from six other countries. Both UKIP and the German AfD have already declared that they would not see any possibility to cooperate with a possible new right - wing formation . Also, it remains to be seen what will be the future of the current eurosceptic political groups European Conservatives and Reformers (ECR, including inter alia Forza Italia) and Europe of Freedom and Democracy (EFD, including inter alia Danish People’s P arty, UKIP and the Finns Party). If some of their member parties should decide to join the group around the Front National both ECR and EFD could fall below their quorum. Unity in policy positions: Doubtful. Given their fragmentation and lack of common po litical narratives, the low consensus in the political group and weak party discipline, influence in the decision - making process and the scope of legislation is likely to be limited, though. 60.0 58.2 48.0 45.9 43.5 43.1 37.0 36.0 27.1 0.0 20.0 40.0 60.0 80.0 IT GR DE ES FR EU - 28 NL UK CEE 8 2014 2009 EP elections: Low turnout, but large cross - country differences 1 Source: European Parliament Focus Germany 27 | June 4, 2014 Current Issues Suspension of austerity While the European Parliament’s capacity to act will not be at stake, the election results could imply that market-friendly orientation in some dossiers could come under pressure given the relative losses of the conservatives and liberal forces and the stronger influence of the social democrats and left-wing parties. Particularly the trade agreements under negotiations such as the T-TIP between the EU and US are a case in point. The stronger share of left forces in the plenum could also lead to a stronger positioning of the Parliament when it comes to the further development of mechanisms of economic surveillance: The Parliament could advocate even more tolerance in the interpretation of fiscal deficits within the excessive deficit procedure – and could, for instance, claim that public spending on investment that is assumed to be growth stimulating could be excluded from the calculcations of public deficits. Moreover, the parliament could also raise structural issues and revive former proposals such as a European unemploy- ment insurance or a partial mutualization of public debt within a debt redemption fund or a eurobills scheme. While the Parliament does not have the formal right of a legislative initiative to change the respective acts of secondary law it could politically support future initiatives by single member states in the Ecofin Council. Germany: Continued support for the governing grand coalition In Germany Chancellor Merkel’s CDU/CSU came in at 35.3% and became the strongest party but suffered losses – minus 2.6 pp compared to the 2009 EP elections and minus 6.2 pp compared to the federal elections in 2013 – which are mainly attributable to the Bavarian party wing CSU. Despite the eurocritical tone in the CSU campaign, the main beneficiary was the anti-Euro party AfD. The SPD scored slightly above expectations (27.3%) and much better than the mere 20% it achieved in 2009. The fact that Martin Schulz (currently EP president) was running as the European Social Democrats’ candidate for President of the Commission has certainly helped to garner votes especially EPP ECR EFD Others Green Left S&D Greens ALDE 35 194 31 32 56 275 85 58 3 Source: European Parliament 35 194 31 32 56 275 85 58 Seats in European Parliament 2009 3 EPP ECR EFD Others Green Left S&D Greens ALDE 42 190 105 38 46 213 64 53 Source: European Parliament 4 Seats in European Parliament 2014 0 5 10 15 20 25 30 35 40 Total 18 - 29 yrs. 30 - 44 yrs. 45 - 59 yrs. 60 yrs. and above Source: Forschungsgruppe Wahlen Age distribution of SPD voters 5 Election result among age cohorts (%) Focus Germany 28 | June 4, 2014 Current Issues from left-leaning voters. Schulz’ candidacy might have also helped to increase voter turnout compared to 2009 – 48.0% vs 43.4%. However, the fact that there were also municipal elections in 10 out of 16 Länder might have played an important role as well. According to the polls, 54% of the voters casted their votes on the grounds of national politics, only 40% because of European policy issues. In this regard it should not come as a surprise that the SPD could increase their share among the 60+ voters by 10 pp to 34% (CDU/ CSU lost in this age group but still leads with 42%). The AfD scored in line with optimistic forecasts and received 7.0% of the votes. The fact that the AfD could increase its share compared to the last federal elections (+2.3 pp) appears natural since it is the only party with an agenda almost exclusively focused on an issue with a European dimension, i.e. the dissolution of the Eurozone in its current composition. The representation in the EP will give the party an ideal platform future media campaigns towards their German electorate. The good result might improve the AfD’s chances to gain seats in the regional elections in three German states later this year. As Germany has 96 seats in the EP, the number of each party’s seats is roughly equivalent to its vote share. As the AfD entered into a parliament for the first time of its existence voter migration in Germany merits a closer look. Although the CDU/CSU was able to maintain its position as the strongest party in Germany, they still suffered heavy losses and lost votes to all parties but the liberal FDP (small gain of 20.000 votes). The conservative party lost 510,000 voters to the Alternative for Germany (AfD), compared to the parliamentary elections of the Bundestag 2013. Also the social democratic SPD benefited greatly from the conservative camp. They won 340,000 votes from former CDU/CSU voters. In a press conference the day after the European Elections, Chancellor Merkel explicitly regretted the election success of right-wing populist forces. The best remedy, according to Merkel, would be (1) growth, (2) competitiveness and (3) jobs in order to reestablish trust into politics. At the same time, Merkel explicitly ruled out any cooperation with the AfD – also in the long run. As a reaction some second and third row politicians from the CDU have proposed to refrain from any ban of thinking and consider the conditions what would have to be met for a cooperation in the long run. Others such as the Prime Minister of the State of Hesse (Volker Bouffier) said that the AfD should be carefully watched. Peter Tauber, the CDU’s general secretary in turn emphasized that the AfD would suffer from the same fate such as the Pirates party: Internal conflicts, fragmentation, sinking into insignificance. In any case the internal debate on how to deal with the AfD will gain momentum in the upcoming months – this will Sources: ARD and Infratest dimap 0 1 2 3 4 5 6 7 8 9 Total 18 - 29 yrs. 30 - 44 yrs. 45 - 59 yrs. 60 yrs. and above Source: Forschungsgruppe Wahlen Age distribution of AfD voters 6 Election result among age cohorts (%) 0 100 200 300 400 500 600 German voter migration to the AFD 7 in thousands of votes - 1500 - 1000 - 500 0 500 1000 CDU/CSU SPD FDP Left Greens AfD CDU/CSU FDP SPD Greens Left AfD German voter migration from and to the parties 8 in thousands of votes Sources: ARD and Infratest dimap Focus Germany 29 | June 4, 2014 Current Issues be particularly the case if the AfD campaigned with non-european but local issues in the upcoming state elections. We do not expect a change in Germany’s European policy course despite the good showing of the AfD. Chancellor Merkel and Finance Minister Schäuble have recently re-stated that the German government would like to see a further strengthening of eurozone governance incl. the bilateral reform agreements and some sort of EU finance minister. The government also supports a review of the balance of powers between the EU institutions and the member states – though rather limited in scope and far away from what is being discussed in the UK, for example. Next steps The elections will be followed by tough bargaining between parties and their prospective political groups. This will also be the time to see whether a new far- right grouping under the French FN leader Marine Le Pen will be set up. 24 June is the deadline for political groups to submit the list of MEPs. On the European Council on 26-27 June, EU leaders could decide on their proposal for EC presidency, though this decision is likely to be part of a package on the appointment for other top jobs on EU level. After Chancellor Merkel has confirmed her political support on 1 June, Jean-Claude Juncker is set to be the favourite candidate for the President of the European Commission. The bargaining process of the upcoming weeks could also include talks on potential package deals regarding other personnel matters such as (1) the President of the European Council, (2) High Representative for Foreign affairs and (3) possible the next president of the Eurogroup – although formal decisions on the latter posts will not be taken. After having elected its own president the EP has scheduled the hearing of the Commissioner candidates in the EP plenary – provided there has been a nominee appointed by the EU leaders. On 16 July the Parliament will prospectively vote on the candidate for the office of the President of the European Commission. An absolute majority is necessary. The current Commissioners will provisionally remain in office until the next Commission is confirmed. Nicolaus Heinen (+49 69 910-31713, nicolaus.heinen@db.com) Focus Germany 30 | June 4, 2014 Current Issues Chart of the month Europe's consumers more optimistic but wide gaps remain Reports that consumer confidence in the euro area in May reached its highest level since end-2007 gave rise to expectations that households have overcome the crisis. In fact the surveys suggest that the increase in private consumption accelerated further in early 2014. The first year-over-year increase since Q3 2011 was registered at the end of 2013 (0.3%). The uptrend in consumer confidence is broadly based, with confidence having declined in only two of the 18 euro-area countries compared to last year. Pronounced increases from low levels were registered especially in the crisis- ridden countries. Consumer confidence in Spain reached its highest level since October 2001, and in Italy since June 2002. In Germany, the last higher reading was in July 2011. EMU consumers also showed greater optimism when it came to the components of consumer confidence – especially regarding general business activity and unemployment over the next 12 months. The gap between the confidence levels registered in Germany and EMU as a whole did not narrow further recently, however, as sentiment stagnated for instance in France. Overall, though, the upturn in confidence seems somewhat exaggerated. Consumer confidence is represented in the form of a diffusion index, with consumers reporting whether their situation has improved, deteriorated or remained unchanged. A marginal improvement, provided it is widespread, would therefore lead to a marked increase in the index value. In many euro-area countries, the income and labour market situation does not suggest that households can boost their consumption considerably in 2014. This is due to high and only slowly falling unemployment, strict wage moderation designed to regain competitiveness, and the deleveraging required for many households. For these reasons, a large part of the consumption increase in the euro area – we expect +0.5% – this year will be down to Germany (+1.3%). In light of their share of almost 30% in total consumption, Germany's consumers are likely to contribute more than 50% of consumption growth. Oliver Rakau (+49 69 910-31875, oliver.rakau@db.com) -100 -80 -60 -40 -20 0 20 40 99 01 03 05 07 09 11 13 Min EMU Max Germany Balance of opinion, % Source: EU Commission EMU consumer confidence: Broad based upward trend DX -10 0 10 20 30 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Difference between German and EMU confidence level, %-points Sources: EU Commission, Deutsche Bank Research Sentiment convergence has stalled lately DX Focus Germany 31 | June 4, 2014 Current Issues Chartbook – Total economy — The German economy started strongly into 2014. At 0.8% qoq GDP growth was the highest since Q1 2011 and doubl ed Q4’s rate. Due to the mild winter that benefitted construction investment (+3.6% qoq) the rate overstated the underlying momentum which should be about 0.4% qoq – the average of the last five quarters. This is higher than Germany’s growth potential of about ¼% that is currently surpassed also because of high immigration. — Only the domestic economy (+ 1.7% - p.) contributed to Q1 GDP growth, especially private consumption and construction (each 0.4% - p.). In contrast, net exports were a drag on growth ( - 0.9% - p.) due to weak exports. This is the opposite growth composition from last quarter when only export s supported growth. Over the last five quarters, however, the current strength of domestic demand is obvious. It contributed on average 0.5% - p. while net exports were a small drag on average ( - 0.1% - p.). — In Q2 there should be some payback for GDP growth (+0 .2% qoq) as construction investment normalizes. This was already heralded by the decline of construction spending in March. In general, however, sentiment indicators point to very solid (domestically driven) growth. Despite its decline in May the ifo index remained on an elevated level mainly in the domestically driven construction and retail sector. The services PMI even rose further in May. In contrast, the ifo of the more export driven manufacturing was at a moderate level and the manufacturing PMI even declined markedly. This points to a muted outlook for exports at the current juncture. — Thanks to average quarterly growth rates of 0.4% qoq , GDP should expand by 1. 8 % in 2014. Domestic demand should be the major growth pillar, just like in 2013. Private co nsumption (+1.3% yoy) should provide impetus thanks to the positive labour market dynamic. Construction spending and investment in machinery & equipment should grow at a healthy pace, in part thanks to strong Q1 rates. Net exports are set to be a drag on o verall growth as strongly rising imports more than make up for only moderately improving exports. Sources: Federal Statistical Office, Markit, ifo, Deutsche Bank Research - 2 0 2 4 6 - 1 0 1 2 3 10 11 12 13 14 % qoq (left) % yoy (right) Real GDP growth - 6 - 4 - 2 0 2 4 6 05 06 07 08 09 10 11 12 13 14 15 Private consumption Government consumption Machinery & equipment Construction Net - trade GDP (% yoy) Contribution to real GDP growth (% - points) 70 80 90 100 110 120 130 08 09 10 11 12 13 14 Climate Situation Expectations ifo index - total economy (2005=100) 30 40 50 60 70 08 09 10 11 12 13 14 Composite Services Manufacturing Purchasing manager index Focus Germany 32 | June 4, 2014 Current Issues Chartbook – Foreign trade — Foreign trade was weak in 2013. Goo ds exports fell 0.2% and imports by a good 1%. Around mid - 2013 the trough was reached and a moderate recovery started. In March 2014 German exports were up 3.1% yoy (3M mov. avg.) and imports by 4.5%. Due to the still weak global trade (March: +1.8% yoy) a nd comparably strong domestic demand in Germany, imports have risen more strongly than exports lately. Thus, the trade balance fell from still EUR 17.6 bn in December to nearly EUR 15 bn in March. — The improvement in exports is regionally broad - based. Expor ts to EMU were up 1.9% yoy (export share 2013: 37%) as the region emerged from recession. US exports (share: 8%) even gained 6.9%. Exports to Asia were up 4.5% yoy (share: 16%). In case of Asia and the US, export growth has levelled off, while exports to E MU have lost momentum largely due to the weak March. — It is foremost the recovery in automobile exports that drives the modest increase (Mar.: +7.0% yoy). Especially as European car market is driven by pent - up demand after years of restraint domestic demand . By contrast, the other German export engine, mechanical engineering, was stuttering ( - 0.4% yoy). Foreign demand in the metal industry ( - 6.4% yoy) remained weak. — Leading indicators paint a mixed picture for exports . While ifo export expectations recovered in May, PMI new export orders point to muted export demand growth. In addition, US and Chinese data was mixed to weak lately. While the US weakness was probably largely weather related, Chinese data remains rather muted . Sources: Federal S tatistical Office, Markit, ifo, Deutsche Bank Research, CPB 0 5 10 15 20 25 30 35 40 45 50 - 30 - 20 - 10 0 10 20 30 40 08 09 10 11 12 13 14 Trade balance (right) Exports (left) Imports (left) Merchandise trade % yoy, 3M mov. avg. (left); EUR, bn (right) - 40 - 30 - 20 - 10 0 10 20 30 40 08 09 10 11 12 13 14 Total Asia USA EMU German exports by region % yoy, 3M mov. avg. - 20 - 10 0 10 20 30 40 50 10 11 12 13 14 Chemicals Elec. engineering Mech. engineering Metals Automobile Exports by sector % yoy, 3M mov. avg. - 2 - 1 0 1 2 - 30 - 20 - 10 0 10 20 30 10 11 12 13 14 German merchandise exports (left) Global trade (left) Manufacturing PMI - new export orders (right) ifo export expectations (right) Exports and leading indicators % yoy, 3M mov. avg. (left); Standardized values (right, 4M lead) Focus Germany 33 | June 4, 2014 Current Issues Chartbook – Industry — The German industry increasingly benefits from the recovery of the global economy over the course of 2013. Industrial production as well as new orders (partly due to b ig - ticket orders) recovered strongly and were up 4.9% and 5.4% yoy in March (3M mov. avg.). Growth of new orders has moderated again lately as the intake of big - ticket orders normalized. Thanks to the mild winter construction supported the recovery of indu strial output over the last few months. This effect should dissipate in Q2. — The ifo index and t he PMIs point to a further improvement of industrial production with (so far limited) downside risk s to foreign demand . — Of the largest industrial sectors the aut omobile industry should achieve the highest growth rate in 2014. We expect an increase of 5% in real terms. The essential driver behind this is the recovering car demand in Western Europe, where German manufactures have a market share of about 50%. In mech anical engineering , we see a production increase of 2%. The sector should benefit from foreign demand and the increasing inclination of domestic companies to invest. However, Q1 2014 was quite weak. Domestic production in the electrical engineering industr y could grow 3.5%. For the metal indus try we even expect a 4% increase . The chemical sector could see growth of 1%. Q 1 resu lts in the chemical industry disappoint ed ; however, we assume a moderate recovery of orders and production in the course of 2014 . The food industry – a very stable sector as it is – could see production stagnat ing in 2014. All told, the manufacturing output should expand by about 4% in real terms in 2014 (after - 0.1% in 2013) . Sources: Federal Statistical Office, ifo 60 70 80 90 100 110 120 130 -40 -30 -20 -10 0 10 20 30 40 08 09 10 11 12 13 14 Industrial production (left) New orders (left) ifo manufacturing expectations (right, 4M lead) Industrial production, new orders & ifo expectations % yoy, 3M mov. avg. (left); index (right) -50 -40 -30 -20 -10 0 10 20 30 40 08 09 10 11 12 13 14 Total Domestic Foreign (EMU) Foreign (Non - EMU) New manufacturing orders by region % yoy, 3M mov. avg. 60 70 80 90 100 110 120 130 08 09 10 11 12 13 14 Automobile industry Chemical industry Electrical engineering Mechanical engineering Metal industry Production of largest industrial sectors (2010=100, sa) 50 60 70 80 90 100 110 120 130 08 09 10 11 12 13 14 Automobile industry Chemical industry Electrical equipment Mechanical engineering Metal goods ifo business expectations of the largest industrial sectors (2005=100) Focus Germany 34 | June 4, 2014 Current Issues Chartbook – Domestic economy — The cyclical recovery since spring 2013 has translated into upward momentum on the labour market towards the end of 2013. In May the labour market disappointed due to the unexpected increase of the number of unemployed (+2 4,000). This was, however, caused by the spring rebound taking place in March and April thanks to the extremely favourable weather and the sub - par relief from labour market policies . The number of unemployed fell by 4 ths. mom on average over the last thre e months and stands markedly below its previous year’s level. The employment build - up also improved (3M mov. avg.: +40 ths. mom; +0.9% yoy). Mainly due to immigration employment gains exceed unemployment decrease. Leading indicators suggest that the positi ve trend should continue in the next few months. The unemployment rate should fall to 6.6% in 2014 after 6.9% in 2013. — Retail sales were up by 0.9% yoy (3M mov. avg.) in April and continued their moderate and volatile upward trend. The record level of the Gfk consumer climate (highest since early 2007) and EC consumer confidence (highest since mid - 2011) as well as the positive labour market suggest a modestly increasing trend of retail sales. — After weakness in 2013 investment in M&E and construction spendin g should pick up again this year. Investment in M&E was strong in Q1. However, domestic investment goods orders and capacity utilization currently do not point to a further strong acceleration in the remainder of 2014. Still M&E should rise by 7% in 2014 ( 2013: - 2.4%). — The construction sector benefits from high net immigration and rising disposable income propelling housing demand. Construction activity (Mar.: +5.7% yoy, 3M mov. avg.) and orders (+18.7%) are markedly higher than last year. Construction spen ding could grow by a good 5% in real terms in 2014 (2013: - 0.2%). Sources: Federal Statistical Office, Deutsche Bank Research, Gfk, EU Commission, ifo 85 90 95 100 105 110 115 - 400 - 200 0 200 400 600 800 08 09 10 11 12 13 14 Unemployed (left, inverted) Employees (left) ifo employment barometer (right, 6M lead) Unemployment barometer, employment and unemployment '000 yoy (left); index (right) - 4 - 3 - 2 - 1 0 1 2 3 4 - 3 - 2 - 1 0 1 2 3 4 08 09 10 11 12 13 14 Gfk consumer climate (left) EC consumer climate (left) Retail sales (right) Retail sales and consumer confidence Normalized data (left), % yoy, 3M mov. avg. (right) 96 97 98 99 100 101 102 103 - 30 - 20 - 10 0 10 20 08 09 10 11 12 13 14 Investment in M&E DB investment climate Investment in machinery & equipment and DB investment climate % yoy (left); index normalized to 100 (right) 0 50 100 150 200 250 91 95 99 03 07 11 Construction activity New orders Construction activity and new orders 2010=100, 3M mov. avg. Focus Germany 35 | June 4, 2014 Current Issues Chartbook – Financial markets — According to the preliminary release the inflation ra te fell more than expected from 1.3% in April to 0.9% in May. A large part of this decline should be due to the fall back in package holidays inflation, which lowe red services inflation (1.4% vs 2.3% prev.). In addition, food prices continued their down war d trend (0.5% vs 1.8% prev.) falling to the lowest rate since March 2010. This took 0.1% - points off headline inflation. I n contrast, the yoy - decline in e n ergy inflation continued to taper off as the EUR weakened slightly and the oil price rose somewhat. Th is added about 0.1% - point s . According to our calculation c ore inflation was clearly down to 1.2 - 1.3% in May (prev. 1.8% ). — At the ECB’s May press conference, Draghi sounded again a lot more dovish. He announced that the governing council is “comfortable wit h acting next time” depend ing on the inflation/inflation expectations development and the change of the ECB’s inflation forecasts in June . After disappointing EMU Q1 GDP numbers, the weak monetary indicators and lower than expected inflation rates for May so far (Germany, Italy and Spain), we expect the ECB to announce a package of measures: full allotment, ending SMP - sterilization, a rate cut including a small negative deposit rate and a targeted LTRO. — Since the start of 2014 10 Y US treasury yields fell f rom 3% to 2.5% recently. This was caused by uncertainty about the strength of the underlying economic recovery, the dampened inflation environment and dovish Fed - comments. Given diverging interest rates and growth expectations for EMU and the US, the yield spread between 10Y US treasuries and German Bunds has nearly doubled since mid - 2013 to a good 1pp as of late. In contrast, an improved economic outlook and continued policy accommodation have lowered the peripheral’s spread vs Germany to about 1.5% (mid - 2 013: around 3pp). — The diverging expectations for EMU and the US are also reflected in our expectations for the USD/EUR exchange rate. The USD should appreciate markedly over the course of 2014. The USD/EUR is currently at 1.36. Sources: Fed eral Statistical Office, ECB, EU Commission, Global Insight, Reuters, Deutsche Bank Research -20 -10 0 10 20 -4 -3 -2 -1 0 1 2 3 4 08 09 10 11 12 13 14 Total (left) Core inflation (left) Food (right) Energy (right) Consumer prices (% yoy) 0 1 2 3 4 5 6 08 09 10 11 12 13 14 ECB refi rate 3M interest rate EMU: Refi rate & 3M interest rate (%) 0 1 2 3 4 5 6 7 8 08 09 10 11 12 13 14 US DE FR IT ES 10Y government bond yields (%) 1.2 1.3 1.4 1.5 1.6 90 100 110 120 130 08 09 10 11 12 13 14 Nom. eff. EUR - exchange rate (lhs) Real eff. EUR - exchange rate (lhs) USD per EUR (rhs) Exchange rate development for the EUR 1999Q1=100 (left), USD per EUR (right) Focus Germany 36 | June 4, 2014 Current Issues Chartbook – Lending — Lending to cor porates remained weak in 2013 with the declines being more pronounced in the Eurozone than in Germany. While reductions i n Germany reflect a mix of modest investment activity and firms’ use of alternative means of financing, the drop in the Eurozone is the result of ongoing deleveraging processes. During Q1 2014 the downward movement slowed somewhat, most recently April reco rds - 3.3% yoy for the Eurozone but lending still has not turned the corner. In Germany, Q1 proved rather disappointing but most recent figures show some stabilization (April - 0.3% yoy; compared to March: - 1.2%). — Ho useholds in the Eurozone also continue del everaging weighing on new borrowing ( - 0.2 % yoy). By contrast, l ending to households in Ge rmany continues to rise (April: +1.1% ) . — The stable but moderate credit growth in Germany is solely driven by growth in mortgage lending. April (+2% yoy) is unchanged f rom last year’s developments. Given the low mortgage rates ( March 2.7%), credit growth remains rather modest, which partly reflects portfolio shifts by households and local supply shortages. Consumer credit remained restrained ( April - 1. 7% yoy) also reflec ting rising income situation for many households reducing the need to finance consumption via credit. — For companies in Germany, financing conditions continue to be very favourable. Interest rates for corporate credit remained at 3% in March. — Credit constra ints hit new historic lows in May. Only 17.4% of companies from industry and trade cu rrently see credit constraints (April: 18.2 %) . Similarly, construction companies report relatively very favourable conditions. Only 22 % note credit constraints, also a his toric low . Easy access to credit contrasts with the subdued growth of lending volumes to corporate s in Germany. Sources: ECB, ifo, Deutsche Bank Research -10 -5 0 5 10 15 20 06 07 08 09 10 11 12 13 14 EMU - non - fin. corporations EMU - households DE - non - fin. corporations DE - households Lending to the private sector (% yoy) -6 -4 -2 0 2 4 6 05 06 07 08 09 10 11 12 13 14 Credit for consumption Households - lending for house purchase Loans to households (% yoy) 0 1 2 3 4 5 6 7 06 07 08 09 10 11 12 13 14 ECB refi rate Mortgage loans (households, new loans, fixed 5 - 10 years) Company loans (<1m EUR, new loans) Interest rates (%) 0 20 40 60 08 09 10 11 12 13 14 construction sector industry and trade Companies' view on access to credit Credit constraints: Percentage of companies reporting restrictive access to credit. Higher values indicate more restrictive access to credit from companies' perspective Focus Germany 37 | June 4, 2014 Current Issues Chartbook – Public finances — In 2013, Germany was the only eurozone country – apa rt from Luxembourg – without a budget deficit. But the federal and Länder governments (in total) still report deficits. The general budget only edged into the black thanks to the municipalities and social - security surpluses. Budgets for 2014 and 2015 are a lso projected to close with small surpluses. — The German public debt ratio stood at 78.4% of GDP at the end of 2013. The positive development was partly attributable to growing revenues, but also to the fact that the bad banks continue to run down their por tfolios. — General government debt is set to decline further during the next few years. The reduction of the bad bank portfolios alone will cut the debt by 0.5% of GDP p.a.; moderate economic growth will also help lower the debt - to - GDP ratio. — Tax revenues c ontinue to grow. Cumulated from January to April revenues are up 3.4% on the same period last year. While taxes on income (because of lower corporate tax) recently grew at a weaker pace, VAT receipts soared in March and April. Cumulated from January to Apr il VAT revenues are up 4% on the year - earlier period (2013: growth till April 1.1%). This is mainly due to domestic VAT growth (growth of import VAT was quite lower). Sources: Deutsche Bank Research, European Commission, Bundesbank 30 40 50 60 70 80 90 - 10 - 6 - 2 2 6 10 95 99 03 07 11 15 Budget deficit (left) Public debt (right) Public debt and public deficit as % of GDP - 5.0 - 4.0 - 3.0 - 2.0 - 1.0 0.0 1.0 2.0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 Structural Cyclical Budget balance Budget balance General Government, % of GDP - 10% - 5% 0% 5% 10% 15% 20% 10 11 12 13 14 Tax revenues Monthly data, yoy and yoy 12 months moving average - 4% - 2% 0% 2% 4% 6% 8% 10% 12% 14% 12 13 14 Total tax revenues Income tax Value Added Tax Excise duties Development of important taxes Change yoy, 12 months moving average Focus Germany 38 | June 4, 2014 Current Issues Dieter Bräuninger (+49 69 910-31708, dieter.braeuninger@db.com) Nicolaus Heinen (+49 69 910-31713, nicolaus.heinen@db.com) Germany: Events of economic-, fiscal- and euro-politics DX Date Event Remarks 4/5 June G7 leaders' summit, Brussels Originally scheduled as a G8 summit in Sochi, Russia, which was cancelled following a G7 meeting focused on the Ukraine crisis on 24 M arch. G7 leaders suspended Russia’s membership. Topics: foreign policy, the global economy, trade, energy security, climate change and development. 5 June Meeting of the ECB Council, press conference We expect a package of measures to be announced: extens ion of the full allotment regime, ending sterilization, a rate cut including a small negative deposit rate and a targeted LTRO. 19/20 June Eurogroup/ECOFIN meeting European semester – discussion on SCPs and euro area specific recommendations, IMF Art. IV consultation with the euro area, Greece adjustment programme, Banking Union and euro area aspects. 26/27 June European Council, Brussels Presumably among others economic situation in the EU and foreign relations (e.g. Ukraine crisis). 1 July Brussels Ita ly takes over Presidency of the EU from Greece. 3 July Meeting of the ECB Council, press conference Review of the monetary policy stance. 7 Aug Meeting of the ECB Council, press conference Review of the monetary policy stance. Source: Deutsche Bank Research Focus Germany 39 | June 4, 2014 Current Issues Heiko Peters (+49 69 910-21548, heiko.peters@db.com) Oliver Rakau (+49 69 910-31875, oliver.rakau@db.com) Germany: Data calendar DX Date Time Data Reporting period DB forecast Last value 5 Jun e 2014 8:00 New orders manufacturing (Index, sa), pch mom April 2.0 - 2.8 6 Jun e 2014 8:00 Industrial production (Index, sa), pch mom April 0.3 - 0.5 6 Jun e 201 4 8:00 Trade balance (EUR bn, sa) April 17.1 15.0 6 Jun e 2014 8:00 Merchandise exports (EUR bn, sa), pch mom (yoy) April 2.7 (3.3) - 1.8 (0.2) 6 Jun e 2014 8:00 Merchandise imports (EUR bn, sa), pch mom (yoy) April 3.5 (1.2) - 1.1 (4.1) 23 Jun e 2014 9 :30 Manufacturing PMI (Flash) June 51.5 52.3 23 Jun e 2014 9:30 Services PMI (Flash) June 55.5 56.4 24 Jun e 2014 10:30 ifo business climate (Index, sa) June 110.0 110.4 27 Jun e 2014 14:00 Consumer prices preliminary (Index, sa), pch mom (yoy) June 0.4 ( 1.1) - 0.1 (0.9) 30 Jun e 2014 8:00 Import prices (Index, sa) pch mom (yoy) May - 0.2 ( - 2.3) - 0.3 ( - 2.4) 30 Jun e 2014 8:00 Retail sales (Index, sa), pch mom May 0.5 - 0.9 1 Jul y 2014 10:00 Unemployment rate (%, sa) June 6.7 6.7 14 Aug 2014 8:00 Real GDP (Index, sa), % qoq Q2 2014 0.2 0.8 Sources: Deutsche Bank Research, Federal Statistical Office, Federal Employment Agency, ifo, Markit Focus Germany 40 | June 4, 2014 Current Issues Heiko Peters (+49 69 910-21548, heiko.peters@db.com) Oliver Rakau (+49 69 910-31875, oliver.rakau@db.com) Financial Forecasts DX US JP EMU GB CH SE DK NO PL HU CZ Key interest rate, % Current 0.125 0.10 0.25 0.50 0.0 0 0.75 0.20 1.50 2.50 2.40 0.05 June 14 0.125 0.10 0.15 0.50 0.00 0.50 0.20 1.50 2.50 2.40 0.05 Sep 14 0.125 0.10 0.15 0.50 0.00 0.50 0.20 1.50 2.50 2.50 0.05 Mar 15 0.250 0.10 0.15 0.50 0.00 0.50 0.30 1.50 3.00 3.25 0.05 3M interest rates, % Current 0.23 0.21 0.31 0.53 June 14 0.35 0.20 0.30 0.52 Sep 14 0.35 0.20 0.20 0.52 Mar 15 0.35 0.20 0.20 0.52 10Y government bonds yields, % Current 2.53 0.59 1.31 2.61 0.75 1.80 1.39 2.66 June 14 2.50 0.60 1.40 2.90 1.10 2.40 1.90 3.10 Sep 14 3.00 0.70 1.60 3.00 1.25 2.55 2.10 3.20 Mar 15 3.25 0.80 2.00 3.30 1.45 2.80 2.45 3.30 Exchange rates EUR/USD USD/JPY EUR/GBP GBP/USD EUR/CHF EUR/SEK EUR/DKK EUR/NOK EUR/PLN EUR/HUF EUR/CZK Current 1.36 101.96 0.81 1.68 1.22 9.10 7.46 8.16 4.14 302.81 27.48 June 14 1.35 105.00 0.81 1.67 1.22 8.85 7.46 8.20 4.09 303.80 27.00 Sep 14 1.33 109.00 0.82 1.62 1.26 8.70 7.46 8.35 4.05 3 02.90 27.00 Mar 15 1.20 116.00 0.80 1.50 1.27 8.35 7.46 8.00 3.98 301.50 27.00 Sources: Bloomberg, Deutsche Bank Focus Germany 41 | June 4, 2014 Current Issues German Data Monitor DX Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Dec 2013 Jan 2014 Feb 2014 Mar 2014 Apr 2014 May 2014 Business surv eys and output Aggregate Ifo business climate 105,3 107,2 108,8 110,9 109,5 110,6 111,3 110,7 111,2 110,4 Ifo business expectations 101,8 103,4 106,0 107,8 107,4 108,9 108,2 106,3 107,3 106,2 PMI composite 49, 9 52,9 54,5 55,4 55,0 55,5 56,4 54,3 56,1 56,1 Industry Ifo manufacturing 100,4 102,7 104,5 106,9 105,2 106,3 107,3 107,0 107,5 106,9 PMI manufacturing 48,7 51,2 52,9 55,0 54,3 56,5 54,8 53,7 54,1 52,3 Headline IP (% pop) 1,4 0, 8 0,7 1,3 0,1 0,4 0,6 - 0,5 Orders (% pop) 1,0 1,5 2,3 0,1 0,1 0,1 0,9 - 2,8 Capacity utilisation 82,1 83,2 83,2 83,4 84,3 Construction Output (% pop) 11,3 1,8 0,2 4,7 1,2 2,2 1,8 - 1,0 Orders (% pop) 1,5 - 1,0 3,4 1,7 - 1,5 4,3 - 3,5 - 2,6 Ifo construction 123,7 120,4 121,2 122,6 123,6 124,2 123,1 120,6 120,6 120,3 Services PMI services 49,9 52,6 54,1 54,0 53,5 53,1 55,9 53,0 54,7 56,4 Consumer demand EC consumer survey - 4,2 - 3,2 - 2,8 0,3 - 2,2 - 0,8 - 0,7 2,3 3,1 5,5 Retail sales (% pop) 0,1 - 0,2 - 0,4 1,6 - 1,7 1,9 0,7 0,1 - 0,9 New car reg. (% yoy) - 3,7 - 1,4 1,6 2,8 5,4 - 2,0 4,3 5,4 - 3,6 Foreign sector Foreign orders (% pop) 2,8 0,6 3,9 - 1,3 1,8 - 1,3 0,7 - 4,6 Exports (% pop) 0,3 0,3 1,6 0,3 - 1,0 2,3 - 1,3 - 1,8 Imports (% pop) 1,4 - 0,3 0,6 2,2 - 1,0 3,2 0,4 - 1,1 Net trade (sa EUR bn) 48,0 49,3 52,3 48,1 17,6 17,3 15,8 15,0 Labour market Unemployment rate (%) 6,9 6,8 6,9 6,8 6,8 6,8 6,8 6,7 6,7 6,7 Change in unemployment (k) 19,7 - 4,7 14,3 - 45,7 - 16,0 - 26,0 - 12,0 - 11,0 - 25,0 24,0 Employment (% yoy) 0,5 0,6 0,6 0,8 0,7 0,8 0,8 0,9 1,0 Ifo employment barometer 104,9 106,3 107,2 107,5 107,5 107,0 108,0 107,4 107 ,4 106,9 Prices, wages and costs Prices Harmonised CPI (% yoy) 1,5 1,7 1,3 1,0 1,2 1,2 1,0 0,9 1,1 0,6 Core HICP (% yoy) 1,0 1,2 1,1 1,1 0,7 1,2 1,2 0,9 1,4 Harmonised PPI (% yoy) - 0,1 - 0,3 - 0,7 - 1,0 - 0,5 - 1,1 - 0,9 - 0, 9 - 0,9 Commodities, ex. Energy (% yoy) - 7,0 - 12,2 - 10,4 - 11,1 - 10,2 - 11,0 - 11,0 - 11,3 - 5,8 - 5,4 Oil price (USD) 102,5 110,4 109,3 108,2 110,8 108,3 108,9 107,5 107,7 Inflation expectations EC household survey 22,5 26,2 25,5 22,0 25,5 24,0 22,0 19,9 18,0 18,1 EC industrial survey - 0,6 2,8 6,1 5,6 8,6 7,8 4,8 4,1 2,5 1,9 Unit labour cost (% yoy) Unit labour cost 1,4 1,2 1,2 0,5 Compensation 1,7 2,0 2,0 2,5 Hourly labour costs 1,1 1,2 1,9 0,3 Money (% yoy) M3 3,8 2,5 2,7 3,5 2,7 3,1 3,9 3,5 3,7 M3 trend (3m cma) 2,4 3,2 3,5 3,7 Credit - private 1,3 - 4,0 - 3,1 - 3,6 - 3,1 - 3,8 - 3,9 - 3,6 Credit - public - 22,4 - 17,7 - 17,1 - 1,4 - 17,1 - 5,8 - 5,8 - 1,4 % pop = % change this period over previous period. Sources: Deutsche Bundesbank, European Commission, Eurostat, Federal Employment Agency, German Federal Statistical Office, HW WI, ifo, Markit Focus Germany Our publications can be accessed, free of charge, on our website www.dbresearch.com You can also register there to receive our publications regularly by E - mail. Ordering address for the print version: Deutsche Bank Research Marketing 60262 Frankfurt am Mai n Fax: +49 69 910 - 31877 E - m ail: marketing.dbr@db.com Available faster by E - mail: marketing.dbr@db.com Focus Germany is part of the Current Issues series and deals with macroeconomic and economic policy issues in Germany. Each issue also contains a timet able of financial and economic policy events as well as a detaile d data m onitor of German economic indicators. Focus Germany is a monthly publication.  So far, so good ................................ ................................ .... May 2 , 2014  2% GDP growth in 2015 despite adverse employment policy ................................ ....... February 28, 2014  Onward and upward ................................ .................... January 27, 2014  Launchpad to the past ................................ ............. November 29, 2013  Exuberance and fear ................................ ................... October 31, 2013  Germany after the elections ................................ .......... October 1, 2013  German GDP up 0.5% in 2013 – despite slowdown in H2 ................................ ........... September 3, 2013  Structural growth limitations ................................ .............. July 31, 2013  Structural improvements support exceptional position ....... July 1, 2013  The brave new world of monetary policy ........................... June 4, 2013  GDP forecast: Uptick in Q1, slippage in Q2 ...................... April 30, 2013  Sentiment indicators – another setback in spring ............... April 2, 2013  The worst is (probably) over ................................ ............. March 1, 2013  Gradual improvement in 2013 ................................ ..... January 28, 2013  German business cycle at the turning point? ............ December 3, 2012  Euro crisis brings economy to a standstill in the winter half ................................ ......... November 2, 2012  Global economy hurts - no quick fix ................................ .. July 25 , 201 2 Tell me, pray ................................ ................................ .... June 17 , 201 2  The austerity versus growth debate – what can be learned from Germany ................................ .... May 9 , 201 2  Cautious GDP call maintained, despite some upside risks ................................ ................. April 11 , 201 2  Recession risk has receded – 2012 GDP forecast now 0.5% ................................ ........ March 13, 201 2  Flatlining ................................ ................................ ...... February 7 , 201 2 © Copyright 2014. Deutsche Bank AG, Deutsche Bank Research, 60262 Frankfurt am Main, Germany. All rights reserved. When quoting please cite “Deutsche Bank Research”. The above information does not constitute the provision of investment, legal or tax advice. Any views expressed reflect the current views of the author, which do not necessarily correspond to the opinions of Deutsche Bank AG or its affiliates. Opinions expressed may change without notice. Opinions expressed may differ from views set out in other documents, including research, published by Deutsche Bank. The above information is provided for informational purposes only and without any obligation, whether contractual or otherwise. 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