British and German paths to possible growth

Both the United Kingdom and Germany seem to have overcome the economic crisis as growth is picking up again in both countries, yet with some reservations in the German case as recent figures show. Although in the UK the economy is still growing below the pre-crisis trend, almost 2% growth in GDP is an encouraging sign. That is not a common scenario across the rest of Europe: other countries are looking at the two in search for a model.

However, the two countries are following alternative paths of recovery, with Britain taking more advantage of new infrastructure launches than Germany. In the UK, employment continues to rise steadily, housing activity is also increasing and credit growth is improving. In addition, the country is benefiting from the fact that the Eurozone, its key export market, is also coming out of the crisis. Therefore, British exports are rising again. In the first quarter of this year, the UK economy expanded at its fastest annual pace since 2007, according to the Office for National Statistics (ONS), as private investments were supported by an increase of household spending.

All these symptoms suggest a healthy recovery of the British economy after the biggest crisis in the last decades. Is it a new economic approach as the Conservative government suggested when it came into office in 2010? Prime Minister David Cameron as well as Chancellor George Osborne emphasized that the economy had become unbalanced and that the coalition would implement measures to rebalance it. To what extent has this been achieved and what are the main driving forces of this recovery?

Although looking at the figures, British economic recovery has been significant, experts have raised concerns that these improvements are too dependent on consumer spending and on credit growth. Mark Carney, the Governor of the Bank of England pointed out that the economic progress so far had been “neither balanced nor sustainable” and required continued support.

Despite the fact that there are encouraging signs of recovery, Chancellor Osborne recognizes that the recovery has not yet been consolidated and that the economy is still too unbalanced. According to him, the British recovery cannot be based entirely on consumers and the success of the City of London. More investments and exports are necessary.

This is why the government announced an infrastructure plan comprising 200 projects to be completed in the period of 2014-15 and another 200 to be launched in the same period. With this measure, the coalition intends to give incentives to businesses to create up to 150,000 jobs.

In addition, Alasdair Reisner, Chief Executive of the Civil Engineering Contractors Association, pointed out that renewing the country’s infrastructure could add up to 5% to GDP. This will help the construction sector, which accounts for about 6% of the British economy, to pick up again as it is still 10% below its pre-crisis peak.

However, the sudden increase in infrastructural investments is also due to a lack of investments in the period of 2009 to 2012, when public sector net investment fell from £48.5 billion to £28 billion. According to the coalition, £36 billion will be spent on the projects starting this year, with £5 billion coming directly from the state, £21 billion from the private sector and a further £10 billion from joint public/private investment.

The projects will not only be implemented in the area of Greater London, which hosts the largest part of the population and economic activity, but also in the north of England and in Scotland with three offshore wind farms. A new high-speed rail line will connect Manchester and Leeds, which according to Chancellor Osborne will help create “a Northern powerhouse”, increase economic activity in the region and eventually help restore balance across the UK’s London-dominated economy.

According to UK Trade & Investment’s annual report for 2013/14, over 30,000 jobs have been created across over 300 projects in the area of infrastructure and energy in the past financial year. It will be seen in the course of the next two years whether the expected figures of job creation and GDP growth will be achieved. So far, economic growth in the UK has been shaped by an increase in consumption and borrowing, which is why it is important to balance the growth with infrastructural investments.

In Germany, there has been solid economic growth in the past two years, although the second and third quarters are looking less promising. This is mainly due to three factors: The decrease of exports to Russia in light of the economic sanctions; the higher than expected growth in the winter because of the mild climate at the beginning of the year – several construction works had been brought forward – and  the stagnation of the next two major economies of the Eurozone, Italy and France.

Nonetheless, the positive development of the labor market and the domestic economy has been the driving forces of this recovery. Both private investments and household incomes have undergone a strong increase. According to the German Minister for the Economy, Sigmar Gabriel, a balanced budget along with increased public investments in infrastructure, education and R&D shall be the basis of further growth.

The growth of consumption in Germany has been driven by a strong increase of the purchasing power due to higher employment and higher incomes. Regarding exports, the German economy depends on the purchasing power of its partners, mainly in the Eurozone. Given the current prospects, exports are expected to grow by over 4%.

The growth of the German economy is based on more diverse factors than the British case. This more balanced outlook comes from an increased demand in the domestic economy on the one hand and growing exports on the other hand. The high domestic demand also leads to more imports. This is a new phenomenon in the German economy as the gap between high exports and lower imports is closing. Whereas incomes in Germany are rising (and are further expected to rise with the implementation of the minimum wage), the purchasing power is higher, which leads to more consumption.

Both German households and the German government are more cautious about when to spend and are rather risk-averse in terms of spending. A balanced budget has traditionally been given a higher priority than investments. Thus, the money that is spent in Germany is mostly not down to borrowing, but to savings and real income.

German business has been investing more in the past two years due to favorable conditions for financing their investments and promising prospects. The Ministry of the Economy is predicting a 4% increase in private investments, which will significantly contribute to economic growth. However, German investments remain behind the average of OECD countries and this is a source of concern. The German investment rate has been the lowest of all industrialized countries for a long time.

Recently, the IMF pointed out recently that Germany is lagging behind in public investments, particularly in infrastructure. According to the IMF, Germany is in a healthy position to increase its infrastructural investments by 0.5% of its GDP, which would be €14 billion more per year, although the federal government has budgeted far less than that. Yet, not only the IMF, but also political leaders in Germany argue that this is far from sufficient in order to ensure the needed rehabilitation of roads and bridges.

Economic growth in Germany is driven by public and private spending, although this has dropped in the last few months. This decrease has made leading German economists like Marcel Fratzscher from the German Institute for Economic Research (DIW) to revise their growth forecasts for the German economy. The expected growth from the beginning of the year of 1.8% would be down to less than 1% by the end of 2014. Yet, the increased consumption cannot fully compensate the lack of expected exports to major EU partners like Italy and France, who have been suffering from stagnation.

Both trends of increased consumption in Germany and the UK still need to be consolidated. In the latter case, consumption is not due to higher purchasing power, but rather to more confidence and optimism in the economy. Thus, more jobs and activity are also meant to strengthen the social climate, as in the UK we have not seen a rise of real incomes across the board.

Whereas in the United Kingdom, infrastructural programs are aimed not only at boosting economic activity, but also at creating jobs, the main purpose of Germany’s measures do not focus on the creation of jobs in that sector – partly in light of near-full employment. The focus here is merely on rehabilitation. This suggests that infrastructural investments in Germany might not be considered as a top priority by the current government.

Thus, it can be seen how there are different approaches when it comes to handling investments in infrastructure and their role for economic growth. Whereas the focus in Germany lies on creating an economic climate for higher purchasing power and more economic activity, which will boost the labor market, the UK government specifically targets new infrastructural projects to create jobs.

This measure in the UK shall diversify economic growth and make it less dependent on a single driving force. In Germany on the other hand, the dip of economic recovery can be seen as a warning and make the government realize that more investments and a more favorable economic environment for investments are needed. Overall, the more balanced setup of the German economy provides favorable conditions for growth opportunities.