Looking at recent economic data and leading indicators, such as the Ifo Business Climate Index, I get the impression that the economic recovery of Europe’s largest economy knows no bounds. Indeed, after posting its fastest economic growth rate since re-unification (at 2.2%), my colleagues at Business Monitor International have upgraded their real GDP growth forecast for 2010 to 2.8% (having previously projected 2.0% growth). So can the German Wirtschaftswunder last?

Ifo Business Climate Index

In order to answer this question, let’s look at what has been driving the robust performance of the German economy.

1. Germany remains an export-driven economy. The collapse of the euro during the second quarter of the year certainly helped to boost the export competitiveness of German goods to non-eurozone states.
2. Export growth to non-EU states during this period was particularly strong, driven in large part by soaring demand from China.
3. In the eurozone, too, growth surprised to the upside (France grew 0.6% – well above expectations), which given that the bloc still accounts for 60% of German exports, helped to boost order numbers.
4. It also helps that Germany remains a highly productive and competitive economy, with unit labour costs kept down as manufacturers successfully negotiated lower wages with unions during the country’s 4.7% recession in 2009.

Looking at the latter point in particular, we note that a ‘part-time revolution’ of sorts has helped to improve unit labour costs for manufacturers. This has in part been facilitated by the so-called Hartz IV programme introduced under the previous administration of Gerhard Schroeder, in which social benefit payments helped Germans accept lower-income jobs. With little long-term job security to speak of, a record number of West Germans accepted part-time work in 2009. This has certainly allowed employers to be more flexible and re-hire workers quickly when needed.

Part-time workers

Can It Continue?
While fixed investments have been a strong driver of the blockbuster economic growth rate recorded in the second quarter, strong export numbers will need to be sustained to ensure further robust economic growth. This is where the picture becomes less encouraging heading into 2011.

In previous posts and a multitude of podcasts available on this blog, Risk Watchdog and key Business Monitor analysts have warned of the perils of slowing global economic activity as inventory restocking begins to wind down, stimulus measures are withdrawn and overleveraged households continue to painfully rebuild their balance sheets. Add to this the fact that austerity programmes across Europe are being introduced and all of a sudden the much-hyped recovery begins to look less stable than headline growth numbers in Q2 seem to suggest.

While sovereign credit fears will likely continue to dog investor confidence in Europe for the next few years, likely keeping the euro under pressure for the time being, disappointing US macroeconomic data is doing its fair bit to put the US dollar under some pressure of its own.

What is more, even though Germany will remain a European outperformer due to its highly competitive high-quality manufacturing base, faltering external demand cannot be ignored, even if (and that’s a big IF) China continues to grow at a rapid pace. Finally, let’s remember the propensity of German households to save – far exceeding anything seen in other eurozone states. Though a boost to consumer confidence on the back of strong GDP growth may see this unwind briefly, consumer frugality will not be gone for too long. Indeed, wait until Germans are once again asked to dig deep in their pockets to bail out yet another troubled peripheral eurozone economy, which can no longer meet its interest payments on government debt. Surely no one thinks that the European Monetary Union’s structural woes are a thing of the past!

Spread of Irish 10-Year Bond yield over German 10-Year yield, %

At least bond markets don’t seem to suggest that this is the case, and Ireland’s sovereign debt downgrade by Standard & Poor’s on August 24 is a sobering reminder of this. So the answer to our question is a clear ‘no’. Germany’s economic miracle (Wirtschaftswunder) is unsustainable and despite all the positive data, Germans have some very heavy luggage (in the shape of the eurozone) to schlep around for the next few years.