The best ways to invest in a resurgent Germany – Europe‘s economic engine

The 2010s was a dismal decade for Europe. It began with the euro crisis between 2010 and 2015, when sharp recessions and mass unemployment devastated southern Europe; the Covid-19 pandemic has snuffed out the tentative recovery. However, while Italy and Spain languish and France stagnates, Germany, the continent’s powerhouse (it accounts for around 30% of eurozone GDP) proved resilient. Global momentum boosted its export-led economy, helping to ensure that GDP expanded by an average of almost 2% a year between 2009 and 2019, according to the World Bank, compared with an annual 1.5% for the rest of the EU. And Germany looks poised to outperform its neighbours in the next decade too, not least because it is moving beyond its traditional strengths of manufacturing and engineering into new industries. 

A big post-Covid-19 bounce

Germany is deemed to have dealt with Covid-19 better than most developed countries. However, the social distancing and lockdowns mean that its economy hasn’t emerged completely unscathed, with the OECD economic organisation of developed countries projecting that its GDP will fall 8% in 2020. A furlough scheme paying 60% of the salary of workers on zero or reduced hours has not been enough to stop unemployment rising to a five-year high of 6.2%.

Still, Germany has several advantages that will ensure that its economy bounces back more quickly than elsewhere, says Andrew Kenningham of Capital Economics. “Before the virus struck, Germany was growing much faster than other countries in Europe.” It is also much less dependent on consumption and tourism, two areas that have been hit particularly badly by the pandemic and are likely to be the last to recover, even after a vaccine is distributed. By contrast, the German manufacturing sector has experienced much less disruption to production and demand.

Another reason why Germany should recover relatively quickly is because of its “strong balance sheet”, says Kenningham. Germany is notorious for its puritanical distaste for government spending and debt (it is perhaps not a coincidence that the words for debt and guilt are the same in German). This meant that it went into the crisis with government debt equivalent to around 60% of GDP (compared with 85% for the UK, 98% for France and 138% for Italy). 

While public debt has jumped over the last nine months, previous fiscal rectitude reduces the need for dramatic spending cuts and tax rises now and also provides scope for further support of the economy in 2021. The public sector isn’t the only part of the economy that has been thrifty. German consumers are far less inclined to splurge than their Anglo-Saxon counterparts. Household debt in Germany is worth 54% of GDP, compared with 89% in Britain.

Exports power emerging markets

German manufacturing is an important engine of economic growth, says Dr Steve Coulter, head of industrial strategy, skills and sustainability at the Tony Blair Institute for Global Change. This is because manufacturing accounts for a large portion of Germany’s exports, which in turn comprise 50% of GDP (compared with 30% of GDP in the UK). What’s more, many of these exports go to the fast-growing Asian economies, especially China. While the market for cars and machine tools, two of Germany’s biggest exports, “virtually dried up overnight” during the first wave of the pandemic, it has quickly recovered.

There is always the risk that German companies may suffer from any move away from globalisation, especially if “Chinese consumers decide to start switching to domestic brands”, says Coulter. Beijing is keen for domestic companies to shed their low-quality, bargain-basement image and start developing premium products, reducing demand for foreign goods. However, this is a bigger problem for the luxury-goods sector, dominated by the likes of France’s LVMH, than for German manufacturers. The reputation of German companies is based on their ability to “deliver quality goods that are both reliable and reasonably priced”.

German manufacturing excels at producing goods that target the “upper-middle part of the market”, aimed at those who want something more than basic quality, but don’t necessarily want to pay luxury prices. While this segment may be less prestigious than goods at the absolute top end of the market, it still leads to “surprisingly high margins” for firms that can supply the emerging middle class with popular products. Car companies, such as Mercedes and BMW, have been particularly successful in this context.

The Mittelstand: Germany’s backbone

A unique feature of the German economy is the extent to which it relies on the Mittelstand. This segment of the economy comprises a vast number of small and medium-sized firms, but also larger companies with a substantial degree of family ownership or influence that distinguishes them from traditional listed or private companies. According to the Deutsche Börse, the German stock-exchange operator, 58% Germany’s workforce is employed in the Mittelstand and it accounts for around 57% of economic output.

One of the main strengths of these firms is their ability to take a long-term view: they “spend a relatively high amount on research and development”, says Joerg Zeuner, chief economist at Union Investment. This reinvestment means that they can punch above their weight when it comes to staying “on the edge of innovation” and “developing new ideas”. They have remained competitive with global rivals in engineering and manufacturing. At the same time, they have increasingly been moving into new sectors, such as renewables.

Many people argue that smaller firms will always struggle to take advantage of economies of scale “and it’s certainly true that their relative importance to the German economy has slightly declined over the past few decades”, says Coulter. However, they still have several factors in their favour that bode very well for the future. While they compete fiercely between each other when it comes to selling products, “they are very good at organising collective training in order to ensure high labour productivity”. They also have good relations with their local banks, “which are much more forgiving than those in the UK”. 

Biotech: a new growth sector

One area that demonstrates the durability of the German model is biotechnology. Germany “has quickly become one of the leading countries in Europe for biotechnology-focused companies”, says Anthony Ginsburg, managing director of GinsGlobal Index Funds. The revenue of the German biotech sector climbed from €3.7bn in 2016 to €4.9bn in 2019. The number of German biotech firms has increased to more than 660, including 23 listed ones, with the workforce rising from 18,000 in 2015 to over 50,000 today.

A key reason for this is the large amount of money, both public and private, invested in research. If you count all universities, colleges and non-academic research laboratories, there are almost 202 research facilities in Germany. The German government is also working hard to make sure that research breakthroughs don’t just stay in the laboratory, but are turned into marketable products. It has created more than 30 biotech hubs to encourage “close collaboration between research institutes, technology parks, regional political players and biotech firms” and they are already starting to make “a big difference”.

Germany’s status as a major player in the biotechnology industry has been cemented by its performance during the Covid-19 crisis. Not only is the vaccine developed by the Mainz firm BioNTech the front runner in the race to be the first to win regulatory approval, but Bosch and Roche have also successfully developed rapid diagnostic tests, with Roche’s antibody test showing a 99.8% accuracy rate. As of last month, there are 97 Covid-19 clinical studies under way in Germany – half of which have reached the trial stage. 

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