UBS Research Focus Germany in Fast Lane

UBS research focus
Wealth Management Research

October 2010
Germany in the fast lane
The return of the Teutonic Tiger

Export strength – blessing and curse
Germany faces long-term structural challenges
Investing in Germany
ab
Contents
Editorial...................................................................................................... 3
UBS research focus
Highlights................................................................................................... 4
This report has been prepared by
UBS AG. Please see important disclaimer Chapter 1
at the end of the document. Past per-
formance is not an indication of future
The return of the Teutonic Tiger.................................................................. 6
returns. The market prices provided are
closing prices on the respective principal
Chapter 2
stock exchange. Export strength – blessing and curse......................................................... 12
Publisher Chapter 3
UBS AG, Wealth Management Research,
Germany faces long-term structural challenges......................................... 18
P.O. Box, CH-8098 Zurich
Editor in Chief Chapter 4
Dirk Faltin, Economist, UBS AG
Investing in Germany................................................................................ 26
Editors
Roy Greenspan Bibliography ............................................................................................ 32
Anna Foca
Authors Selected UBS WMR publications .............................................................. 33
Lena Lee Andresen, Strategist, UBS AG
Dirk Effenberger, Strategist, UBS AG
Dirk Faltin, Economist, UBS AG
Gerit Heinz, Analyst, UBS Deutschland AG
Andreas Höfert, Chief Economist, UBS AG
Markus Irngartinger, Strategist, UBS AG
Daniel Kalt, Economist, UBS AG
Georg Klein-Siebenbürgen, Analyst,
UBS Deutschland AG
Caesar Lack, Economist, UBS AG
Philipp Schöttler, Strategist, UBS AG
André Schütz, Analyst, UBS Deutschland AG
Thomas Wacker, Analyst, UBS AG
Editorial deadline
1 October 2010
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Valérie Iserland
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2 Germany in the fast lane

Editorial
Dear reader,
Like a phoenix rising from the ashes, the German economy has staged a remarkable re-
covery so far this year. During the dark days of 2009, the economy contracted at its fast-
est pace in post-war history; this year, Germany is surging ahead of its peers. Even unem-
ployment, which has been Germany’s Achilles heel for so long, is falling at an astonish-
ing pace – recently reaching levels last seen nearly 20 years ago. Indeed, among the
major economies, Germany stands out in that its unemployment rate is now lower than
Andreas Höfert before the global economic recession.
How durable Germany’s economic comeback is remains an open but important question,
given its status as Europe’s largest economy, with 82 million people and a gross domestic
product of EUR 2.4 trillion (USD 3.23 trillion). Are we witnessing a new “economic mira-
cle” like the so-called Wirtschaftswunder that followed World War II? Or has the German
economy simply launched a short-lived breakaway, destined to rejoin the rest of the de-
veloped economies grinding along at a snail’s pace?
Continued success for Germany could be seen as vindication for the European economic
and social model. Indeed, in countries where the usefulness of more fiscal spending is
hotly debated, many experts are studying the German example, where early and decisive
fiscal consolidation has not stood in the way of a strong economic recovery.
Dirk Faltin
Some policy makers in Germany are even using their newfound position of strength to
demand that weaker economies – especially in peripheral Europe – try to emulate the
German growth model’s focus on exports and competitiveness. But can the export-led
German economy maintain its dazzling performance if the export field becomes over-
crowded with would-be competitors? And what if Germany’s outperformance ultimately
depends on its trading partners spending beyond their means?
Investors looking to benefit from the German economic powerhouse must confront
these questions in order to determine the best investment strategy. In this issue of
UBS research focus, we provide investors with extensive background on Germany’s cur-
rent growth, its near-term outlook and long-run structural prospects. By tracing key
trends arising from the composition and cyclical character of the German economy, we
are able to identify some likely winners and losers from the current high-growth, low-
interest environment. We hope you will find our advice useful.
Andreas Höfert Dirk Faltin

Global Head Head Thematic Research
Wealth Management Research
UBS research focus October 2010 3

Highlights

The return of the Teutonic Tiger Germany faces long-term structural
Germany’s brisk recovery in 2010, likely ahead of challenges
all major economies this year, will probably fade Germany’s strong cyclical growth before and after
somewhat in the second half and into 2011. Nev- the global recession has diverted attention from
ertheless, Germany’s exceptionally strong export its weak average growth performance this dec-
position is bolstered by the still relatively weak ade. Germany’s rapidly aging society, which com-
euro, which should remain a support for growth pares unfavorably to most of its peers, is a key
in the near term. As long as global demand is challenge to its growth potential. The results of
buoyant, Germany stands to benefit. These fac- Germany’s very low birth rate are practically irre-
tors also support the domestic economy in this versible now, especially since immigration will
cycle. Importantly, Germany is unburdened by the probably not be able to stabilize the population.
direct effect of a burst housing bubble, and pri-
vate sector financial balance sheets are generally
strong. The performance of the labor market has
also been impressive. Interest rates are an issue to
watch: The current Eurozone rates are too low for
Germany and the risk of a housing bubble cannot
be ignored. But in the near term, we think
growth in Germany is likely to surprise positively,
in absolute terms and compared with other econ-
omies. The biggest risk to this favorable cyclical
outlook stems from any potential renewed slump
in global demand. For Europe as a whole, Germa-
ny’s return to strong growth this year is a double-
edged sword: It raises economic activity across
the continent, while at the same time fueling
long-standing imbalances.

Germany undoubtedly has one of the most suc-
cessful export economies in the world. The coun-
try’s export strength is based on its ability to pen-
etrate high growth markets, especially in the
Central and Eastern Europe (CEE) region and in
Asia, and on its superior competitiveness gained
through corporate restructuring and wage mod-
eration. Thus, Germany’s advantages in foreign
trade are of a lasting nature and they allow Ger-
many to benefit more during global cyclical up-
swings than most of its peers. However, this trade
dependency has its downsides as well. During
economic downturns Germany tends to suffer
more than comparable countries that are less
dependent on global trade. Also, Germany’s
growth model may be vulnerable to protection-
ism, to structural shifts in its main trading part-
ners and to lower-cost competition. Importantly,
Germany’s export success does not seem to ben-
efit the German people at large. In our view, it
will be important to achieve a more balanced
growth model in future.

Labor market participation is already quite high, Investing in Germany

meaning that the potential to offset the decline in The outlook for German equities is positive: they
population by expanding the potential labor force should benefit from the global recovery even if it
is limited. However, annual working hours are continues at a more moderate pace going for-
very low in Germany and could be raised to partly ward. If Germany manages to tilt its economic
offset the negative effects of a shrinking labor structure more towards consumption, the cyclical
force. Capital accumulation, which in theory swings of the stock market might also be less
could substitute labor, will not be raised signifi- pronounced in the future. In any case, it seems
cantly, in our view. However, there would seem prudent to add some consumer-related stocks to
to be scope for improving total productivity, by German portfolios, as we think the biggest
countering adverse trends in Germany’s innova- bounce of the global economy lies behind us and
tion potential and by continuing reforms of the the German consumer seems to be in good mood
education system, including the implementation – not least thanks to the favorable labor market
of an immigration policy that attracts highly edu- conditions. A slide back into recession – though
cated immigrants. not our base case – could have severe negative
effects on German equities due to their cyclical
bias. German government bonds rank among the
safest bonds issued by Western countries. How-
ever, current yield levels lead us to conclude that
longer-dated maturities should be avoided and
that investors should seek alternatives beyond
government bonds.
Industrial recovery is much stronger in Germany Export market shares of the biggest exporters
than in the Eurozone as a whole
% of total world exports
Industrial production, index levels
120 14
115 12
110 10
105 8
100 6
95 4
90 2
85
0
80
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Germany Eurozone China Germany Japan US
Source: Reuters EcoWin, UBS WMR Source: WTO database, UBS WMR

Chapter 1

Germany is back. During the global economic
crisis German output contracted more than
in most comparable countries. Now the
country’s economy has regained its pre-crisis
strength. The cyclical outlook remains favo-
rable.
Germany has been surprising people lately. The

world’s fourth-biggest economy has long been
admired for its efficiency, innovation and skilled
and disciplined workforce. Yet critics have also
scorned Germany’s inflexibility, costly social sys-
tem and opaque web of banks and industry. Ger-
many’s recent economic surge has led some to
praise its superior competitiveness, while others
complain that the country’s growth model beg-
gars its European neighbors and other countries
as well.
In this UBS research focus we take a close look at

the German economy. We assess its near-term rate of over 9%), Germany’s growth challenged
outlook and its longer-term structural prospects. even that of China. Full-year growth is now likely
The present chapter discusses the business cycle to exceed 3% for 2010. Needless to say, this
in Germany. In the second chapter we examine surge puts Germany ahead of every other country
the implications of Germany’s reliance on export- in the Eurozone, the 16 countries sharing the
driven economic growth. In the third chapter we euro common currency. Figure 1.1 makes it clear
round out the picture by looking at structural that Eurozone industrial activity is practically en-
trends and challenges and the longer-term out- tirely «Made in Germany».
look for Germany. The final chapter interprets our
findings from an investor’s point of view. However, before we get too excited, these num-
bers need to be put into perspective. The sharp
Germany regains its pre-crisis punch rebound this year comes after a nearly 5% con-
Four years ago, Germany was hailed as the “Teu- traction of the German economy in 2009. Indeed,
tonic Tiger,” an exporting powerhouse and the the total output loss during the crisis amounts to
growth engine of Europe. In 2006, the future more than 6.5% (measured from the peak in
looked bright for what was then the third-largest
economy in the world. Unlike most of its Euro-
pean peers, Germany had seemingly found the Fig. 1.1: Industrial recovery is much stronger in Germany
recipe for participating in the rapid development than in the Eurozone as a whole
of the emerging economies in Central and East- Industrial production, index levels
ern Europe (CEE) and Asia. Then came the global
120
recession, starting in late 2007. During the down- 115
turn, Germany suffered more than most other 110
comparable economies – at least in terms of lost 105
output. Now, with the global recession over, the 100
95
German economy appears to have recovered its
90
pre-crisis strength. 85
80
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
In the first half of 2010, the German economy
boomed. In the second quarter alone, it grew at Germany Eurozone
the fastest pace since reunification, back in 1990.
Up 2.2% from the first quarter (an annualized Source: Reuters EcoWin, UBS WMR

early 2008). Hence, even if the current speed of has depreciated by about 6.5% over the first six
recovery could be maintained, it would take an- months of 2010, compared to the previous six
other year to fully make up for the output lost months. According to OECD estimates, a 10%
during the crisis. depreciation of the euro would add about 1% to
German GDP in each of the next two years.2
Exports feed German growth
The recovery in the first half of this year reflected At first glance, these numbers suggest that the
a surge in foreign demand for German merchan- lower real effective euro exchange rate could
dise. Exports jumped by more than 8% in the boost German GDP by 0.6 to 0.7% next year and
second quarter of 2010 compared to the first beyond. The government debt crisis in Greece
quarter, the strongest expansion since 1990. Im- and the precarious fiscal situation in other coun-
ports also grew by a robust 7%. Thus, net trade – tries of the Eurozone are behind the weaker euro.
exports minus imports – directly accounted for We think this dynamic makes it likely that the
nearly half of the expansion in the second quar- euro exchange rate should remain favorable for
ter. Domestic demand was also strong, but much German exporters in 2011.
of this strength, especially in corporate invest-
ment spending, was also ultimately due to the The relatively weaker euro also puts German ex-
surge in foreign demand (see Fig. 1.2). porters at a relative advantage versus their Euro-
zone competitors. To get a sense of the magni-
Why Germany is an export champ tude of this advantage, we consider the so-called
We will examine the structural reasons for Germa- purchasing power parity (PPP) for different Euro-
ny’s trade success in detail in the second chapter. pean countries. The PPP exchange rates represent
Here, it suffices to say that German exporters greatly long-run equilibrium exchange rates. As shown in
benefit from some broad economic developments. Figure 1.3, Germany’s long-term PPP against the
For one thing, Germany embraced globalization US dollar is nearly 1.5, compared to only 1.25 for
early and earnestly. It also sharpened its price com- the Eurozone as a whole. For the less competitive
petitiveness through corporate restructuring, pro- southern European countries, the comparable PPP
duction outsourcing to lower-cost countries, and exchange rates are even lower, just below 1.2.
wage moderation, to name a few key factors. The average euro-US dollar exchange rate this
German exporters have also had a boost lately

from the euro’s weakness.1 The so-called real 1
Note that despite the recent appreciation, the euro is still
effective euro exchange rate, which compares the relatively weak when compared to a basket of currencies.
euro to a basket of trading partners’ currencies, 2
OECD (2001)
Fig. 1.2: Net trade was the main driver of economic activity Fig. 1.3: Germany can live with a higher euro exchange rate
Quarterly real GDP growth composition, in %, y/y Euro/US dollar exchange rates in purchasing power parities (PPP)
5 Germany
3 France
1 Austria
–1 Netherlands
–3 Spain
–5 Italy
–7
Portugal
–9
2007 2008 2009 2010 Greece
0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6

Domestic final consumption Investment Net trade Eurozone total average
Source: Reuters EcoWin, UBS WMR Source: Reuters EcoWin, UBS WMR

Chapter 1
year has so far been around 1.3. From the PPP More than just exports
rates, it is clear that Germany can successfully While exports are clearly the mainstay, the big
compete at such an exchange rate, while most surprise in Germany’s economic data in the sec-
other Eurozone exporters struggle to sell their ond quarter was robust domestic demand. Private
products abroad. households, government spending and corporate
investments all contributed. Indeed, total domes-
Germany’s export-driven rebound in the first half tic demand accounted for 1.4% of the 2.2%
of 2010 also simply reflects the severity of the expansion in the second quarter, the most since
decline in 2009. Germany is recovering faster in 2006. After three negative quarters, consumer
2010 because it contracted faster in 2009 (see spending rose by a healthy 0.6% in the second
Fig. 1.4). Thus, global trade fell about 20% from quarter.
peak to trough, partly sentiment-driven. When
confidence revived, orders that had been on hold Gross fixed investments posted a solid improve-
were reactivated. German exports dropped about ment in the first half of 2010, with investment in
25% in 2009 and are now benefiting more from machinery and equipment soaring 4.4% per
the correction than most other countries. Since quarter. Construction investment rose even faster
the lows in May 2009, German exports have now in the second quarter, also reflecting the excep-
risen some 30%, nearly regaining pre-crisis levels. tionally long and cold winter, which put many
construction projects on hold until the second
Export demand likely to fade quarter.
Foreign demand for German goods may moder-
ate in coming months and in 2011 given that the Fiscal policy and the labor market “miracle”
fiscal programs launched in many countries A number of other factors also supported Germa-
worldwide in response to the crisis are set to ex- ny’s domestic demand. First, as noted, the Ger-
pire. While the German government implemented man government launched a big fiscal stimulus
its own significant measures to support the econ- package in 2009, topped only by the US, Canada
omy, the country’s export orientation meant that and Australia among the G7 economies. It may
it also benefited from the spending programs of have accounted for about 3% of 2008 GDP. The
its main trading partners. For example, Chinese impact of these measures should be visible in
demand for German-made goods accounted for 2009 and 2010 in roughly equal shares.3
only 2% of the 25% drop in German exports last
year. Yet orders from China contributed some 9%
to the 30% recovery, due in no small part to the
large Chinese fiscal stimulus package, of some
EUR 400 billion. 3
OECD (2009)
Fig. 1.4: German exports recovered rapidly

Exports as % of GDP
43
38
33
28
23
18
1995 1997 1999 2001 2003 2005 2007 2009 2011
Germany France Italy UK
Source: Reuters EcoWin, UBS WMR

The unexpectedly strong labor market also bu-

Fig. 1.5: Germany’s unemployment rate is falling rapidly
oyed domestic demand. Germany is the only
large economy where, after the global crisis, un- In %
employment is lower than before it. Indeed, as
13
Figure 1.5 shows, Germany’s unemployment rate 12
rose only 0.7% to a peak of 8.3%. It then edged 11
lower, averaging around 7.8% in the first half of 10
2010. In contrast, the Eurozone unemployment 9
rate rose by almost 3% during the crisis, and now 8
hovers at a high 10%. 7
6
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
This solid labor market performance, in our view,
reflects Germany’s exceptional social cohesion. Germany Eurozone
Companies asked employees to work part-time to
avoid large-scale layoffs. The government helped Source: Reuters EcoWin, UBS WMR
with short-shift subsidies to as many as 1.5 mil-
lion workers at one time. Payrolls have proven
relatively robust, expanding at a monthly rate of
Fig. 1.6: German house prices have remained stable
around 30,000 workers (equivalent to an annual-
ized rate of 1%) over the summer months. We House price index (1995 = 100)
think employment prospects are brightening as
200
companies’ hiring intentions are up sharply and
180
consumers’ unemployment worries are steeply
160
down. As workers went full-time again and, in
some cases, even to overtime, compensation per 140
employee recovered meaningfully in the first half 120

of 2010, which should support consumer spend- 100
ing in the coming months. 80
1995 1997 1999 2001 2003 2005 2007 2009 2011
Firms and households not overleveraged Germany Eurozone

Unlike many of its peers, Germany did not have a
housing bubble. As shown in Figure 1.6, German Source: Reuters EcoWin, UBS WMR
house prices have been stable throughout most
of this decade, while house prices in Spain and
Great Britain more than doubled. Of course, Ger-
Fig. 1.7: German households have improved their
man private households and, in particular, the
balance sheets
banking sector, were hurt by the bursting of Net assets of private sector excluding financial sector (% of GDP)
housing bubbles in other countries, but at least
300
there was no such bubble at home. In sum, Ger-
man households and companies do not hold ex- 250
cessive amounts of debt. German households and 200
firms did not expand their debt level over the last 150
decade, in contrast to many of its European 100
neighbors (see Figs. 1.7, 1.8, 1.9). 50
0
Interest rates too low 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Does all this mean that the German economy has Germany Eurozone (ex Germany)
de-coupled in a sustainable way from the other
developed economies? The answer is no. Germa- Source: Reuters EcoWin, UBS WMR
ny’s trade-dependence means that its growth
performance is clearly linked to that of its trading
partners. However, there is a final and, in our

Chapter 1
view, especially important factor supporting both

Fig. 1.8: German households were net lenders prior to
consumer spending and corporate investment is the recession
Germany’s historically low interest rates. The Eu- Net lending/borrowing of households, as % of disposable income, 2007
ropean Central Bank has cut its short-term policy
20
rate to a record low of 1%, particularly to support 10
those economies that are laboring from past ex- 0
cesses in their housing markets. For Germany, –10
however, current interest rates are clearly too low. –20
–30
Austria
Germany
France
Italy
Belgium
EU
Netherlands
US
Spain
UK
Ireland
Figure 1.10 shows so-called Taylor interest rates,
which combine data about economic activity and
inflation to indicate the appropriate level of short-
Gross household savings rate, 1995–2007 Gross household investment rate,
term interest rates. By this measure, current short- Net lending (+) / borrowing (–), 1995–2007 1995–2007
term interest rates are more than one percentage Note: Eurostat statistics in focus, 29/2009.
point too low for Germany. Source: Eurostat, UBS WMR
The upshot is that the German economy is over-

stimulated, a fact that should not be underesti-
Fig. 1.9: German companies were net lenders prior to
mated. Unduly low interest rates contributed the recession
greatly to the housing bubbles in Spain and Ireland, Net lending/borrowing of companies, % of gross value added, 2007
and triggered a more traditional consumption
40
boom in Greece. Earlier in the decade, suffering 30
20
from weak demand, Germany needed low rates. As 10
0
it accounts for roughly a third of the Eurozone –10
economy, the European Central Bank (ECB) set –20
–30
rates to fit Germany’s needs. These were clearly too –40
Netherlands
UK
Germany
Belgium
Ireland
US
Austria
EU
Italy
France
Spain
low for many of the other countries. We see an
increasing risk of some form of over-investment or
real estate bubble forming in Germany if interest
Gross fixed capital formation, 1995–2007 Gross savings, 1995–2007
rates remain so low for much longer. Net lending (+) / borrowing (–), 1995–2007
Note: Eurostat statistics in focus, 28/2009.
The recovery is a double-edged sword Source: Eurostat, UBS WMR

Germany’s strong economic rebound this year has
been greeted with mixed feelings among its neigh-
bors. As the biggest economy in Europe, it pushes Fig. 1.10: Taylor rate shows that interest rates are too
up demand for the products of other European low for Germany
countries. On the other hand, Germany’s export- In %
led rebound fuels the current account imbalances
6
that are at the heart of the sovereign debt prob-
5
lems facing some Eurozone countries. Ironically,
4
over the last few months, many in Germany have 3
chastised other Eurozone countries, most notably 2
Greece, for their “profligacy,” not realizing that 1
these excesses create the trade and current ac- 0
count surpluses that allow the German govern- –1
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
ment to run smaller budget deficits especially if, as
we believe, interest rates will remain too low for 3-month Libor Taylor rate for Germany
Germany for a considerable period of time.4
4
For a detailed discussion of these issues, please refer to
the August UBS research focus, entitled “The future of the
euro.”

Conclusions
Germany’s brisk recovery in 2010, likely ahead of
all major economies this year, will probably fade
somewhat in the second half and into 2011. Nev-
ertheless, Germany’s exceptionally strong export
position is bolstered by the weak euro, which
should remain a support for growth in the near
term. As long as global demand is buoyant, Ger-
many stands to benefit. These factors also sup-
port the domestic economy in this cycle.
Importantly, Germany is unburdened by the direct

effect of a burst housing bubble, and private sec-
tor financial balance sheets are generally strong.
The performance of the labor market has also
been impressive. Interest rates are an issue to
watch: They are too low for Germany and the risk
of a housing bubble cannot be ignored. But in
the near term, we think growth in Germany is
likely to surprise positively, in absolute terms and
compared with other economies.
The biggest risk to this favorable cyclical outlook

stems from any potential renewed slump in global
demand. For Europe as a whole, Germany’s re-
turn to strong growth this year is both a blessing
and a curse, as it raises economic activity across
the continent, while at the same time fueling
long-standing imbalances.

Chapter 2

Germany is the export champ of Europe. Its
brisk export-driven recovery underpins our
positive near-term outlook on the German
economy. In this chapter, we take a close
look at Germany’s export strength and con-
sider its benefits and its drawbacks.
Until this year, when it was surpassed by China,

Germany was the world’s biggest exporter of
goods. Between 1995 and 2007 exports in-
creased by 8% and imports by around 7% per
year, on average. The strong increase in both im-
ports and exports in recent years led to the emer-
gence of the so-called “bazaar theory,” according
to which Germany is increasingly becoming a
trading place for goods and services (see Box 1).
Surely, one major factor driving Germany’s export

growth has been the rapid expansion of the glo-
bal economy, which by extension increased the
market for Germany’s exports. Between 2000
and 2007, the size of the potential export market
(measured as the weighted sum of goods and
services imports by Germany’s trading partners)
increased by more than 50%. Other countries German goods fill
experienced similar increases in their potential Asian harbors
export markets, but what sets German exporters Germany’s export success is driven by
apart is their ability to maintain and in some cases cost-competitiveness …
increase market share in the face of growing Germany’s exceptionally strong export perform-
competition from low-cost emerging countries ance has generated much speculation about its
(see Figs. 2.1 and 2.2). sources. Most studies find that the market-share
gains resulted primarily from improvements in the
price-competitiveness of German products.
Fig. 2.1: Destination of German exports Fig. 2.2: Export market shares of the biggest exporters
% of total exports, 2008 % of total world exports
60 14
50 12
10
40
8
30
6
20 4
10 2
0 0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
EU-27
Eurozone
Non-
Eurozone
Asia
CEE
US
Oil exporters
China
Middle East
Russia
Africa
Japan
China Germany Japan US
Source: Federal Statistical Office, UBS WMR Source: WTO database, UBS WMR

Box 1: Germany’s export “bazaar”
The bazaar theory was first proposed by the influ- sufficiently to the levels of wages in the lower-
ential German economist Hans-Werner Sinn (Sinn, cost countries. As a result, Germany is gradually
2006). He argued that Germany is turning into a losing its production capabilities and degenerat-
trading place, or bazaar, as its share of production ing into a mere trading place, or bazaar.
content, in terms of total value added, diminishes.
According to Sinn, high and inflexible domestic Some economists dispute Sinn’s conclusions,
wages force German companies to respond to arguing that offshoring has not reduced the
low-cost competition by shifting parts of their pro- depth of production in Germany, but simply im-
duction to lower-cost countries. This output is then proved price competitiveness. What is more,
re-imported and the finished product is “Made in Marin et al. (2003) find that multinational firms in
Germany,” commanding a premium price. Germany are not outsourcing the low-skill parts
of production, but rather the most skill-intensive
While this is a normal consequence of globali- activities, often to Eastern Europe. This has impor-
zation, Sinn argues that it has gone too far. He tant implications for education levels in Germany,
feels it prevents domestic wages from adjusting which we will discuss in the next chapter.
Having adopted the euro in 1999 at a somewhat

Fig. 2.3: Weak wage growth in Germany
overvalued exchange rate, German exporters
Nominal and real wage growth, in %, y/y
sought to restore price competitiveness by push-
ing for wage moderation. As a result, wages grew 4
only very little in the first half of this decade. In 3
2008, the level of real wages, adjusted for infla- 2
tion, was virtually the same as in 2001 (see Fig. 1
2.3)1. Secondly, German companies also sought 0
to take advantage of lower production costs by
–1
off-shoring parts of their production chain, espe-
–2
cially to the Central and Eastern European (CEE)
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
countries (see Fig. 2.4)2.
Germany, real wages Germany, nominal wages
Eurozone, nominal wages
Fig. 2.4: Germany has gained price competitiveness

Real effective exchange rates (at unit labor costs)
1
The prolonged effort to contain costs through wage mod- 125
Falling price competitiveness
eration was diluted by the appreciation of the euro be- 120
tween 2002 and 2008. That means that Germany’s cost- 115
110
competitiveness improved primarily versus other Eurozone
105
countries, which explains the significant rise of Germany’s
100
export market share within the Eurozone.
95
2
Outsourcing and off-shoring can also explain the surge in 90
German exports to these countries as the foreign-based 85 Rising price competitiveness
subsidiaries or contracting firms are likely to have been 80
equipped at least in part with capital goods produced in 1994 1996 1998 2000 2002 2004 2006 2008 2010
Germany, and they are sourcing intermediate inputs from
there (Bundesbank, 2006a). Similarly, the sharp increase in Germany France Italy Spain
imports from Central and Eastern Europe might be ex-
plained by subsidiaries or contracting firms supplying inter-
mediate or finished products to German parent companies. Source: Reuters EcoWin, UBS WMR

Chapter 2
… and in the longer run by non-price factors

Fig. 2.5: German exports are focused on capital goods
In contrast to cost or price factors, non-price fac-
tors, such as quality improvements or efficiency % of total exports, 2009
gains, seemed to have played only a minor role
100
during the pre-crisis export boom. In the longer
run, however, non-price factors are important. 80
Thus, Danninger and Joutz (2007) show that ties 60

to fast-growing trading partners were an impor- 40
tant driver behind Germany’s export strength
20
from 2000 to 2005. In general, we think that
German companies benefit in particular from 0
their long-standing experience in overseas trade, Japan Germany EU-27 France Italy Spain US UK
their high degree of international integration, and Consumer goods & commodities Investment & intermediate goods
a product range geared towards investment (capital goods)
goods, which are in high demand, especially in Source: UN Comtrade, UBS WMR
the fast-growing emerging economies (see Figs.
2.5, 2.6 and 2.7).
Fig. 2.6: Composition of Germany’s exports
This is important, because if German exports were
growing only because of a surge in global invest- % of total exports, 2008
ment activity, then its export success would come

to an end as soon as either the global cycle ma- 17.5 Vehicles
tured or lower-cost competitors entered these Machinery
growth markets. However, with its reliance on Chemical products
cost-competitiveness and structural non-price 42.3 Iron and steel products
14.8
factors, we think Germany’s edge in international Electrical products
markets should be of a longer-term nature. Others
Export dependency increase economic 13.9

5.2
6.3
volatility
Germany’s export boom was halted by the global
economic crisis of 2008. In 2009, German exports Source: Federal Statistical Office, UBS WMR
registered their sharpest decline in postwar his-
tory. Indeed, with exports falling some 25% in
early 2009 compared to the previous year, Ger- Fig. 2.7: Destinations of exports in 2009
many suffered more than most comparable coun-
tries. The reason for this lies in the composition of % of total exports
German exports, which are, as we have seen, 100
strongly geared towards capital goods (machinery
80
and transportation equipment) and durable con-
sumer goods, such as automobiles. Demand for 60
such products can be easily delayed during times 40
of rising economic uncertainty, in contrast, for
20
example, to staples such as food and energy.
0
Companies usually freeze their investment Japan Germany EU-27 Italy US France UK Spain
projects when the economic outlook darkens, so China Major emerging markets * (ex China) Rest of world
demand for German-made investment goods Note: *Eastern Europe, Brazil, India, Indonesia, Russia
drops sharply. But when economic prospects Source: UN Comtrade, UBS WMR

improve again, capital goods orders also tend to

Fig. 2.8: German output growth is more volatile than in
rebound more strongly. Hence, Germany suffers comparable countries
more in the downturn, but also benefits more Standard deviation of industrial output change over the past 10 years
than most of its peers in an economic recovery.
8
7
Indeed, as can be seen in Figure 2.8, German
6
economic production is more volatile than that of
5
most of its neighbors. This is not a trivial dynamic.
4
Since the introduction of the euro, in 1999, about 3
80% of Germany’s real GDP growth – adjusted 2
for inflation – was generated from net exports 1
(see Fig. 2.9) and a quarter of Germany’s work- 0
force is employed in the export sector. Sharp Germany France US UK
swings in the economic cycle can, therefore, be a
real challenge, not least for fiscal and monetary Source: Reuters EcoWin, UBS WMR
policy makers.
Exporters face protectionism and low-cost

Fig. 2.9: Net trade was the key source of growth between
competition in the long-run
2000 and 2007
Germany’s exceptionally open trade posture
Real GDP, in % y/y and annual growth contributions
makes it susceptible to increased economic vola-
tility and the protectionist sentiment of its trading 4
partners. Given its export dependence, any trend 2

towards protectionism harms Germany more than 0
most of its peers. However, this is probably miti-
–2
gated to some extent by its specialization in high
quality investment goods and durable consumer –4
goods. These kinds of products resist easy substi- –6
tution. This could change, however. As Germany’s 1992 1994 1996 1998 2000 2002 2004 2006 2008
Asian trading partners reach a more mature stage Net trade Total real GDP growth
of development, their demand for capital goods Domestic demand
will likely diminish in favor of consumer goods. Source: Reuters EcoWin, UBS WMR
Also, Asian and in particular Chinese manufactur-

ers are moving up the value chain themselves, Fig. 2.10: Chinese exports focusing on capital goods
thus starting to encroach on Germany’s product
range (see Fig. 2.10). As a result, German manu- % of total exports
facturers face increasing competition from their

60
prime export markets, especially from China and
50
India, with their large pools of low-cost labor.
40
Hence, we doubt that German exporters can rely
30
only on cost-cutting to remain competitive in the
20
long term. Instead, they will have to focus on
10
innovation and efficiency to maintain their export
success, factors that we discuss in more detail in 0
1992 1994 1996 1998 2000 2002 2004 2006 2008
the next chapter.
Agricultural & commodities Intermediate goods
Capital goods Consumer goods
Source: UN Comtrade, UBS WMR

Chapter 2
Export orientation weakens domestic In general, saving is a good thing, as it forms the
consumption … basis for investment. Yet if savings are persistently
There is another problem with Germany’s export- higher than spending in an economy, it means
led growth model. It appears to weaken domestic that domestic savings go elsewhere and are una-
demand – both private household consumption vailable to finance investments at home. German
and corporate investment spending. The flip-side savings were invested in building up facilities in
of Germany’s price competiveness is low wage Eastern Europe. They also helped to fuel the con-
growth and high unemployment. The evidence struction and consumption booms in Greece,
regarding employment is less straightforward. Spain and Ireland. Some of these savings were in
While some (Sinn, 2006) argue that offshoring portfolios and found their way into low quality
increases domestic unemployment, others have financial assets. As the bubbles in southern
found no such effect in their research (Klodt, Europe burst, German savers – and the German
2004). However, there can be no doubt that banking sector, which had moved these savings
wage growth stagnated throughout most of this into the low quality assets – incurred substantial
decade, leading to exceptionally weak household losses.
consumption growth (see Fig. 2.11). Thus, the
perception remains that Germany is buying its Rebalancing the German economy
export success with a reduction or at least slower We think Germany needs a more balanced
expansion of its population’s overall living stand- growth model. This has been widely acknowl-
ards. edged by experts and policy makers. Yet most
pundits and politicians in Germany demand ad-
… and appears to drag on corporate invest- justments from deficit countries while striving to
ment further improve Germany’s export competitive-
Since the inception of the euro, German corpo- ness. This seemingly irrational behavior can be
rate investment spending has been unusually explained by considering Germany’s industrial
weak (see Fig. 2.12). In part, this reflects the and institutional structure as it has evolved over
growth of offshoring activities, which diverted time.
investments from domestic projects in favor of
CEE countries. We can also see this in the current The success of Germany’s export-oriented growth
account, which reflects all savings and spending model could be Germany’s own worst enemy. It
in the economy. Germany has been running sur- has created an almost invincible alliance of pow-
pluses throughout this decade, meaning that erful employers and unions who share a vested
German households have saved more than they interest in the model’s continuation. They have so
have spent (see Fig. 2.13). far been able to thwart any attempt to restructure
Fig. 2.11: Weak German consumer spending since 2002 Fig. 2.12: Corporate investment in France and Germany
Consumer spending and nominal wage growth, in %, y/y Index Q1 2000 = 100
10 130
8 120
6
110
4
100
2
0 90
–2 80
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Consumption Wages France Germany
Source: Reuters EcoWin, UBS WMR Source: Reuters EcoWin, UBS WMR

the German economy. Even though external fac-

Fig. 2.13: Increasing imbalances within the Eurozone
tors – in particular, the spending patterns of its
trading partners – will change, for the moment, Current account balances, in % of GDP
at least, Germany’s power brokers are insisting on
12
continuity. Also, it must be said, policies that pro-
8
mote a more balanced growth mix – for example,
4
through taxes, subsides or wages – risk weaken-
0
ing Germany’s competitiveness without suffi-
–4
ciently strengthening domestic demand. These
are issues to watch closely in Germany’s political –8
arena over the coming years. –12

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Conclusions Germany France Italy Spain

Germany is undoubtedly one of the world’s most
successful export economies. Its export strength is Source: Reuters EcoWin, UBS WMR
based on its ability to penetrate high-growth mar-
kets, especially in the CEE region and in Asia. Its
success also reflects its superior cost competitive-
ness, which has been achieved through corporate
restructurings and wage moderation. These ad-
vantages in foreign trade appear to be durable.
They should allow Germany to benefit more dur-
ing global cyclical upswings than most of its
peers.
However, export dependency has its drawbacks as

well. During economic downturns, Germany
tends to suffer more than countries that are less
dependent on global trade. Also, Germany’s
growth model may be vulnerable to protection-
ism, structural shifts in its main trading partners,
and growing cost competition. It is important to
note that Germany’s export success does not
seem to benefit the broad population. We think
achieving a more balanced growth model is one
of the country’s key challenges for the future.

Chapter 3
Germany faces long-term structural

challenges
Germany’s recent robust economic perform-
ance will not go unchallenged. In this chap-
ter, we look at structural trends, domestic
and foreign, that will influence Germany’s
long-term growth outlook.
Germany’s strong cyclical performance before

and especially after the global financial crisis has
diverted attention from its weak underlying eco-
nomic growth. Adverse developments in per-cap-
ita GDP, which is a common measure of living
standard, have also been papered over by the
good export news lately. In fact, the gap between
Germany’s per-capita GDP and the average of the
upper half of OECD countries actually widened
over the past decade (see Fig. 3.1) and total eco-
nomic growth between 1998 and 2007 averaged
just 1%, compared to over 2% in France and
around 3% in the UK and US. Indeed, according
to OECD estimates, Germany’s long-term growth
potential averaged just 1.2% in the period from
1998 to 2007 compared to 2.4% for the OECD
as a whole (see Fig. 3.2). The question is: How
will Germany’s growth potential develop in fu-
ture?
Demographic challenges
Demographics are an important factor determining The most recent projections assume that by 2060
a country’s long-term growth potential. Like many Germany’s population will decline from 82 million
other industrial countries, Germany faces pro- today to somewhere between 65 and 70 million
found, even unprecedented, demographic changes (see Fig. 3.3). From an economic point of view, the
in the coming decades. A persistently low birth demographic issue does not so much reflect the
rate over the past four decades or so, combined decline in the overall population as it does the shift
with rising life expectancy, make demographics an in the population’s age structure. In particular, the
inescapable economic issue. contraction of the potential labor force is the main
Fig. 3.1: Germany’s living standard slipped behind Fig. 3.2: Germany’s growth potential lagged behind
the OECD average
GDP per capita gap to upper half of OECD countries, in %, 2008
Potential GDP growth, in %
30 3.5
20 3.0
10 2.5
0 2.0
–10 1.5
–20 1.0
–30 0.5
Spain
Italy
Japan
France
Finland
Germany
UK
Canada
Netherlands
US
Norway
0.0
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Germany OECD
Note: Percentage gap to the simple average of the upper half of OECD countries in terms of GDP per capita in constant
2005 PPP.
Source: OECD (2009), UBS WMR Source: OECD, UBS WMR

problem, since this is the age bracket that contrib-

Fig. 3.3: Population expected to decline
utes to pension funds and tax revenues.
Number of persons
To illustrate the magnitude of the problem, the
85,000,000
old-age dependency ratio, which compares the
80,000,000
non-working population (those 65 and above)
75,000,000
and the prime working age population (15 – 64)
70,000,000
is expected to rise from 42 in 2008 to 73 by
65,000,000
2060. This means that, while 42 pensioners de-
pended on 100 workers in 2008, some 73 retirees 60,000,000
will claim benefits from the contributions of 100 55,000,000
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060
workers in 50 years (see Figs. 3.4 and 3.5).
The number of Germany’s workers could fall by Historical Lower limit Upper limit
around 28% between 2007 and 2060, which Note: From 2009 results of the 12th coordinated population projection.
would be an annual average drop of around 0.5%. Source: Federal Statistical Office, UBS WMR
Assuming this decline has a full impact on labor as
a production factor, the trend rate of GDP would
be reduced by an average of about one-third of a
Fig. 3.4: Dependence ratio increases
percentage point per year.1 Thus, Germany’s trend
Ratio of dependent people to working population, in %
rate of growth would soon turn negative, which
normally implies a contracting economy. 120
total dependency ratio
100
However, there are offsetting factors, such as the 80
growth in the capital stock and in total factor pro- 60 old-age dependency ratio
ductivity. In general, an economy’s potential 40
growth rate is determined by three factors: 20 young-age dependency ratio
0
● the quantitative input of labor (labor force 1950 1970 1990 2010 2030 2050 2070
potential) and capital (capital stock)
Note: From 2009 results of the 12th coordinated population projection.
● improvements in the quality of individual pro-
Source: OECD, UBS WMR
duction
● the efficient combination of the two factors

(total factor productivity) (see Box 2). Fig. 3.5: Strong increase in the number of older people
Population by age groups, in %

Germany’s long-term growth potential
We estimate that from 2011 to 2050 Germany’s 2008 2060
average potential growth rate will be about 0.9%
20 19 16
per year, assuming net immigration of 200,000 34
and no changes to the birth rate, the capital accu-
mulation rate and total factor productivity. The
61 50
aging effect on potential growth would be worst
towards the end of the 2020s and in the 2030s,
when the bulk of the baby boomers retire from Below 20 years 20 to 65 years 65 years and older
the labor force (see Fig. 3.6). Germany’s expected Note: From 2009 results of the 12th coordinated population projection.
potential growth rate compares unfavorably with Source: OECD, UBS WMR
1
The so-called output elasticity of labor, i.e. the effect of
labor supply changes on output, is typically assumed to be
two-thirds versus one-third for capital.

Chapter 3
Box 2: Determining potential growth
GDP readings can be regarded as a combina- The level of total economic output is given by:
tion of long-term production potential and a
shorter-term cyclical component. The produc- Yt = TFPt* f(Lt, Ct)
tion potential – or potential growth – of an
economy refers to the total economic output And the growth rate of total economic output is
that can be produced with the production fa- given by:
cilities, labor and capital that are available at
any given time. The calculation takes account ΔlnYt = ΔlnTFPt + a*ΔlnLt + (1 – a)*ΔlnCt
of technological progress and assumes that
capacity utilization is at long-term average Thus, the growth of total economic output is
levels. determined by the change in technological
progress (ΔlnTFPt) and the weighted growth rates
Output in period t (Yt) is derived from a combi- of the inputs of labor (a*ΔlnLt) and capital
nation of the input factors labor (Lt = potential ((1–a)*ΔlnCt). The weights correspond to the
labor force) and capital (Ct = capital stock). TFPt shares of income from labor (a) and from capital
(total factor productivity) captures the level of (1–a) in national income.
technology or technological progress.
The following diagram summarizes the various
factors affecting the variables in the economic
output equation:
Yt = TFPt • f (L t , C t)
Quality Quantity
Technological progress
Development of capital stock
= total factor productivity
Potential labour Participation Retirement Working hours

force rate age per employed person
Domestic
Immigrants
population
Birth rate Number

Birth rate

those of all other G7 countries, apart from Italy

Fig. 3.6: Germany’s growth potential
(see Figs. 3.7 and 3.8). We expect Germany’s Estimated growth potential and contributions, in %
per-capita GDP to grow by about 50% until
4
2050, compared with 65% for the G7 as a
whole (see Fig. 3.9). 3
2
Germany’s low birth rate
1
The diagram in Box 2 summarizes approaches to
counteract the demographically inducted de- 0
cline in the potential growth rate. The input
–1
factor labor, which typically accounts for about 1990 2000 2010 2020 2030 2040 2050
two-thirds of total output, offers most options
Population Hours TFP GDP per capita
for policy makers. Participation (aging) Capital GDP Labor productivity (GDP/hours)
Source: UN, Penn World Table 6.1, Groningen University, UBS WMR
Germany’s fertility rate, only 1.34 children per
woman of child-bearing age in 2008, has been
notoriously low for decades (see Fig. 3.10 and
Map 1). Without any net immigration, the fertil- Fig. 3.7: Potential growth rates for G7 countries
ity rate would have to be 2.1 to maintain the Estimated growth potential, in %
current population. Measures to increase the
4.0
fertility rate can only work very gradually and 3.5
their effects would not be felt for some 20 3.0
years, when the additional children enter the 2.5
2.0
labor market. Thus, most projections assume
1.5
only marginal changes in Germany’s birth rate in 1.0
future, with little effect on the population pro- 0.5
jections for the next 50 years. 0
1980 1990 2000 2010 2020 2030 2040 2050
Immigration can boost the labor supply Germany Japan France Canada
US UK Italy
The next option to boost the potential labor sup-
ply is immigration. This has been quite volatile in Source: UN, Penn World Table 6.1, Groningen University, UBS WMR
the past, but Germany has usually had net immi-

gration ranging between 129,000 and 354,000
persons annually since the 1950s. In the past five Fig. 3.8: Projected potential growth rates for G7 countries
years or so, net immigration has declined mark-
Average growth rates of total potential GDP, in %
edly. Between 2000 and 2007, annual net immi-
gration averaged 129,000. According to UN pro- 2.5
jections, Germany should attract net immigration
2.0
of around 200,000 people per year in future. Yet,
1.5
assuming an unchanged birth rate, the total pop-
ulation and the potential labor force can only be 1.0
maintained with an annual net immigration of 0.5
about 450,000. Thus, in order to offset the ef-
0.0
fects of Germany’s low fertility rate, net migra- Japan Italy Germany France UK US Canada
tion would need to more than double in future,
which seems highly improbable. To get a sense of 2011–2020 2021–2040 2041–2050
the impact on potential growth, we estimate that
without immigration, Germany’s potential Source: UN, Penn World Table 6.1, Groningen University, UBS WMR
growth rate would fall to below 0.5% by 2050

compared to the 0.9% with net immigration of
around 200,000 people.

Chapter 3
Raising the labor market participation rate Map 1

An effective and potentially quick way of counter-
Natural population change (live births minus deaths),
acting the deteriorating demographics would be to by regions, average 2003–07
boost the labor market participation rate and to per 1,000 inhabitants
extend the effective working hours of those who < = –6.0 0.0 – <= 2.5
–6.0 – <= –3.0 2.5 – <= 5.0
are employed.2 The participation rate measures the
–3.0 – <= –1.0 5.0 – <= 10.0
actual labor force (employed plus registered unem- –1.0 – <=0.0 > 100
ployed persons) as a share of the potential labor DK: average 2006–07
force (everyone between ages 16 and 64). How- UK: average 2003–06
ever, Germany already has one of the highest labor

market participation rates in Europe, surpassed
only by the Netherlands, Denmark and Sweden.
The same is true for Germany’s female labor mar-
ket participation rate, which at 70.2% in 2008
stood above the EU average of 63.4%, and the
young age participation rate (15 to 24), which at
51.5% in 2008 was lower, for example, than in
Austria (61.5%) and the Netherlands (72.7%), but
still higher than the EU average at 44.6%. In short,
there is some scope to raise labor market
participation rates in Germany, but it appears to be
more limited than in most other countries.
2
One way to increase labor input would be to reduce struc-
tural unemployment. However, it is important to note that
this would not increase the growth potential, which is Source: Eurostat, UBS WMR
based on the potential labor force (including both the em-
ployed and the unemployed), but can only exert an effect
on actual economic growth. Raising the participation rate
means integrating the part of the working age population
into the labor force that has so far not been available to the
labor market.
Fig. 3.9: Projected GDP per capita growth rates Fig. 3.10: Germany has a low fertility rate
Average GDP per capita growth rates, in % Number of births per woman
1.6 2.5
1.4
2.0
1.2
1.0 1.5
0.8 1.0
0.6 0.5
0.4
0.0
0.2
0.0 –0.5
Germany Italy Spain EU Netherlands UK France
Japan US Italy Germany UK France Canada
2011–2020 2021–2040 2041–2050 2008 2008–2060

Note: 2008–2060 projection by the EU Commission.
Source: UN, Penn World Table 6.1, Groningen University, UBS WMR Source: EU Commission (The 2009 Ageing Report), UBS WMR

One obvious approach to the aging problem Table 1: German pension age is close to OECD average
would be to raise the minimum age for claiming a Average effective age of retirement versus the official age, 2002–2007
pension in line with the increase in life expect- Men Women
ancy3. However, in comparison to other major Effective Official Effective Official
European countries, Germans already appear to Iceland 68.9 67 Portugal 65.5 65
retire rather late, as can be inferred from the rela- Portugal 66.6 65 Iceland 65.3 67
tively high labor market participation rate of per- New Zealand 66.5 65 Ireland 64.9 65
sons aged 55 to 64, which stood at 60.3% in Sweden 65.7 65 Turkey 64.3 58
2008 compared to only 48.9% for the average of Ireland 65.6 65 Switzerland 64.1 64
the 27 European Union countries (see also Table 1). Switzerland 65.2 65 United States 63.9 65.8
While this is in principle a favorable comparison United States 64.6 65.8 New Zealand 63.9 65
for Germany, the potential for further improve- Australia 64.4 65 Norway 63.2 67
ments here as well appears to be more limited Norway 64.2 67 Spain 63.1 65
compared to the rest of the EU. We have simu- Turkey 63.5 60 Sweden 62.9 65
Denmark 63.5 65 Australia 62.2 63
lated two different scenarios in order to estimate
Canada 63.3 65 United Kingdom 61.9 60
the effect of higher retirement ages on German
United Kingdom 63.2 65 Canada 61.9 65
productivity. In our first scenario, we estimate that
Greece 62.4 58 Netherlands 61.3 65
making the retirement age two years higher by
Czech Republic 62.2 62 Denmark 61.3 65
2020 would lift the potential growth rate only Germany 62.1 65 Finland 61.0 65
marginally, to 1% on average by 2050. In our Netherlands 61.6 65 Germany 61.0 65
other scenario, making the pension age five years Poland 61.4 65 Greece 60.9 58
higher by 2050 would yield an average potential Spain 61.4 65 Italy 60.8 57
growth rate of 1.1%. Thus the overall impact Italy 60.8 57 Luxembourg 60.3 65
would be quite small, with the effect being felt Finland 60.2 65 France 59.5 60
more strongly until about 2035. After that, the Hungary 59.7 62 Czech Republic 58.5 59
labor force would shrink more rapidly, as the baby Belgium 59.6 60 Belgium 58.3 60
boomers finally leave the labor force. Slovak Republic 59.3 62 Hungary 58.2 60
Luxembourg 59.2 65 Austria 57.9 60
Germans work short hours Austria 58.9 65 Poland 57.7 60
The factor labor can also be increased by means of France 58.7 60 Slovak Republic 54.5 62
longer working hours. Here, it would appear that OECD average 62.7 63.7 OECD average 61.4 62.8
Germany has the most scope for adjustment. Ger-
many and the Netherlands have the shortest work-
ing hours in the developed world. Weighing in at
just over 1,300 hours, Germans’ annual working lift the potential growth rate to around 1.4% by 2050 com-
time falls nearly 470 hours short of the US and 160 pared to 1.1% with unchanged hours. The average potential
hours below their French neighbors. Given that growth rate would rise from 0.9% to 1.2%, still below our
weekly hours in Germany are in line with the Euro- expectations for the G7 countries as a whole. To match the
pean average (but some two to three hours below expected G7 average growth potential of 1.6% over the period
the US and the UK), this annual discrepancy is Germany would need to return to the 2’000 annual working
largely attributable to more paid holidays and more hours seen in the late 1960s.
part-time employment in Germany. Indeed, so-
called atypical employment, including part-time Capital stock and efficiency
employment and small scale self-employment, has A decline in the supply of labor can, in principle, be compen-
risen rapidly over the past decade. sated by increased capital accumulation, that is, higher capital
If average annual hours in Germany could be in- input. Yet, as an input factor in total production, labor carries
creased by around 200 placing them roughly in much more weight than capital, meaning that a drop in the
line with the European Union average, this would input of labor has to be compensated by a much stronger rise
in the capital stock. To achieve this, measures may be taken to
attract capital investments from abroad, which would also con-
3
Germany is planning to raise the pension age gradually to tribute to a reduction of the external imbalances, for example,
67 years the persistent current account surplus discussed in Chapter 2.

Chapter 3
There also appears to be some scope for improv-

Fig. 3.11: Germany is among the most innovative
ing Germany’s attractiveness for international countries in the EU
investments. Despite some progress in reducing Innobarometer, PRO INNO Europe, 2009
anti-competitive product regulations, Germany
0.7
remains more heavily regulated than many other
0.6
countries, ranking 14th out of 28 countries on 0.5
the OECD’s Product Market Regulation indicator, 0.4
16th on barriers to entrepreneurship and 20th on 0.3
0.2
barriers to trade and investment. The picture is 0.1
confirmed by the 2010 edition of the World 0.0
Netherlands
Spain
Greece
Switzerland
Sweden
Finland
Germany
UK
Austria
Ireland
France
EU-27
Czech. Rep.
Portugal
Italy
Bank’s Doing Business survey, which ranks Ger-
many only 102 out of 181 countries in the survey.
Other factors hampering capital investments in-
clude the relative lack of venture capital and pri- Innovation leaders Innovation followers
vate equity investment in Germany. Source: PRO INNO Europe, UBS WMR
Strong on innovation, but there are risks

Innovation is another important way to improve
Fig. 3.12: German enterprises are most innovation-focused
labor efficiency and potential growth. In most in Europe
country rankings, Germany ranks in the upper Enterprises engaged in innovation as share of all enterprises, in %, 2006
range of innovation performance (see Figs. 3.11
70
and 3.12)4. In general, Germany tends to perform 60
fairly well in terms of new patents. For example, 50
OECD figures show that German companies file 40
30
the third-highest number of patents in medium-
20
high and medium-low technology sectors, after 10
Switzerland and Sweden, while in high technol- 0
Germany
Belgium
Finland
Austria
Ireland
Sweden
Portugal
Greece
EU
UK
Netherlands
Italy
Spain
ogy sectors they rank eighth. However, financing

and government support for innovation projects
are typically just about or even below average in
Germany 5. These weaknesses are worrisome, as Note: From Eurostat Statistics in Focus 33/2009.
they could endanger Germany’s strong position in Source: Eurostat, UBS WMR
the long run. Indeed, some indications suggest
that Germany’s innovation potential is already
diminishing. Thus, in the 1990s, German compa- Fig. 3.13: Germany spends below average on education
nies filed 4.8 patents per million workers each
year. Yet, in the period from 2000 to 2006, this Public spending on education as % of total public expenditure
ratio has come down to only 0.25 patents per 16

million workers per year.
12
4
The Innovation Indicator by Rae and Sollie (2007) ranks 4
Germany 11th out of 27 OECD countries.
5
OECD (2010a) 0
US UK Spain France Germany Italy
Total spending on education Spending on tertiary education
OECD average (total) OECD average (tertiary education)
Note: From Education at a Glance, 2010.

Education is the key Map 2

In an increasingly knowledge-driven global econ- Educational attainment level by regions, 2007
omy, human capital is a major factor for a coun- Percentage of the population aged 25–64 having tertiary education
try’s competitiveness, especially in terms of inno-

< = 12.5 Data not available
vation. The latest OECD report on education gives 12.5 – <= 20.0
cause for some concern. Thus, according to the 20.0 – <= 27.5
OECD the number of students taking up univer- 27.5 – <= 35.0
sity-level education in Germany is still well below > 35.0
the OECD average and especially well below that

of Germany’s main peers (see Map 2). Also, on
the funding side, the OECD figures show that Ger-
many spends below OECD average on education
(see Fig. 3.13). Finally, regarding the quality of
education, the OECD’s PISA study for 2006 shows
mostly only average results for Germany, despite
some improvement on earlier assessments.
Interestingly, the PISA report shows that students
that were born abroad (first-generation immi-
grants) scored much worse than their German
peers. The difference in academic attainment was
about twice as big as the OECD average. Impor-
tantly, the performance difference remained the
same for second-generation immigrants, which
may reflect difficulties with the integration of
immigrants in Germany.
This relates to a further problem of education in Source: Eurostat, UBS WMR

Germany: the unfavorable skill-mix between emi-
grants and immigrants and the emerging brain
drain. Thus, while Germany is an important
source of highly skilled migrants to countries such ade. Germany’s rapidly aging society, which com-
as the United States and Switzerland, it does not pares unfavorably to most of its peers, is a key
attract a sufficiently high number of comparable challenge to its growth potential. The results of
foreign workers. The proportion of highly edu- Germany’s very low birth rate are practically irre-
cated migrants is lower in Germany than in many versible now, especially since immigration will
other OECD countries. probably not be able to stabilize the population.
Labor market participation is already quite high,
This unfavorable skill mix is partly related to the meaning that the potential to offset the decline in
strong recruitment of low-skilled labor in the population by expanding the potential labor force
postwar economic boom, which triggered addi- is limited. However, annual working hours are
tional low-skilled immigration in later decades very low in Germany and could be raised to partly
through family connections. These problems offset the negative effects of a shrinking labor
would need to be addressed via a comprehen- force. Capital accumulation, which in theory
sive immigration policy that allows the country could substitute labor, will, in our view, not be
to attract more highly skilled workers from raised significantly. However, there would seem to
abroad. be scope for improving total productivity, by
countering adverse trends in Germany’s innova-
Conclusions tion potential and by continuing reforms of the
Germany’s strong cyclical growth before and after education system, including the implementation
the global recession has diverted attention from of an immigration policy that attracts highly edu-
its weak average growth performance this dec- cated immigrants.

Chapter 4
As we have shown in the previous chapters,
the structure of the German economy brings
with it certain advantages and threats. These
structural characteristics also have implica-
tions for investments in German equities and
bonds.
The cyclical story in the stock market and

beyond
The German stock market rebounded sharply
alongside the global economic recovery, initially on
improving business sentiment (see Fig. 4.1) and
later, with muted momentum, based on real eco-
nomic data. As discussed in previous chapters,
exports are traditionally an important driver of the
German economy. In fact, there has been a good
correlation between exports and DAX and MDAX 1
movements since 2003 – with the exception of the
2008 financial crisis.
automobiles), and Materials sectors account for
Taking a regional share index and breaking it roughly 45% of the German market, compared
down into its sector components gives a general with only 32% of the Eurozone market. The cycli-
picture of how cyclical the index is, and hence cal nature can also be seen by the higher volatility
how it is likely to perform during different phases of the German stock market compared to the US
of the economic cycle. The German equity market market on average.
exhibits a higher weighting in cyclical sectors than
the Eurozone does overall (see Fig. 4.2), making it Moreover, the relatively weaker euro should sup-
a beneficiary of supportive macroeconomic data. port foreign demand for German products. It also
The Industrials, Consumer Discretionary (primarily boosts exports to the emerging markets, which
make up an increasing share of German exports
and bring the added benefit of strong growth po-
tential. Even if the euro were to strengthen, we
1
The DAX is a blue chip stock market index of 30 major think German companies should still be competi-
German companies. The MDAX (mid-cap DAX) included 50
Prime Standard shares from sectors excluding technology tive at higher exchange rate levels, as we have
that rank below the companies included in the DAX. seen in Chapter 1.
Fig. 4.1: German stocks are correlated with business climate Fig. 4.2: More cyclical than the Eurozone
Ifo Business Climate Index (lhs) vs. DAX (rhs) Sector diﬀerential MSCI Germany vs. MSCI EMU, in %
110 9,000 8.0

105 8,000 6.0
4.0
100 7,000 2.0
95 6,000 0.0
90 5,000 –2.0
–4.0
85 4,000 –6.0
80 3,000 –8.0
Materials
Healthcare
Consumer
Discretionary
Industrials
Information
Technology
Utilities
Telecomm.
Services
Consumer
Staples
Financials
Energy
75 2,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Ifo Business Climate DAX Index
Source: Bloomberg, UBS WMR Source: Factset, UBS WMR

In addition to these cyclical factors, Germany is better in the following six months, with almost
currently benefiting from good consumer senti- 80% of observations showing an average per-
ment. This should fuel domestic consumption, formance of 6.1%.
which could also be supportive for the stock mar-
ket even if export momentum fades. ● But what if the Ifo Business Climate Index
started to trend downwards from high levels?
An Ifo at peak levels must not translate into In the 31 cases since 1990 where the Ifo fell
weak equity markets while in the range of 100 to 110, the three
In order to find out how the German stock mar- months stock market performance after the
ket is geared to the economic cycle, we investi- release turned out to be slightly positive. How-
gated the degree of correlation between the ever, after six month the average performance
MSCI Germany2 and one of the most important was negative.
domestic economic indicators, the Ifo Business
Climate Index. This monthly survey of diverse Put simply, a lowering Ifo index could indicate
industry representatives gives a good overview of slowing growth, but this will not necessarily trans-
the current state of the economy as well as busi- late into poor performance for the MSCI Ger-
ness prospects for the next six months. many index. In fact, the German stock market has
historically performed well as long as the indica-
According to the September data, both expecta- tor remained in boom territory.
tions and the assessment of the current situation
remain at multi-year highs, which means that the Keep an eye on medium-sized companies
German economy continues to be in the boom Having shown that Germany is currently the
territory according to the Ifo business cycle clock growth engine of Europe, and why we believe that
(see Fig. 4.3). Given the high levels, a sideways economic growth will remain robust over the com-
movement or even a regression becomes more ing years, we expect the large-cap DAX index to
likely, as economic growth momentum seems to perform quite well. The mid-cap MDAX also pro-
be slowing already. Our base case scenario sees vides interesting opportunities. We would advise
the economy turning to a more moderate growth long-term investors with a higher risk tolerance to
path, hence we think the Ifo index is unlikely to put some money in the mid cap segment of the
backslide severely. equity market.
What would this scenario mean for the perform-

ance of the German stock market? We looked to
historical precedent for an indication. Although
we do not expect the past to repeat itself, there
are episodes that bear more than a passing re-
semblance to the current situation. Looking at
patterns since 1990, we found that when the Ifo Fig. 4.3: The Ifo business cycle clock
index ranged between 100 and 110, the MSCI
Germany was likely to follow one of two trajecto- Ifo current assessment and Ifo expectations over the last 24 months
ries: 110
upswing boom
105
Ifo expectations subindex
Sept. 2010
● If the Ifo trended sideways, which it has 100
started to do with its September release, in 95
two-thirds of all observations the stock market 90
showed a positive performance in the follow- 85
ing three months (with an average of +3.2% 80
over the period). Results were even slightly 75
recession downturn
70
80 85 90 95 100 105 110 115
Ifo current assessment subindex
2
The MSCI Germany is a broad equity index including
50 companies. Source: Ifo Konjunkturtest, UBS WMR

Chapter 4
Medium-sized firms benefit from emerging

Fig. 4.4: Sales distribution of MDAX companies by region
markets demand
The MDAX index tracks the mid-cap segment and In %
comprises 50 companies. On average, the compa-
nies in this index generate about a third of their
revenues in Germany (see Fig. 4.4). Our expecta- 8.2
Germany
tions for a more robust domestic economy, as 13.3 32.9 Europe ex Germany
discussed in Chapter 1, should support the earn- US
ings growth of German companies, and their EM Asia
stock prices. 14.5
RoW
However, the future of global economic growth 30.7

lies with emerging markets. These countries face
less sovereign debt problems and therefore less
fiscal tightening, and they have healthier banking Source: Commerzbank, Thomson Reuters, UBS WMR
systems and more favorable demographics. In
terms of revenue, investors in medium-sized com-
panies achieve a slightly higher exposure to de-
Fig. 4.5: Higher industrial share in MDAX
mand from emerging markets – especially devel-
oping Asia – than they would with an investment DAX vs. MDAX, in %
in the DAX. Investments in this market segment 30.0
are thus more geared to strong economic mo- 24.0
mentum than in the large caps. 18.0
12.0
Financials share is low among mid caps 6.0
This feature also reflect the sector composition of 0.0
the equity market segments. The MDAX is heavily –6.0
geared to Industrials and has a much lower –12.0
Industrials
Consumer
Discretionary
Materials
Energy
Consumer
Staples
Health Care
Information
Technology
Telecomm.
Services
Financials
Utilities
weight in Financials than the DAX (see Fig. 4.5).

We believe that there is still a lot of pent-up de-
mand for capital goods after the financial crisis.
Accordingly, we see especially smaller sized com- Source: Factset, UBS WMR
panies as the beneficiaries of a multi-year capital
spending cycle. With all the regulation like Basel
III imposed on the banking sector and sovereign
debt issues still lingering, direct exposure to these
factors can be reduced by choosing an invest-
ment in the MDAX.
Cyclical mid caps even benefit from slow

growth
Medium-sized companies show a higher sensitiv-
ity to the economic cycle. Accordingly, although
they suffer more than large caps in downturns,
they usually perform particularly well in an up-
swing. When leading indicators lose momentum
but growth remains robust, mid caps can still
perform relatively well, as seen between 2003
and 2006. In our view, medium-sized companies
offer attractive opportunities for long-term inves-
tors who can bear temporary setbacks caused by
volatile economic data. The difference between

mid and large cap performance is likely to be-

Fig. 4.6: Global economic expansion supports MDAX
come less pronounced when global economic
US purchasing manager sentiment (ISM) index above 50 signals expansion;
momentum slows and risk aversion rises, however diﬀerence in yearly change of MDAX and DAX in percentage points
(see Fig. 4.6). Index in %
70 40
65 30
German interest rates at the most
60 20
depressed levels since Bismarck
55 10
The post-financial crisis period will be remem- 50 0
bered for decades as a time of ultra-low interest 45 –10
rates. This holds true not only for the ECB’s policy 40 –20
rate, but also for Bund yields. Ever since rates 35 –30
were first recorded in 1871, when the German 30 –40
empire was founded and Bismarck was appointed 1989 1992 1995 1998 2001 2004 2007 2010
its Imperial Chancellor, yields on 10-year govern- ISM Manufacturing MDAX relative to DAX
ment bonds have never been lower than they are Source: Thomson Reuters, UBS WMR`
today (see Fig. 4.7). Even more relevant for the
economy, inflation-adjusted real interest rates are
well below their 50-year average.
Fig. 4.7: 10-year government bond yields at lowest level
since Bismarck
After the Lehman collapse in the midst of the In %
financial crisis, 10-year interest rates fell to 12
around 3%. But now that the global economy
10
has found its way out of the woods and equity
markets have recovered, interest rates are down 8
another 100 bps, close to 2%. What is pushing 6

bond yields lower and bond prices up? 4
2
Three main factors are contributing to the current
low interest rate environment: 0
1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
● Consumer price inflation remains at subdued end of month yearly average
levels and will likely stay low in the coming Source: Reuters EcoWin, UBS WMR
year. Hence, investors are demanding a low
premium for future inflation. In addition, inves-
tors have accounted for slower trend growth
Fig. 4.8: Positive correlation between equities and
going forward. As discussed in Chapter 3, we bond yields has broken down since mid-2009
agree with this growth outlook for the Ger- In % Index
man economy. 8 9,000
● The ECB’s ultra-loose monetary policy is keep- 6 7,000

ing a lid on interest rates.
4 5,000
● Some of the Eurozone’s member states face 2 3,000

challenging times ahead. Investors started
questioning the sustainability of the peripheral 0 1,000
2000 2002 2004 2006 2008 2010
countries’ public debt late last year, and called
10-year Bund yields DAX-30
for higher risk premia. As a consequence, in-
vestors sought the relative safety of German Shaded area: periods of strong negative correlation between equity markets return and bond yields
(measured by 180day rolling correlation)
government bonds, which explains the recent Source: Reuters EcoWin, UBS WMR
decline in bond yields. While risk aversion on
bond markets was certainly high and has even
increased of late, it did not spill over to equity

Chapter 4
markets. Bund yields and equities are currently Conclusions

negatively correlated, meaning that one rises Our outlook for German equities is positive: they
as the other falls. This is a rather rare phenom- should benefit from the global recovery even if it
enon. In the past, such a constellation has continues at a more moderate pace going for-
typically been resolved by a sudden increase in ward. If Germany manages to turn its economic
yields, rather than a drop in equity prices (see structure more towards consumption, the cyclical
Fig. 4.8). swings of the stock market might also be less
pronounced in the future. In any case, it seems
While there are some factors in place which speak prudent to add some consumer-related stocks to
for low interest rates, their current extreme levels German portfolios, as the biggest bounce of the
seem hard to justify given the positive near-to me- global economy lies behind us and the German
dium term outlook for the German economy. With consumer seems to be in a good mood – not
soft factors like high risk aversion calling the shots, least thanks to the favorable labor market condi-
the bond market is subject to changes in risk senti- tions. A return to recession – though not our base
ment, which usually happen faster than changes in case – could have severe negative effects on Ger-
fundamental factors. While we would not rule out man equities due to their cyclical bias. German
that German Bund yields fall even further, we see a government bonds rank among the safest in the
good chance for yields to finally pick up: not least Western countries. However, current yield levels
because the European Central Bank (ECB) is in our lead us to conclude that longer-dated maturities
view not likely to start raising the policy rate before should be avoided and that investors should seek
mid-2011, and, as we set out in Chapter 1, the alternatives beyond government bonds.
recovery in Germany is likely to continue. Long-
term interest rates usually react quite a bit in ad-
vance of the first rate hike in a tightening cycle.
The implications for investors are manifold. Most
importantly, we think bond investors will face much
more challenging conditions in the future. The
bond bull market that has been in place for at least
the last 20 years seems close to an end. Given that
the prices of long-dated bonds react more strongly
to a given change in yields, we recommend avoid-
ing longer-term government bonds.
Conservative investors might find more value in

government bond alternatives. Luckily, the Ger-
man market offers a broad spectrum of risk sub-
stitutes, most notably covered bonds (mostly
Pfandbriefe) and bonds from agencies or the Ger- Fig. 4.9: Government bonds and alternatives dominate
man Länder (see Fig. 4.9). We advise more per- the German bond market
formance-oriented investors to prefer corporate Structure of German bond market in % of outstanding bonds
bonds, since their performance is not just driven
by interest rate changes, but also the credit qual-
12
ity of the issuer. Bunds
32
Local Governments*
In the longer run, interest rate and bond market 16
Banks
developments will also depend on the future
Corporates
course of the 16-country-Eurozone. We provide 7 Agencies, others*
a brief discussion of some of the relevant aspects 9
Pfandbriefe*
in Box 3 (see page 32). For more detailed infor- 24
mation, please refer to the August 2010 UBS
research focus, “The future of the euro.” Note: *marks alternatives to Bunds (government bonds)
Source: Deutsche Bundesbank, Kapitalmarktstatistik August 2010

Box 3: If Germany were to leave the Eurozone
The fiscal crisis in Greece and the precarious exist. We think voluntary exchange offers are the
fiscal situation in other Eurozone countries is most likely way that issuers could re-denominate
ultimately due to persistent current account without facing legal difficulties. However, nu-
imbalances. As we have argued in the August merous obstacles stand in the way of determin-
2010 UBS research focus “The future of the ing which bonds may be re-denominated, as
euro“, one, surprising solution would be for some companies use foreign issuance vehicles
Germany to quit the euro. Clearly, this is a risk and some may want to keep their bonds in euro
scenario, but if Germany exited the Eurozone if part of their revenues remains in Euro. We
and had its own currency, its government think short-term bonds could be covered by a
bonds may actually become even more attrac- transition period, and long-term bonds of na-
tive as euro investors would be tempted to tional and local governments are most likely to
benefit from a likely appreciation of this new be exchanged.
currency. Germany’s short-term policy rates
would also likely need to be higher to fight It is important to note that export-oriented com-
inflation than they would in the weaker re- panies could suffer as a new German currency
mainder of the Eurozone. A German exit from would potentially appreciate strongly and this
the Eurozone would also have consequences would undo the present currency advantages for
for outstanding bonds of German issuers. domestic exporters. Thus the short-term impact
of Germany leaving the Eurozone would probably
Most bond documentations do not contain a be negative, while longer-term performance
clause allowing an issuer to re-denominate would depend to a large extent on the global
into another currency, especially when the economy, structural developments and domestic
currency defined for payments continues to consumers.

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Selected UBS WMR publications
UBS research focus: UBS research focus:
The rush for resources chal- The future of the euro
lenges emerging markets In 2009, at the euro’s 10-year anni-
Despite the recent economic slow- versary its inception was hailed as a
down, resources are becoming resounding success. Yet, the “Great
scarcer again. Emerging markets are Recession” has provided a severe jolt
in the spotlight – their resource to the currency’s credibility. In many
demand has risen sharply. Resource Eurozone countries, deficit and debt
use and resulting scarcities can have levels have surged to unprecedented
adverse environmental and social heights and investors are concerned
consequences for emerging markets, with the apparent cracks in the
and may act as a drag on economic union. We believe that, in the long-
growth. Finding solutions to mitigate term, the Eurozone may need to be
the adverse effects and to make reshaped, meaning that some coun-
growth more sustainable will, in our tries may have to leave the euro for it
view, offer interesting opportunities to survive.
for companies and investors.
32 pages A4; English, German, French,
36 pages A4; English, German, French, Italian, Russian; August 2010.
Italian, Spanish, Portuguese; SAP No. 82092E-1005
September 2010.
SAP No. 82092E-1006
Global outlook UBS investor’s guide

4th Quarter 2010 This research publication appears
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lication from UBS Wealth Manage- mation and forecasts which are
ment Research that provides a com- important for the financial planning
prehensive assessment of the global and investment decisions of active
macroeconomic outlook, key invest- Wealth Management clients. UBS
ment opportunities and important investor’s guide gives the back-
financial market risks. The report is ground to UBS’s current investment
published quarterly. strategy and the latest global eco-
nomic developments, together with
20 pages A4; English, German, French, market analyses and recommenda-
Italian, Spanish, Portuguese, Chinese tions for equities, bonds, currencies
traditional, Chinese simplified and Russian; and the emerging markets. Please
September 2010. ask your client advisor.
SAP no. 83351E-1003
56 pages A5; English, German, French,
Italian, Chinese (traditional and simplified);
September 2010.
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UBS Research Focus Germany in Fast Lane

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UBS Research Focus Germany in Fast Lane

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UBS research focus

Wealth Management Research

Germany in the fast lane

The return of the Teutonic Tiger

2 Germany in the fast lane

Andreas Höfert Dirk Faltin

UBS research focus October 2010 3

Germany in the fast lane

Export strength – blessing and curse

4 Germany in the fast lane

Labor market participation is already quite high, Investing in Germany

Germany Eurozone China Germany Japan US

UBS research focus October 2010 5

The return of the Teutonic Tiger

Germany has been surprising people lately. The

In this UBS research focus we take a close look at

6 Germany in the fast lane

German exporters have also had a boost lately

0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6

UBS research focus October 2010 7

Fig. 1.4: German exports recovered rapidly

Germany France Italy UK

Source: Reuters EcoWin, UBS WMR

8 Germany in the fast lane

The unexpectedly strong labor market also bu-

employee recovered meaningfully in the first half 120

Firms and households not overleveraged Germany Eurozone

cessive amounts of debt. German households and 200

UBS research focus October 2010 9

view, especially important factor supporting both

point too low for Germany. Source: Eurostat, UBS WMR

The upshot is that the German economy is over-

The recovery is a double-edged sword Source: Eurostat, UBS WMR

10 Germany in the fast lane

Importantly, Germany is unburdened by the direct

The biggest risk to this favorable cyclical outlook

UBS research focus October 2010 11

Export strength – blessing and curse

Until this year, when it was surpassed by China,

Surely, one major factor driving Germany’s export

China Germany Japan US

12 Germany in the fast lane

Box 1: Germany’s export “bazaar”

Having adopted the euro in 1999 at a somewhat

Source: Reuters EcoWin, UBS WMR

Fig. 2.4: Germany has gained price competitiveness

UBS research focus October 2010 13

… and in the longer run by non-price factors

Thus, Danninger and Joutz (2007) show that ties 60

ment activity, then its export success would come

Export dependency increase economic 13.9

14 Germany in the fast lane

improve again, capital goods orders also tend to

Exporters face protectionism and low-cost

partners. Given its export dependence, any trend 2

Also, Asian and in particular Chinese manufactur-

facturers face increasing competition from their

Source: UN Comtrade, UBS WMR

UBS research focus October 2010 15

16 Germany in the fast lane

the German economy. Even though external fac-

arena over the coming years. –12

Conclusions Germany France Italy Spain

However, export dependency has its drawbacks as