Germany Is Asking Itself The Wrong Questions

We’re probably asking the wrong questions about the German economy.

Since the onset of hostilities in Ukraine in late February, economists, analysts and every pundit with a platform was keen to insist that a complete embargo on Russian energy was a nonstarter in Berlin — an economic death sentence.

Although there are other holdouts, Berlin’s reluctance to countenance an import ban is the main hurdle for a bloc-wide embargo. There’s no guarantee a deal could be struck even with Olaf Scholz’s blessing, but absent German participation, the idea is merely a pipe dream (figuratively and, in this case, literally).

Certainly, Germany’s dependence on Russian gas means any effort to punish the Kremlin for military aggression by way of curtailed energy imports is destined to be an exercise in cutting off one’s nose to spite one’s face in the near-term. The familiar figure (above) shows why.

On Wednesday, the consortium of economic institutes that advises the German government quantified that near-term risk and downgraded their 2022 GDP outlook.

“In the baseline scenario, Germany’s gross domestic product increases by 2.7% in 2022,” the new report said. That forecast was an extremely robust 4.8% in the autumn outlook.

“The main reasons for the revision are the war in Ukraine and the worse-than-expected course of the pandemic in the past winter half-year,” the institutes said. The figure (below) shows that downgrade, and also the expected re-acceleration in 2023.

The group sees inflation at 6.1% this year and 2.8% next. German prices rose at a pace unseen in decades last month, a continuation of the harrowing trend.

But the real takeaway from the Joint Economic Forecast Project Group’s spring update was the projection for the economy in the event of a total stoppage of Russian energy (shown in orange, above).

“Due to the high level of uncertainty about energy supplies from Russia, which are important for Germany’s economic performance, the institutes have calculated two scenarios in their spring report,” the accompanying color said. In the supply freeze scenario, the economy expands just 1.9% in 2022 and contracts by 2.2% in 2023.

“The cumulative loss of GDP in 2022 and 2023 in the event of a supply freeze is likely to be around €220 billion, equivalent to more than 6.5% of annual economic output,” the report said. Inflation would remain elevated at 5% next year in the event of a supply halt.

The calculations came as German businesses lobbied the government to consider the consequences of bowing to pressure from Kyiv and other European capitals, where at least some politicians have addressed Scholz in caustic terms, accusing Berlin of financing Putin’s war machine.

Read more: Energy, Weapons And Weaponized Energy

Although the heads of Deutsche Bank, Mercedes, Siemens and other corporate behemoths support existing sanctions, they detailed the pitfalls of supply chain snarls and soaring energy costs during discussions with Scholz earlier this week.

As Bloomberg noted, “chemicals giant BASF and steelmaker Thyssenkrupp have warned of irreversible damage to Europe’s biggest economy should sanctions against Russia be extended to include imports of natural gas.”

Economy Minister Robert Habeck is at pains to accelerate plans aimed at reducing the country’s reliance on Russian fossil fuels, but Scholz has consistently balked at the suggestion Germany should jeopardize its near-term energy security.

And yet, what about the long-term? “Thinking like an economist, [Berlin] sees voluntarily switching off the gas as bad because it would mean a deep German recession,” Rabobank’s Michael Every wrote this week, adding that,

There are various figures bandied about, but some say GDP might fall as much as 6%. On the other hand, has Germany calculated the cost of buying Russian gas, for now, and de facto helping it win the war in Ukraine? I don’t mean the direct human cost, which social media is pointing out. I mean the future economic cost to Germany of having a victorious, entrenched, revanchist, irredentist Russia as a neighbor, and inspiring a new global alliance around it. [If] you think that would cost less than 6% of GDP over time, and [wouldn’t] carry even larger tail risks, you must be an economist.

I could scarcely put it better myself. If it’s usually a mistake to listen to economists, relying on their (implicit) foreign policy advice when there’s a war raging two doors down could be a grave, even existential, error.

As I wrote earlier this month, policymakers often make manifestly insane choices because insanity can be synonymous with expediency. Sanity, on the other hand, is generally associated with policy proposals conducive to long-term stability.