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Structural factors causing underperformance of the
manufacturing sector compared to services in 2018-19 have been
pushed to the background during the pandemic.
The characteristics of the COVID-19 shock contrast starkly with
those of the Global Financial Crisis (GFC) in 2008-09, allowing
Germany's manufacturing sector to weather the current second wave
of virus infections even better than the first.
Germany's GDP growth pattern in 2021 will be dominated by the
speed with which administrative restrictions and increasing
vaccination enable a sustained service-sector recovery, but robust
manufacturing activity will put a floor under any setbacks.
How has Germany's manufacturing sector performed prior
to the pandemic?
Germany's manufacturing sector contributes much more to GDP than
that of most of its European peers, its output constituting roughly
24% of gross value added. As globalization gained momentum in
recent decades, this has been the key factor behind Germany's
export strength and the driving force for GDP growth. Since 2008,
however, a series of crises has led to cyclical and, more recently,
also structural setbacks - the GFC of 2008-09, the subsequent
eurozone debt crisis, the various problems besetting Germany's key
automotive industry since 2015 (diesel emission scandal, city ban
debate linked to NO2 emissions, structural shift away from
combustion engines to electric mobility), the UK's Brexit decision
in 2016, increasing global trade protectionism fueled by the Trump
administration in the US, and finally somewhat diminished impetus
from Chinese growth due to a government shifting policy focus from
investment to consumption.
Although German manufacturing firms coped quite well with the
GFC and the eurozone debt crisis, helped by short-time work
schemes, the cumulative effect of the above-mentioned factors
triggered a downward trend in output from early 2018 onwards. At
the end of 2019, German production ex-construction was about 9%
lower than in December 2017.
The initial blow from COVID-19 was less severe for
manufacturing than it appeared
When the COVID-19 virus began to spread in Europe from February
onwards, triggering a fairly strict lockdown in Germany between
mid-March and late April, it seemed at first that manufacturing was
hit as hard as services due to officially enforced shutdowns of
activity. However, this overlooks that government restrictions only
forced firms to adapt their production processes in order to
safeguard physical distancing requirements and ensure the use of
protective equipment, rather than forbidding production per se
(except for cases of major virus outbreaks in meat processing
plants). Many firms, most notably in the automotive industry,
voluntarily enacted plant shutdowns lasting several weeks in order
to adapt accordingly.
Manufacturing firms shut down production voluntarily for three
main reasons: First, it would have been impossible in most cases to
implement above-mentioned protective measures alongside the normal
production process. Second, supply chain disruptions linked to the
extremely severe shutdown in China in February-March would have
caused interruptions to German production in March-April anyway
(given shipping times of 4-6 weeks). Third, with consumer demand at
home and abroad being stifled by closed shops, manufacturing firms
would not have known where to store mounting inventories.
Importantly, the manufacturing sector was also much more
familiar with - and thus better placed than services to take
immediate advantage of - the existing short-time work instrument,
and it could utilize better the various other fiscal support
measures launched during Q2 2020.
Manufacturing and services both posted sharp recoveries
in Q3 - but only the former proved sustainable in late
2020
The successive loosening of administrative restrictions from May
2020 onwards, enabled by temporarily receding COVID-19 cases,
allowed economic activity to rebound strongly across the board. In
manufacturing, this was led by automobiles, admittedly from a very
low base. The second wave that emerged in October and eventually
forced the government to impose another strict lockdown between
mid-December and at least mid-January 2021 (including closed shops,
services, and schools) caused an almost immediate halt to most
service-sector activities but will have limited impact on
manufacturing.
The difference is that services, which often can only operate
with human contact, are now almost back to square one as long as
the lockdown lasts, whereas manufacturing firms may consider the
measures they took in March-April as a one-off investment that
permits them to produce close to normal now. The sharp divergence
between manufacturing and service PMI indicators since August is
telling (see chart). In addition, the manufacturing sector's strong
export links to Asia are very helpful now that this region largely
has the pandemic under control.
Outlook for 2021
Although the structural problems hurting Germany's manufacturing
sector in 2018-19 have not vanished, they are overridden at present
by its ability - better than in most other European countries
currently - to satisfy Asian (partly pent-up) demand. Ironically,
the usually cyclically much more volatile manufacturing sector is
an anchor of stability in this pandemic, whereas service sector
activity will fluctuate with lockdown needs and vaccination
progress in the coming months.
Posted 23 December 2020 by Timo Klein, Principal Economist - Western Europe, IHS Markit