Growth and Business Cycle

A flourishing economy raises living standards, creates jobs and fills the public coffers with the funds necessary for such tasks as education, environmental protection and social security.

Over the past 60 years the Federal Republic’s social market economy has enabled its citizens to quintuple their average income. Although the long-term growth in prosperity has been considerable, there have been repeated economic setbacks to be overcome, as economies tend to develop not evenly but in waves. An economic boom with high growth rates and rising employment is followed by a downturn with low growth rates and fewer people in work. The IW uses a variety of instruments to keep a close eye on these cycles and publishes regular economic forecasts. In this way, the IW provides political and business leaders with a sound basis for their decision-making.

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Economies tend to develop not evenly but in waves. An economic boom with high growth rates and rising employment is followed by a downturn with low growth rates or even declining production and fewer people in work.

Such economic cycles are the result of positive and negative shocks. Technical progress, for instance, can cause an upswing, whereas soaring oil prices may result in a downturn (supply shocks). Revaluation of a country’s currency weakens its exports and can thus herald an economic decline. Positive expectations on the part of business leaders, on the other hand, can raise the demand for investment and lead to an upswing (demand shocks). Government policies can also trigger economic fluctuations.

In bad times there is a tendency for the government to support demand across the whole economy by means of debt-financed public spending. Often this involves an attempt to stimulate consumption. However, it would make more sense to take measures which strengthen both short-term demand and long-term growth potential, for example by investing in infrastructure and education. However, all debt-financed policies aimed at stimulating the economy run the risk that the debt will not be repaid when business is booming again.

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The Business Cycle Traffic Light (Konjunkturampel) captures at a glance the changes in important economic indicators for Germany, the Eurozone, the USA and China.

This can only be achieved by establishing which improvements and deteriorations in the short-term development of the economy can be defined as relevant. Like its individual underlying indicators the Business Cycle Traffic Light represents the status of information a varying number of months ago, thus partly reflecting the inevitable recognition lags in business cycle diagnosis.

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The German Economic Insitute (IW) publishes bi-annual economic forecasts in which our researchers try to predict economic developments in Germany.

Eine exakte Vorhersage für das Wirtschaftswachstum ist allerdings nicht möglich. Eine Konjunkturprognose ist nur eine sogenannte bedingte Prognose. Die Forscher treffen Annahmen und geben an, welche wirtschaftlichen Entwicklungen unter diesen Bedingungen wahrscheinlich sind.

Für Unternehmen ist eine sinnvolle Konjunkturprognose unerlässlich, etwa in Tarifverhandlungen. Wenn nur ein geringes Wachstum prognostiziert wird, ist der Spielraum für Lohnerhöhungen kleiner. Eine Konjunkturprognose ist zudem wichtig für die Investitionstätigkeit der Unternehmen.

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The German Economic Insitute conducts regular surveys of German companies, asking about on their current business situation and expectations for the future.

Every spring and autumn, the IW contacts some 2,600 companies in the west and 700 firms in the east of Germany to ask about the state of their business and their expectations regarding production, exports, investments, employment, prices and revenues.

The survey includes producers of raw materials, investment and consumer goods, construction and the services sector but excludes the wholesale and retail trades, the banking and insurance industries and the public sector.

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More than a quarter of a century after the fall of the Iron Curtain, the formerly communist eastern states of Germany are making slow but steady progress. Infrastructure is well developed and unemployment is down to single figures. However, per capita economic output has still not caught up with the rest of the country.

After the fall of the Berlin Wall and the end of the Iron Curtain 25 years ago, the Federal Government’s highest priority was to bring the standard of living in eastern Germany up to the level in the west. To achieve this, billions of euros’ worth of subsidies flowed eastwards to rebuild the newly acceded states, an investment that significantly increased the per capita income of the Federal Republic’s new citizens. However, as the resultant boom ebbed, the catch-up process came to a standstill and did not resume until 2001. Today the average eastern German has just over two-thirds of his western counterpart’s purchasing power.

The remaining gap is nowhere more apparent than in the DAX, the blue-chip share index of the top 30 companies listed on the German stock exchange: Not one of those companies is headquartered in eastern Germany. On the other hand, eastern Germany now boasts many small- and medium-sized businesses. The labour market is also healthier than it was a few years ago. However, this is the consequence not only of economic success, but also of the fact that many eastern Germans have left the region for lack of prospects. Though this depopulation has now stopped, the demographic transition will continue to affect many parts of eastern Germany. Only such attractive cities as Leipzig, Dresden and Berlin have a good chance of bucking the trend and continuing to grow in the future.

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The State provides many goods and services. Ideally, it restricts itself to public goods, such as roads and schools, which could be supplied either not at all, or only inadequately, by the market.

Beyond this, states generally aim to compensate for social differences by redistributing income among the various levels of society, generations and regions. The state can even transfer income between different periods of time by taking on debt in a phase of economic difficulty and repaying it in better times. The intention behind this is to smooth the fluctuations of the economic cycle. The extent to which the state becomes involved in all its functions can be measured by the ratio of its expenditures to gross domestic product. In Germany, this figure, known as the public sector share, is just under 50%; in other words, the state accounts for approximately half of economic output.

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At the end of every year, the German Economic Insitute conducts a survey of employers' associations (Verbandsumfrage) to assess the mood of German business.

The panel comprises around 50 associations representing all important sectors of the German economy. In addition to the current business climate, the IW researchers monitor the outlook for the future by asking the associations’ representatives about their expectations for production, investment and employment in their industry in the coming year.

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Economic growth is not an end in itself. Increasing gross domestic product, i.e. the value of all the goods and services produced in a single year, raises people’s incomes and thus their standard of living. A flourishing economy creates jobs and fills the state’s coffers with the means to finance education, environmental protection and social security.

There are two possible sources of economic growth. One of these is for people to work harder and invest more capital. Longer working hours, for instance, offer a potentially effective route to greater prosperity in an ageing and shrinking society. Another possibility is to increase efficiency, thereby achieving a better result from the same input. Technical progress offers the best chance of doing this as steadily improving production processes and new products are effective drivers of economic development.

It is also important to invest in minds: in a sound school education, outstanding universities and modern systems of ongoing in-company training. It is equally necessary to continually invest in capital equipment, such as modern machinery. However, whether investors invest their money in Germany, creating good jobs in well-equipped workplaces, depends to a large extent on the profits which they can expect to make here. If it is to succeed in the competition for investment capital that is now globally mobile, Germany must remain an attractive business location and create the conditions necessary for economic growth.

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Growth and Business Cycle

Subtopics:

Business Cycle

IW Economic Forecast Spring 2018

Has the German Economy Reached its Limit?

Methods and Applications of the IW Business Survey

Konjunkturampel

The IW Business Cycle Traffic Lights

Hardly any positive signs

IW Business Cycle Traffic Light

Economic Forecasts

IW Economic Forecast Spring 2018

Die deutsche Konjunktur am Limit?

IW-Konjunkturprognose Frühjahr 2017

Economic Survey

IW Economic Forecast Spring 2018

Methods and Applications of the IW Business Survey

Die deutsche Konjunktur am Limit?

Eastern Germany

25 Years after the Fall of the Berlin Wall

State

Verbandsumfrage

Economic Growth

Economic crisis slows European convergence

The poorer regions are not catching up anymore

How much do we need, and how much will we get?