UBS Research Focus

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 performance 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 Project Management Valérie Iserland Desktop WMR Desktop Translation 24 Translate, St. Gallen, Switzerland; CLS Communication, Basel, Switzerland Pictures www.dreamstime.com Printer Fotorotar, Egg, Switzerland Languages Published in English, German and Spanish Contact ubs [email protected] Order or subscribe UBS homepage: www.ubs.com As a UBS client you can subscribe to the printed version of via your client advisor or via the SAP-No. 82092E–1007 UBS research focus Printed & Branded Products mailbox: [email protected]. Electronic subscription is also available via WMR portal accessible from the UBS e-banking platform.

2 Germany in the fast lane Editorial

Dear reader,

Like a phoenix rising from the ashes, the German economy has staged a remarkable recovery so far this year. During the dark days of 2009, the economy contracted at its fastest pace in post-war history; this year, Germany is surging ahead of its peers. Even unemployment, 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 miracle” 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 developed 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 current 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

Germany in the fast lane

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 private 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 economies. 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.

Export strength – blessing and curse Germany undoubtedly has one of the most successful export economies in the world. The country’s export strength is based on its ability to penetrate 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 moderation. Thus, Germany’s advantages in foreign trade are of a lasting nature and they allow Ger- many to benefit more during global cyclical upswings 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 protectionism, to structural shifts in its main trading partners and to lower-cost competition. Importantly, Germany’s export success does not seem to benefit the German people at large. In our view, it will be important to achieve a more balanced growth model in future.

4 Germany in the fast lane Germany in the fast lane

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

UBS research focus October 2010 5 Chapter 1

The return of the Teutonic Tiger

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 favorable.

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 system 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 numbers 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 German economy appears to have recovered its 95 90 pre-crisis strength. 85 80 In the first half of 2010, the German economy 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 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

6 Germany in the fast lane The return of the Teutonic Tiger

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 investment 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 0.91.0 1.11.2 1.31.4 1.5 1.6 Domestic ﬁnal consumption Investment Net trade Eurozone total average

Source: Reuters EcoWin, UBS WMR Source: Reuters EcoWin, UBS WMR

UBS research focus October 2010 7 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 moderate 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

18 1995 1997 1999 2001 2003 2005 2007 2009 2011

Germany France Italy UK

Source: Reuters EcoWin, UBS WMR

8 Germany in the fast lane The return of the Teutonic Tiger

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 million 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 annualized 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 20092008 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

UBS research focus October 2010 9 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 US EU UK Italy

Figure 1.10 shows so-called Taylor interest rates, Spain France Ireland Austria Belgium which combine data about economic activity and Germany inflation to indicate the appropriate level of short- Netherlands 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 –20 economy, the European Central Bank (ECB) set –30 rates to fit Germany’s needs. These were clearly too –40 US EU UK Italy

low for many of the other countries. We see an Spain France Ireland Austria Belgium increasing risk of some form of over-investment or Germany Netherlands 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 neighbors. 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 ment to run smaller budget deficits especially if, as 2002200120001999 2003 2004 2005 2006 2007 2008 2009 2010 we believe, interest rates will remain too low for 3-month Libor Taylor rate for Germany Germany for a considerable period of time.4

Source: Reuters EcoWin, UBS WMR

4 For a detailed discussion of these issues, please refer to the August UBS research focus, entitled “The future of the euro.”

10 Germany in the fast lane The return of the Teutonic Tiger

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 support the domestic economy in this cycle.

Importantly, Germany is unburdened by the direct effect of a burst housing bubble, and private sector 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 return 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.

UBS research focus October 2010 11 Chapter 2

Export strength – blessing and curse

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 consider 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 increased by 8% and imports by around 7% per year, on average. The strong increase in both imports 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 global 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 US CEE Asia Non- Japan China Africa EU-27 Russia

Eurozone Eurozone China Germany Japan US Middle East Oil exporters

Source: Federal Statistical Ofﬁce, UBS WMR Source: WTO database, UBS WMR

12 Germany in the fast lane Export strength – blessing and curse

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 pushing 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 1 2.3) . 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) countries (see Fig. 2.4)2. 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Germany, real wages Germany, nominal wages Eurozone, nominal wages

Source: Reuters EcoWin, UBS WMR

Fig. 2.4: Germany has gained price competitiveness Real eﬀective exchange rates (at unit labor costs)

1 125 The prolonged effort to contain costs through wage mod- 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 competitiveness improved primarily versus other Eurozone 110 105 countries, which explains the significant rise of Germany’s 100 export market share within the Eurozone. 2 95 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 explained by subsidiaries or contracting firms supplying intermediate or finished products to German parent companies. Source: Reuters EcoWin, UBS WMR

UBS research focus October 2010 13 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 factors, 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 GermanyEU-27 France ItalySpain 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

13.9 Export dependency increase economic 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 history. 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 countries. 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 consumer 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 GermanyEU-27 ItalyUSFranceUKSpain 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

14 Germany in the fast lane Export strength – blessing and curse

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 Indeed, as can be seen in Figure 2.8, German 7 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 GermanyFranceUSUK 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 volatility 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 innovation and efficiency to maintain their export 10 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

UBS research focus October 2010 15 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

16 Germany in the fast lane Export strength – blessing and curse

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 sufficiently strengthening domestic demand. These –4 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 markets, especially in the CEE region and in Asia. Its success also reflects its superior cost competitiveness, which has been achieved through corporate restructurings and wage moderation. These advantages in foreign trade appear to be durable. They should allow Germany to benefit more during 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 protectionism, 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.

UBS research focus October 2010 17 Chapter 3

Germany faces long-term structural challenges

Germany’s recent robust economic performance will not go unchallenged. In this chapter, 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 economic growth. Adverse developments in per-capita 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 economic 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 future?

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 US UK

Italy 0.0 Spain Japan France Finland Norway Canada 1992 1994 1996 1998 2000 2002 2004 20062008 2010 Germany

Netherlands 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

18 Germany in the fast lane Germany faces long-term structural challenges

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 2060. This means that, while 42 pensioners de- 65,000,000 pended on 100 workers in 2008, some 73 retirees 60,000,000 will claim benefits from the contributions of 100 55,000,000 197019601950 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 n 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. n improvements in the quality of individual pro- Source: OECD, UBS WMR duction n the efficient combination of the two factors Fig. 3.5: Strong increase in the number of older people (total factor productivity) (see Box 2).

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 accumulation rate and total factor productivity. The 50 aging effect on potential growth would be worst 61 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.

UBS research focus October 2010 19 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

20 Germany in the fast lane Germany faces long-term structural challenges

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 0 jections for the next 50 years. 1980 1990 2000 2010 2020 2030 2040 2050

Immigration can boost the labor supply Germany Japan France Canada The next option to boost the potential labor sup- US UK Italy 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 immigration 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 immigration 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 population 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- JapanItaly GermanyFranceUKUSCanada 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.

UBS research focus October 2010 21 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 < = –6.0 0.0 – <= 2.5 extend the effective working hours of those who –6.0 – <= –3.0 2.5 – <= 5.0 2 are employed. 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 market 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 structural unemployment. However, it is important to note that Source: Eurostat, UBS WMR this would not increase the growth potential, which is based on the potential labor force (including both the employed 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 GermanyItalySpain EU Netherlands UK France JapanUSItaly GermanyUKFranceCanada

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

22 Germany in the fast lane Germany faces long-term structural challenges

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 3 ancy . 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 lated two different scenarios in order to estimate Denmark 63.5 65 Australia 62.2 63 the effect of higher retirement ages on German Canada 63.3 65 United Kingdom 61.9 60 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- Source: OECD, UBS WMR many and the Netherlands have the shortest working 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.

UBS research focus October 2010 23 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 remains more heavily regulated than many other 0.7 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 UK

Bank’s Doing Business survey, which ranks Ger- Italy Spain EU-27 France Ireland Greece Austria Finland Sweden Portugal

many only 102 out of 181 countries in the survey. Germany Switzerland Czech. Rep. Other factors hampering capital investments in- Netherlands 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 4 and 3.12) . 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 EU UK

ogy sectors they rank eighth. However, financing Italy Spain Ireland Greece Austria Finland Sweden Belgium Portugal and government support for innovation projects Germany are typically just about or even below average in Netherlands 5 Germany . 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 GDP

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 SpainFrance GermanyItaly Total spending on education Spending on tertiary education OECD average (total) OECD average (tertiary education) Note: From Education at a Glance, 2010.

Source: OECD, UBS WMR

24 Germany in the fast lane Germany faces long-term structural challenges

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 innovation. The latest OECD report on education gives < = 12.5 Data not available 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 immigrants) 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.

UBS research focus October 2010 25 Chapter 4

Investing in Germany

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 implications 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 economic 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 MDAX1 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 potential. 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 75 2,000 Energy Staples Utilities

2009200820072006200520042003200220012000 2010 Services Materials Financials Consumer Consumer Industrials Telecomm. Healthcare Technology Information

Ifo Business Climate DAX Index Discretionary

Source: Bloomberg, UBS WMR Source: Factset, UBS WMR

26 Germany in the fast lane Investing in Germany

In addition to these cyclical factors, Germany is slightly better in the following six months, currently benefiting from good consumer senti- with almost 80% of observations showing an ment. This should fuel domestic consumption, average performance of 6.1%. which could also be supportive for the stock market even if export momentum fades. n 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. gated the degree of correlation between the However, after six month the average per- MSCI Germany2 and one of the most important formance 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 performance 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 Sept. 2010 n 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 mar- 90 ket showed a positive performance in the 85 following three months (with an average of 80

+3.2% over the period). Results were even Ifo expectations subindex 75 recession downturn 70 95908580 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

UBS research focus October 2010 27 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 companies in this index generate about a third of their 8.2 revenues in Germany (see Fig. 4.4). Our expecta- 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 14.5 stock prices. 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 companies 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 weight in Financials than the DAX (see Fig. 4.5). Energy Staples Utilities Services Materials Financials Consumer Consumer We believe that there is still a lot of pent-up de- Industrials Telecomm. Technology Information Health Care mand for capital goods after the financial crisis. Discretionary

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 investment 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 upswing. 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 investors who can bear temporary setbacks caused by volatile economic data. The difference between

28 Germany in the fast lane Investing in Germany

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 20001990198019701960195019401930192019101900189018801870 2010 n Consumer price inflation remains at subdued end of monthyearly 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, investors have accounted for slower trend Fig. 4.8: Positive correlation between equities and growth going forward. As discussed in Chap- bond yields has broken down since mid-2009 ter 3, we agree with this growth outlook for In %Index the German economy. 8 9,000 n The ECB’s ultra-loose monetary policy is keep- 6 7,000 ing a lid on interest rates. 4 5,000 n 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 yieldsDAX-30 for higher risk premia. As a consequence, investors 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

UBS research focus October 2010 29 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 phe- should benefit from the global recovery even if it nomenon. In the past, such a constellation continues at a more moderate pace going for- has typically been resolved by a sudden in- ward. If Germany manages to turn its economic crease in yields, rather than a drop in equity structure more towards consumption, the cyclical prices (see 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 quality of the issuer. 12 Bunds 32 Local Governments* 16 In the longer run, interest rate and bond market 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

30 Germany in the fast lane Investing in Germany

Box 3: If Germany were to leave the Eurozone

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

UBS research focus October 2010 31 Bibliography

Bibliography

– Allard, C. et al. (2005), “Explaining differences – Marin, D. et al. (2003), “Ownership, Capital in external sector performance among large and Outsourcing: What drives German invest- Euro Area countries,” IMF Country Reports, No. ment to Eastern Europe,” LMU, Munich, Dis- 05/401. cussion paper No. 2002-3. – Bundesbank (2006a), “Determinants of the – Niefert, M. et al. (2006), “Hightech-Gründun- current accounts in central and east European gen in Deutschland: Trends und Entwicklung- EU member states and the role of German di- sperspektiven,” Zentrum für Europäische Wirt- rect investment,” Monthly Report, January. schaftsforschung, Mannheim. – Bundesbank (2006b), “Germany in the globali- – OECD (2001), “Standard shocks in the OECD zation process,” Monthly Report, December. Interlink Model,” ECO/WKP (2001) 32. – Danninger, S. and F. Joutz (2007), “What ex- – OECD (2009), “Fiscal packages across OECD plains Germany’s rebounding export market countries: Overview and country details.” share?” IMF Working Papers, No. 07/24. – OECD (2010a), “Germany’s growth potential, – Egeln, J. et al. (2007), “Bericht zur technolo- structural reforms and global imbalances,” Eco- gischen Leistungsfähigkeit Deutschlands nomics Department working papers, No. 780. 2007,” Federal Ministry of Education and Re- – OECD (2010b), “Education at a glance 2010: search, Berlin. OECD indicators.” – EU Commission, “2009 Ageing Report: Eco- – OECD (2010c), “OECD Economic Surveys: nomic and budgetary projections for the EU-27 Germany.” member states (2008–2060),” Brussels. – Rae, D. and M. Sollie (2007), “Globalisation – Federal Ministry of Education and Research and the European Union: which countries are (2009a), “Research and innovation for Ger- best placed to cope?” OECD Economics De- many,” Federal Ministry of Education and Re- partment Working Papers, No. 586. search, Bonn. – Sinn, H.-W. (2006), “The pathological export – Federal Statistical Office (2009b), ”Germany’s boom and the bazaar effect: how to solve the Population by 2060 – Results of the 12th coordi- German puzzle,” The World Economy, Vol. 29, nated population projection,” Wiesbaden. No. 9. – Gottschalk, S. et al. (2007), “Start-ups zwischen – Stahn, K. (2006), “Has the impact of key deter- Forschung und Finanzierung: Hightech-Gründ- minants of German exports changed?” De ungen in Deutschland,” Zentrum für Eu- Brandt, O., H. Herrmann and G. Parigi (eds.), ropäische Wirtschaftsforschung, Mannheim. Convergence or divergence in Europe? Growth – Hülskamp, N. and O. Koppel (2005), “Deutsch- and business cycles in France, Germany and lands Position im Innovationswettbewerb - Italy, Springer, Berlin/Heidelberg. Ergebnisse des IW-Innovationsbenchmarkings,” – Von Hirschhausen, C. et al. (2009), “Innova- IW-Trends, Vol. 32, No. 3. tionsindikator Deutschland 2009,” Deutsches – Klodt, H. (2004) “Mehr Arbeitsplätze durch Institut für Wirtschaftsforschung, Berlin. Auslandsinvestitionen,” Die Weltwirtschaft, Vol. 4/2004.

32 Germany in the fast lane 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 UBS global outlook is a flagship pub- monthly and contains current infor- 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 economic 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.

Order or subscribe As a client of UBS you can order or subscribe to the above publications. Please ask your client advisor or send an e-mail to the following address: [email protected] You can find publicly available publications (with freely accessible content) atwww.ubs.com/research. Wealth Management Research is published by Wealth Management & Swiss Bank and Wealth Management Americas, Business Divisions of UBS AG (UBS) or an affiliate thereof. In certain countries UBS AG is referred to as UBS SA. This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness (other than disclosures relating to UBS and its affiliates). All information and opinions as well as any prices indicated are current as of the date of this report, and are subject to change without notice. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result of using different assumptions and/or criteria. At any time UBS AG and other companies in the UBS group (or employees thereof) may have a long or short position, or deal as principal or agent, in relevant securities or provide advisory or other services to the issuer of relevant securities or to a company connected with an issuer. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, into other areas, units, divisions or affiliates of UBS. Futures and options trading is consid- ered risky. Past performance of an investment is no guarantee for its future performance. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in FX rates may have an adverse effect on the price, value or income of an investment. We are of necessity unable to take into account the particular investment objectives, financial situation and needs of our individual clients and we would recommend that you take financial and/or tax advice as to the implications (including tax) of investing in any of the products mentioned herein. This document may not be reproduced or copies circulated without prior authority of UBS or a subsidiary of UBS. UBS expressly prohibits the distribution and transfer of this document to third parties for any reason. UBS will not be liable for any claims or lawsuits from any third parties arising from the use or distribution of this document. This report is for distribution only under such circumstances as may be permitted by applicable law. Australia: Distributed by UBS Wealth Management Australia Ltd (Holder of Australian Financial Services Licence No. 231127), Chifley Tower, 2 Chifley Square, Sydney, New South Wales, NSW 2000. Austria: This publication is not intended to constitute a public offer or a comparable solicitation under Austrian law and will only be used under circumstances which will not be equivalent to a public offering of securities in Austria. The document may only be used by the direct recipient of this information and may under no circumstances be passed on to any other investor. Bahamas: This publication is distributed to private clients of UBS (Bahamas) Ltd and is not intended for distribution to persons designated as a Bahamian citizen or resident under the Bahamas Exchange Control Regulations. Belgium: This publication is not intended to constitute a public offer under Belgian law, but might be made available for information purposes to clients of UBS Belgium S.A. with registered office Avenue de Tervueren, 300 at 1150 Brussels, a regulated bank under the supervision of the “Commission Bancaire, Financière et des Assurances” (CBFA), to which this publication has not been submitted for approval. Canada: In Canada, this publication is distributed to clients of UBS Wealth Management Canada by UBS Investment Management Canada Inc.. Dubai: Research is issued by UBS AG Dubai Branch within the DIFC, is intended for professional clients only and is not for onward distribution within the United Arab Emirates. France: This publication is distributed by UBS (France) S.A., French “société anonyme” with share capital of €d125'726'944, 69, boulevard Haussmann F-75008 Paris, R.C.S. Paris B 421 255 670, to its clients and prospects. UBS (France) S.A. is a provider of investment services duly authorized according to the terms of the “Code Monétaire et Financier”, regulated by French banking and financial authorities as the “Banque de France” and the “Autorité des Marchés Financiers”. Germany: The issuer under German Law is UBS Deutschland AG, Bockenheimer Landstrasse 2–4, 60306 Frankfurt am Main. UBS Deutschland AG is authorized and regulated by the “Bundesanstalt für Finanzdienstleistungsaufsicht”. Hong Kong: This publication is distributed to clients of UBS AG Hong Kong Branch by UBS AG Hong Kong Branch, a licensed bank under the Hong Kong Banking Ordinance and a registered institution under the Securities and Futures Ordi- nance. Indonesia: This research or publication is not intended and not prepared for purposes of public offering of securities under the Indonesian Capital Market Law and its implementing regulations. Securities mentioned in this material have not been, and will not be, registered under the Indonesian Capital Market Law and Regu- lations. Italy: This publication is distributed to the clients of UBS (Italia) S.p.A., via del vecchio politecnico 3, Milano, an Italian bank duly authorized by Bank of Italy to the provision of financial services and supervised by “Consob” and Bank of Italy. Jersey: UBS AG, Jersey Branch, is regulated and authorized by the Jersey Financial Services Commission for the conduct of banking, funds and investment business. Luxembourg: This publication is not intended to constitute a public offer under Luxembourg law, but might be made available for information purposes to clients of UBS (Luxembourg) S.A., a regulated bank under the supervision of the “Commis- sion de Surveillance du Secteur Financier” (CSSF), to which this publication has not been submitted for approval. Singapore: Please contact UBS AG Singapore branch, an exempt financial adviser under the Singapore Financial Advisers Act (Cap. 110) and a wholesale bank licensed under the Singapore Banking Act (Cap. 19) regulated by the Monetary Authority of Singapore, in respect of any matters arising from, or in connection with, the analysis or report. Spain: This publication is distributed to clients of UBS Bank, S.A. by UBS Bank, S.A., a bank registered with the Bank of Spain. UAE: This research report is not intended to constitute an offer, sale or delivery of shares or other securities under the laws of the United Arab Emirates (UAE). The contents of this report have not been and will not be approved by any authority in the United Arab Emirates including the UAE Central Bank or Dubai Financial Authorities, the Emirates Securities and Commodities Authority, the Dubai Financial Mar- ket, the Abu Dhabi Securities market or any other UAE exchange. UK: Approved by UBS AG, authorized and regulated in the UK by the Financial Services Authority. A member of the London Stock Exchange. This publication is distributed to private clients of UBS London in the UK. Where products or services are provided from outside the UK, they will not be covered by the UK regulatory regime or the Financial Services Compensation Scheme. USA: This document is not intended for distribution into the US and / or to US persons. UBS Securities LLC is a subsidiary of UBS AG and an affiliate of UBS Financial Services Inc., UBS Financial Services Inc. is a subsidiary of UBS AG.

34 Germany in the fast lane ab