What a fierce Omicron wave in China could mean for the German economy

So far, China has fared better in the Corona pandemic than any other major economy. As a result, economic losses in China have been lower. On the other hand, the rest of the global economy also benefited from the greater dynamism of the Chinese economy: the role of China as the largest and most reliable supplier of the global economy is even more important today than in the pre-pandemic period.

In China Omicron meets a barely immunised population

Meanwhile, the Omicron variant of the coronavirus is spreading in China. It seems doubtful whether China’s anti-corona measures, which have so far proved successful, will continue to assure success against Omicron longer term. On the one hand, the Omicron variant is considered significantly more contagious than previous variants. On the other hand, the vaccines used in China do not appear to offer comparable effective protection against Omicron. As a result, a highly contagious viral variant meets a population that has no immune protection against Omicron, either through effective vaccination or through numerous past infections.

This could pose a dilemma for Chinese politics: either the previous zero-Covid strategy is being expanded again in scope and severity, or the incidence of infection and disease is rising massively.

German growth is (also) dependent on China

In both cases, there are serious risks to China's economic development this year. Due to the country’s extensive global economic significance, other countries – including Germany, for example – would also be negatively affected. Especially for Germany and its companies, the economic importance of the People's Republic is now enormous. On the one hand, it is considered a sales market for China. In 2020, around 8 percent of German exports went to the Middle Kingdom. And that is even more true for China as a procurement market. China alone accounts for 9 percent of the intermediate goods produced by German industry.

If-then scenario simulates negative consequences for the German economy

The economic impact of the Omicron variant in China cannot yet be seriously estimated. Therefore, our simulation calculation in no way represents a forecast. Rather, in the sense of an if-then scenario, it shows the potential consequences an economic downturn and a further burden on German industry due to continuing supply bottlenecks would have for economic recovery in Germany this year.

Our Omicron scenario includes the following input variables:

• If Omicron were to weigh on China's economic performance in 2022 to the same extent as in 2020, China's growth in 2022 would be just 2.3 percent – our current forecast is currently based on 6.0 percent growth. As a result, Chinese import demand for goods made in Germany, among other things, would be noticeably lower.
   
• International supply chains, in which China plays the central role, would be so disrupted due to production failures in China that German industry would be unable to expand its production in 2022. Germany, for example, is particularly reliant on components in the areas of computer equipment, electronics, and optics. However, the impact of production failures in China and the associated supply bottlenecks is not limited to direct imports from China. In fact, suppliers from other countries are also dependent on Chinese components – and could thus also fail as suppliers to German industry.

A strong recovery for the German economy would not be possible in this scenario

Taking these two key impulses together, our simulation calculations show that the strong recovery of the German economy expected to date, would not be achieved in 2022. In our Forecast from early January 2022, we anticipate GDP growth of 4.0 percent this year. In the assumed scenario, the growth rate would be almost halved to just 2.1 percent. In absolute terms, German economic output in 2022 would thus be 61 billion euros lower than our current forecast.

The simulation calculations were carried out with our World Economic Model VIEW. The model covers more than 90 percent of current global economic performance from a regional perspective, and furthermore, VIEW explicitly records the interactions and feedback between countries. For example, the corona-related weakening of domestic demand in China has led to a decline in exports from all other countries covered by the model, which has depressed the utilisation of their export-oriented sectors, and hence their capital expenditure, which in turn generates negative feedback on China's exports, and so on.

Supply bottlenecks would put a heavy burden on German industrial production

The corona-related closure of ports and loss of workers in China are dampening the country's exports on the supply side and leading to supply shortages and material shortages in other countries. It is not possible to derive the effects directly from the economic or sector-specific effects, as they differ greatly from product to product. If it is possible to substitute lacking Chinese imports, only trade links and wholesale structures will be shifted, possibly with the consequence of higher purchasing and producer prices. At the other extreme, the production or sale of the almost finished product cannot take place because essential parts are missing. The assumption that industrial production in Germany will stagnate in 2022 as a result of supply bottlenecks is an explicit assumption, the relevant result of our simulation calculations are the consequences for the economic development in Germany.

This scenario is not a forecast. If it occurs, the consequences can go beyond 2022.

If the described scenario were to become reality and further delay recovery, a further risk would also arise for long-term development in Germany. Demographic aging in Germany will accelerate significantly from around 2025 – with far-reaching consequences, from the provision of skilled workers to the pension system. This trend break, which in itself poses the greatest of challenges at a time of economic weakness, would make a lasting recovery on a solid growth path much more difficult.