Germany’s economic crossroads: From miracle to malaisehttps://en.majalla.com/node/323241/business-economy/germany%E2%80%99s-economic-crossroads-miracle-malaise
The foundational pillars of Germany’s contemporary economy date back over 70 years, laid by Konrad Adenauer during his Chancellorship from 1949-63 and by his deputy and Economics Minister Ludwig Erhard, who was Chancellor from 1963-66.
Adenauer focused on amending the Constitutional Court’s laws to make it a pioneer in defending citizen rights and regulating political life and public authorities. He also reformed the Bundesbank (Germany’s central bank), ensuring its independence and transparency to maintain monetary stability, thus avoiding a repeat of the catastrophic hyperinflation that hit the Weimar Republic from 1921-23.
Erhard concentrated on establishing a social market economy (Soziale Marktwirtschaft), as envisioned by theorist Alfred Müller-Armack—a middle ground between the extremes of planned and free-market economies. This took the benefits of market economies (free enterprise, pricing, competition) while also protecting citizens from monopolies and unemployment and providing welfare in illness.
This economic system was only legally adopted in May 1990 after Germany's reunification, demonstrating its adaptability to new circumstances. Gradually, this system was mirrored across Europe, culminating in treaties that recognised the ‘social market economy’ as one of the main goals of the European Union.
Volkswagen was one of the first institutions to launch under the new economic model. The New York Times described the company's Beetle (aka 'La Coccinelle') as a symbol of the German economic "miracle." Unlike other cars built for elites (like Fords, Citroëns, or Fiats), the Beetle was small, affordable, and robust, which allowed millions to own one (21.5 million were sold). This made it a vital source of foreign currency.
Adenauer and Erhard created the social market economy, a middle ground between the extremes of planned and free-market economies
Under the slogan 'Wealth for All,' a law was passed to partially privatise Volkswagen. Shares were issued, and both employees and the wider public were encouraged to buy them. Shortly after trading began, the stock price more than doubled.
Challenges to the model
The first challenge to the German economic model came when East and West Germany reunited in 1990. The toxic fallout from the US securitisation crisis in 2007 was another. These events caused strain on the German banking system (Europe's largest), which had been designed to be resilient and shock-absorbent.
This system distinguishes between commercial banks (both specialised and non-specialised), public savings banks, cooperative banks, and regional banks, the latter of which are focused exclusively on financing infrastructure projects.
Reunification led to more non-performing loans, while the 2007 crisis left a mark in real estate and investment banking. Germany responded with a spree of mergers and acquisitions in its banking sector. Bad assets were written off, public money was used to provide support, banking debts were consolidated, and the short-selling of shares in banks, insurance companies, and others was temporarily banned.
Having weathered these crises, Germany remained the locomotive of the EU economy, but the COVID-19 pandemic and the war in Ukraine dramatically reversed its fortunes, turning the Eurozone's largest economy into the "sick man of Europe." Economist Isabella Weber notes that Germany's growth since the end of 2019 has been around 0.3%, while France has hit 3.8%, and the US has chalked up 9.4%.
These crises severely impacted the industrial sector, the backbone of Germany's economy, accounting for around a fifth of its total wealth. Today, the sector is still 9% below its pre-COVID levels and faces a trio of challenges relating to energy, domestic demand, and foreign demand.
The pandemic and war in Ukraine dramatically reversed Germany's fortunes, turning the Eurozone's largest economy into the 'sick man of Europe'
A trio of challenges
Energy prices in Germany had been low for years owing to the ready supply of Russian gas, but after Russia invaded Ukraine and sanctions were imposed, the pipelines were quickly closed, and alternative suppliers were sought. Energy prices in Germany have been high ever since. This has reduced productivity in energy-intensive industries by around 17% compared to before the invasion.
Domestic demand has also slowed due to inflation and rising interest rates. Inflation reached 6.9% in 2022, the highest rate since the 1973 OPEC oil shock. The European Central Bank (ECB) raised key interest rates from 0% in 2022 to 4-4.75%, increasing the cost of debt. Bundesbank Vice-President Claudia Buch warned against complacency over the recent fall in interest rates, as a return to higher rates is possible.
Foreign demand has also slowed amid geopolitical tensions. Orders for German products such as machinery, chemicals, and cars from big markets like China, the US, and Europe have declined. The likelihood of a robust export-driven recovery appears slim, as a US-China trade war threatened by US President-elect Donald Trump could catch Europe—and Germany—in the middle.
Trump's programme includes 10-20% tariffs on European imports to the US. A tenth of Germany's exports go to the US, worth around $160bn in 2022 (imports from the US were worth $77bn). Meanwhile, China's maturing industrial sector has reduced its need for German expertise and is now increasingly a competitor of Germany's.
Trade with China is key for Germany: it supports over a million German jobs, in part because nine out of Germany's ten most valued companies derive at least 10% of their revenues from China (the same can be said for only two of America's ten biggest firms). Closer to home, the EU internal market regulation prevents cost reductions for goods and services, unlike in US markets.
Trade with China supports over a million German jobs. Nine out of ten of its most valued companies derive at least 10% of their revenues from China
Carmakers in a skid
The transition to electric vehicles (EVs) has eroded Germany's long-held dominance in the automotive industry. Its large vehicle manufacturers are steadily losing market share in China, while Chinese EVs are poised to flood European markets, with Tesla launching its own low-cost EV model.
Mercedes-Benz, whose predecessors were responsible for making the world's first automobile powered by an internal combustion engine, became the world's largest luxury premium vehicle brand in 2018, selling more than 2.3m passenger cars, but recently cited reduced production and net profits, and announced plans to cut production of some models, shifting to single-shift operations.
With a global workforce of 600,000, Volkswagen said it planned to close some factories in Germany. Facing sluggish demand in China and Europe, it surprised staff and politicians by declaring an end to a 30-year-old labour agreement banning forced lay-offs. Audi is also expected to close some factories, while BMW announced lowered profit expectations and had to recall 1.5 million vehicles.
Pressure from foreign competitors has led several German companies to adjust their investment strategies. Many are divesting key assets, as Siemens did by selling its Innomotics unit (which manufactures large motors) for around $3.7bn.
German Economy Minister Robert Habeck thinks the problems stem not only from cyclical factors but also from internal structural issues, but there are other views. Politically, tensions within the ruling coalition have surfaced.
On 15 November 2023, the German Constitutional Court annulled a plan to reallocate €63.5bn of unused COVID funds to green investments and industrial support, deeming it a violation of budgetary rules. The government then had to revise its 2023-24 budgets, leading to disputes among coalition partners. Left-wingers wanted more public spending, whereas the fiscally conservative Free Democratic Party wanted more austerity.
To brake or not to brake
The concept of a 'debt brake' was introduced constitutionally in May 2009 by Chancellor Angela Merkel's coalition government (the Christian Democratic Union and the Free Democratic Party). It limits federal borrowing to 0.35% of GDP annually, except in emergencies. For the first decade, the rule was adhered to. Compliance was helped by growth, higher tax revenues, and low interest rates.
During the pandemic in 2020 and its immediate aftermath, however, the Bundestag (German parliament) voted to suspend the debt brake until the end of 2023, when it was reinstated. Critics, including the Social Democratic Party, the Greens, and several economists, argue that the debt brake hinders investments and disrupts funding for strategic projects, such as those linked to climate change and renewable energy.
Both businesses and trade unions said significant investment was needed to restructure the economy, modernise infrastructure, and re-arm the German military in response to Russian aggression, arguing that the rule's strict debt limitations stopped Germany from keeping pace with the likes of the US and China.
They therefore argued that the rule's restrictions—and the government's ability to borrow—be relaxed. Yet the alternative view was articulated in a study by the Friedrich-Naumann Foundation. Presented by Lars Feld, an economic advisor to Finance Minister Christian Lindner and former head of the German Council of Economic Experts.
This study defended the debt brake as an "anchor of stability for the social market economy," saying it reduced debt and interest burdens while increasing fiscal capacity. Feld likened the rule's proposed repeal to "replacing a smartphone screen when the battery is the issue." Moreover, relaxing the debt brake would require a two-thirds majority in the Bundestag, an improbable scenario given the current political dynamics.
The rise of populism
Germany's economic struggles and political discord have been effective recruiters for the country's foremost far-right party, Alternative for Germany (AfD), whose programme includes expelling foreign workers (despite the country's labour shortages) and reducing European integration. Studies say Germany's exit from the EU could cost it 5.6% of GDP (around $728bn) over five years, with around 2.5m jobs lost annually.
Studies say Germany's exit from the EU could cost it 5.6% of GDP (around $728bn) over five years, with around 2.5m jobs lost annually
In response, 30 big German firms (including BMW, Siemens, Deutsche Bank, and BASF) met on 7 May 2024 in a new forum called 'Defending Our Values'—an unprecedented political coalition within the business community that publicly opposes populism and seeks to restore Germany's appeal. Employing 1.7 million staff, the firms say, "Entrepreneurial success is impossible without an open, tolerant, and diverse society."
The challenges facing Germany's companies are not confined to its industrial sector. In the banking industry, Italian bank UniCredit surprised investors by acquiring a 9% stake in Commerzbank to become its second-largest shareholder. Commerzbank was bailed out by the public in 2008. The German government still holds a 16.5% stake but said it planned to reduce this. Days later, UniCredit pounced.
The acquisition sparked discontent among government officials, shareholders, and trade unions, but economic uncertainty and structural challenges have deterred new investments. A report by consultancy FalkenSteg said insolvencies in early 2024 were up 41% on the previous year.
Demographic pressures
A study by the Bertelsmann Stiftung think tank highlights Germany's ageing population and its implications for the labour market. From 2020-40, the number of Germans aged 25-44 is due to fall by 1.6 million (or 7.7%), while the 45-64 age group is set to shrink by 3.2 million (13.3%). Meanwhile, the proportion of the population aged 65+ will increase by 28% by 2040, up from 22% in 2020.
By 2035, 16.2 million Germans will be drawing pensions, up from 12.3 million in 2020. To address labour shortages, Habeck proposed measures such as incentivising women to join the workforce, encouraging older workers to extend their careers, and attracting skilled foreign labour with tax exemptions of up to 30% of their salaries. Yet unemployment remains stubbornly at 6%, with over 2.6 million jobless.
Germany suffers from structural deficiencies in infrastructure investment. Alfred Kammer, the EU representative of the International Monetary Fund (IMF), said, "Without functioning infrastructure, a productive economy is impossible." The poor condition of German roads, delays in rail and housing projects, high corporate taxes, and underdeveloped digital infrastructure are all symptoms. Likewise, climate-related disasters routinely damage agriculture and property.
The partially collapsed Carola Bridge (Carolabruecke) is pictured in the city centre of Dresden, Saxony, eastern Germany, on September 17, 2024, after flooding let loose by storm Boris.
Opportunities for innovation
Speaking to Fortune, Carsten Brzeski of ING Research said the German economy had fallen behind in innovation and modernisation because of "a combination of arrogance, complacency, and naivety". For a long time, German businesses believed they had no serious competition, he said. The result has been a loss of competitiveness.
According to the International Institute for Management Development (IMD), Germany's global competitiveness ranking dropped from 15th in 2021 to 24th in 2024. In the same period, its economic performance ranking fell from 3rd to 13th. Figures from Germany's Federal Statistical Office (Destatis), published in Le Monde on 31 July 2024, reveal that Germany's gross domestic product (GDP) contracted by 0.1%, while France, Spain, and Italy recorded growth of 0.3%, 0.8%, and 0.2% respectively.
All this means that the German economy has become a media talking point. Bild published a postcard to Chancellor Olaf Scholz on the cover of its 3 August 2023 edition, while he was on holiday in France. It read: "Help! Our economy is collapsing."
Likewise, in its 19 August 2023 issue, The Economist's front cover featured Ampelmännchen, the iconic East German traffic light figure, yet instead of the green light's usual firm stride, the figure appeared weak and hooked up to an IV drip. The headline asked: "Has Germany become Europe's sick man again?" The editorial called for a shift in the country's economic model, warning that bureaucratic inertia was preventing reform.
Taking the positives
Despite the doom and gloom, Germany retains unique advantages. The third-largest economy globally (after the US and China), it is still one of the wealthiest nations in the world, with nominal GDP of $4.5tn (Japan's is $4.2tn). It is also a consistent Top 3 exporter, and nearly half of all German companies have international investments, employing over 7m people abroad.
Within the EU, Germany is a hub for global trade flows. No other EU state transports more goods. Its logistics sector employs 3m people—Hamburg's port is a gateway for world commerce, handling 9m containers annually, while Frankfurt Airport was Europe's top freight hub in 2021, moving 2.2m tonnes of cargo.
From 2021-24, Germany's global competitiveness ranking dropped from 15th to 24th, while its economic performance ranking fell from 3rd to 13th
Germany still leads in innovation, investing over 3% of its GDP in research and development, with detailed AI and start-up programmes. Furthermore, the backbone of the German economy is still its medium-sized enterprises, which provide dual training that combines theoretical education in vocational schools with practical on-the-job experience, a model renowned and replicated worldwide.
But a paper by the Observatory of Economic Policies in Europe titled Should Germany's Entry into a Great Recession Alarm Europe? argued that addressing rapid economic, social, and geopolitical changes requires agility and swift decision-making—qualities it said were currently lacking in Germany's famously bureaucratic system.
It highlighted Germany's lagging digitisation, noting that building permits, business licences, and registrations take significantly longer than elsewhere in the EU. This slow, inbuilt caution needs to go, the paper argued, especially given the systemic issues Germany now faces.
How to reverse course
Tanja Gönner, a former Bundestag member and head of the German industry lobby group BDI, said the country "continues to fall behind internationally, and its transformation will cost everyone… but failing to transform will cost far more". Others warn that "when Germany sneezes, the rest of Europe catches a cold".
With Germany's export growth rate having fallen below the global trade growth average, some say it should shift from its current focus on high-quality production to a competitive pricing model, contrasting with the French economy's services-led recovery.
Others say Germany should relax its budgetary restrictions under the debt brake to stimulate recovery through debt-financed investments, as its global peers have done. Still others say it should prioritise innovation. The latter envisages a "second miracle" to rival the legendary success of the 1940s symbolised by the Beetle, whose development was instigated by Adolf Hitler. Be careful what you wish for…
