Germany’s economy, often referred to as the “locomotive” of Europe, is facing challenges as it heads towards a contraction this year. The country’s top economic institutes forecast a 0.6% shrinkage in GDP in 2023, with a slight rebound to 1.3% growth expected next year. This downturn in Germany’s economy has immediate causes that are impacting the broader European Union, but it also highlights long-standing issues of underinvestment both in the public and private sectors. Addressing these problems is crucial for Germany’s future economic health.
Germany’s reliance on exporting goods, which has historically been a key driver of growth, has become a weakness. Exports contribute to over half of Germany’s GDP, compared to around a third in France and 37% in Italy. However, a slowdown in China, an important trade partner, along with sluggish European growth, has resulted in reduced foreign demand for German products such as cars and washing machines.
Recent data on industrial production indicates a year-on-year decline of 1.8% in July, worse than the average 1.1% fall in the EU. This contrasts with small increases in production seen in France and Spain. While German industry has adapted to higher energy prices, with some sectors experiencing significant setbacks, this shock could potentially shrink the country’s output by 1.25%, erasing a substantial portion of its estimated growth for 2024, according to the International Monetary Fund.
These immediate challenges are compounded by long-term issues stemming from a lack of investment and a need for deep reforms in government bureaucracy. German economists have warned that the failure to address these issues will hinder growth for years to come. Crumbling infrastructure, including bridges and roads, has become a well-known problem in Germany. The country also suffers from inadequate internet connections and outdated government software that delays essential authorizations for various industries.
To compound matters, Germany needs substantial investments to facilitate its transition to a greener economy. According to Hubertus Bardt from the German Economic Institute, an additional spending of between 450 and 500 billion euros over the next decade is required to bridge Germany’s “investment gap,” amounting to more than 1% of annual GDP.
Over the past decade, Germany has invested, on average, 22% of its GDP, which is two percentage points less than neighboring France. Public investment, in particular, has consistently fallen below the EU average over the last 20 years. Political and constitutional constraints, stemming from Germany’s commitment to fiscal discipline, have limited the government’s ability to invest in infrastructure, education, and the digital economy. While Germany has maintained a budget surplus between 2011 and 2019, governed by the “debt brake” rule, which limits structural budget deficits to 0.35% of GDP, this has hindered necessary investments.
Insufficient public investment can also deter private spending on capital goods. German companies have faced difficulties finding skilled workers, leading some to invest abroad to secure a workforce. The current unemployment rate of 2.9%, less than half the EU average, during an economic slowdown, highlights flaws in the labor market, including low female participation.
Moreover, energy-intensive industries in Germany are exploring investment opportunities abroad due to concerns about sustained high energy prices. Companies in sectors such as chemicals, aluminum, ammonia, and steel fear the cost implications of reducing dependence on cheap Russian gas. For instance, BASF, a major chemical group, is investing 10 billion euros in a site in China, even constructing a wind farm for energy supply.
Germany’s demographic challenges, with 30% of the population aged 60 and above, also contribute to the underinvestment issue. Without the influx of nearly 1.5 million refugees from Ukraine last year, Germany’s population would have declined for the second consecutive year. To address labor market tensions caused by demographic shifts, looser entry rules for skilled non-EU immigrants and faster bureaucratic processes for employment authorizations are necessary. Germany’s growth potential is estimated at an annual average of 0.7%, half of the euro zone average. However, allowing around 400,000 immigrants may increase this potential growth to 1% per year. Nevertheless, such a decision carries political risks, as the far-right party Alternative for Germany has gained significant support.
Chancellor Olaf Scholz’s center-left coalition government acknowledges the need for increased investment and reduced red tape. However, it faces challenges in delivering on these promises and prioritizing the right areas. Finance Minister Christian Lindner’s push to reinstate the debt brake as early as next year, which was suspended during the Covid-19 pandemic, exemplifies the contradictory priorities within the coalition.
Scholz must act decisively to reverse the years of underspending. Exempting net public investment from the debt brake rule and streamlining bureaucracy at all levels of government would remove unnecessary barriers to growth.
The crucial question remains whether the coalition government, composed of three parties with differing priorities, can overcome short-term thinking and make the necessary tough decisions after decades of relative inaction
More detail via Reuters here… ( Image via Reuters )