In the second quarter of 2023, the German economy stagnated, and before that it declined for two consecutive quarters. Among most economists, this dynamic is considered a sign of a recession. Meanwhile, the key index of business sentiment compiled by the Munich-based ifo Institute based on a survey of more than nine thousand companies fell for the fourth time in a row, rolling back to the lowest value since August 2020 - when the crisis caused by the coronavirus pandemic peaked. Germany is still often called the "engine of Europe", because its potential has been driving the economy of the entire region for many years. But now the country is facing numerous challenges: from the difficult situation on world markets to various structural problems within the German economy itself. Among them are an aging population, a shortage of qualified personnel, bureaucratic delays and slow digitalization.
The economy is cyclical: growth phases are replaced by periods of stagnation — and Germany is no exception. The previous recession caught the country at the turn of the century. In 1999, the authoritative business magazine The Economist called Germany "the sick man of Europe." Back then, Germany was facing problems similar to today's: exports and GDP growth slowed down, and the collapse of the dotcom bubble of 2001 also hurt the country. Chancellor Gerhard Schroeder, who has now ruined his reputation in the West because of his close ties with the Kremlin, was still an energetic popular politician at that time - and was able to unravel this tangle of difficulties through reforms. Paradoxically, it was the Social Democrat Schroeder who carried out reforms to liberalize the economy - reduced social subsidies, raised the retirement age and lowered taxes in order to stimulate economic growth, explains a senior researcher at the German Institute for Economic Research (DIW) Konstantin Kholodilin.
And yet there was a difference with the current challenges: the previous crisis was characterized by mass unemployment and high government debts. Today, the situation is reversed: there is an unprecedented shortage of personnel in the country, and the level of Germany's creditworthiness, on the contrary, is relatively low in comparison with other countries of the Organization for Economic Cooperation and Development (OECD), which includes developed countries that recognize the principles of democracy and free market. So the current Chancellor Olaf Scholz, Schroeder's colleague in the Social Democratic Party (SPD), has to solve problems of a different nature. Scholz, a pragmatic and reserved politician, was initially elected on promises to stick to the course set by his predecessor Angela Merkel.
But today, when Germany is on the verge of an unprecedented crisis since the unification of the country, it will not be possible to maintain the status quo - the country needs reforms again.
What's going on with the German economy
"We have a real problem, especially in the energy-intensive industry and in the construction industry. There are two main reasons for this: high energy prices due to the outbreak of war in Ukraine and a sharp increase in key rates," says Professor of Economics at the University of Dusseldorf, member of the Scientific Advisory Council at the Ministry of Economy of Germany Jens Sudekum. He believes that, despite the leveling of GDP in the second quarter, the economy will continue to fall, reaching the bottom by about the end of 2023, and possibly will move to growth only at the beginning of 2024.
The first victims of the crisis
One of the early victims of the crisis was the chemical industry — the third largest industry in Germany. Chemical manufacturers require large amounts of electricity to produce intermediate materials used in almost all sectors of the economy. In recent months, several large German chemical concerns, including BASF — the market leader that has existed since the middle of the XIX century — have warned of declining profits and the inability to achieve previously set targets this year.
Another German company with a history, Linde, which gained fame more than a hundred years ago thanks to its cooling system for breweries, and now has become the world's largest producer of industrial gases, has decided to abandon stock trading on the Frankfurt Stock Exchange in favor of the New York Stock Exchange due to capital growth restrictions in Germany. At the same time, the company was the most valuable component of the main German stock index DAX.
The real estate sector was also immediately affected by the crisis. Here, in addition to the jumped prices for building materials, the growth of key rates is most pressing: people have become less willing to take out a mortgage due to the high cost of borrowing. According to the largest German real estate market analytical agency Bulwiengesa, in the first half of the year the number of new construction projects fell by almost half, and the decline in housing construction is even greater.
Defense spending growth
The defense industry has recently begun to support the German economy. It began to grow after a long stagnation due to the powerful impetus given by the Russian invasion of Ukraine. On the third day after the outbreak of the great war in February 2022, Olaf Scholz announced the allocation of a record 100 billion euros for the modernization of the army in the coming years. As a result, the share price of Rheinmetall alone, which produces components of Leopard tanks supplied to Ukraine, has doubled in a year and a half.
The news about the allocation of an unprecedented defense package came as a surprise to the country. In post-war Germany, military spending remained consistently low, and the local army, the Bundeswehr, was the subject of numerous jokes. For example, according to German defense industry laws, it is forbidden to produce tanks to replenish reserves. In matters of security, Berlin mainly relies on the United States, which has a military contingent of about 35,000 people in Germany — the largest in Europe.
These days it is exactly one year since the supply of Russian pipeline gas to Germany almost completely stopped. At the end of September 2022, explosions occurred on three lines of the Nord Stream gas pipelines, which put a fat end even to the theoretical possibility of resuming Russian supplies to the country.
However, by that time the gas had almost ceased to flow through the pipes lying at the bottom of the Baltic Sea. After the outbreak of the war, Germany announced that it would refuse to supply the Nord Stream - 2, which had just been completed by that time, and Russia, in turn, significantly reduced the volume of gas pumping through the Nord Stream -1, explaining this by technical problems in the turbines.
Meanwhile, prices for Russian gas, with which Germany provided 40% of its energy consumption, began to rise even before the start of the war, as markets reacted in advance to the growth of geopolitical tensions.
The situation was further aggravated by the country's long-planned abandonment of nuclear energy, which came into force in 2022. The Germans took the Chernobyl and Fukushima accidents painfully, and the decision to gradually close nuclear power plants was made under Angela Merkel.
To date, electricity prices in Germany have reached one of the highest levels in Europe. As a result, production in the country sharply rose in price, which was a serious blow to the economy of Germany, the industrial engine of the EU. This forces companies to look for options abroad — for example, in China or the United States, where energy prices are lower, and the authorities offer favorable subsidies, especially for projects related to the green economy. For example, chemical heavyweight BASF has invested 10 billion euros in a new plant in China and is not planning new investments in Germany in the near future.
As a result of all these phenomena, the volume of new German industrial orders fell sharply in July — by 11.7% on a monthly basis (10.5% on an annual basis).
The automotive industry and the boom in electric vehicles (which overslept)
Germany is known all over the world for its automotive industry and mechanical engineering, and its well-being largely depends on the export of these goods. In the mid-noughties, thanks to Schroeder's reforms, exports were able to increase - then the country even got the nickname "Exportweltmeister" ("Export Champion"). In recent months, Germany's export indicator has changed little, but in July it fell by almost one percent, although analysts expected a larger decline. Whereas imports, on the contrary, began to grow.
According to the IFO survey, the business climate indicator among automakers fell sharply to zero from 34 points in July, mainly due to low order volume.
The superiority of German goods is beginning to be intercepted by Chinese ones — thanks to the lower cost and, in principle, comparable quality. Especially when it comes to electric cars, solar panels or batteries. At the same time, China is the main market for the German automotive industry. The slower-than-expected recovery of China's economy after severe coronavirus restrictions, which were completely lifted only at the beginning of 2023, also had a negative impact on German companies.
There is an opinion that in Germany, the birthplace of the internal combustion engine, they simply "overslept" the boom of electric vehicles. German automakers initially treated the trend dismissively, not taking it seriously. While their competitors from China and the United States were already heavily invested in the new technology. Today, the capitalization of Tesla alone significantly exceeds all German car companies combined. And the leader of the Chinese automotive industry, BYD, recently surpassed Volkswagen in sales in the domestic market for the first time.
Nevertheless, the German car industry is still trying to catch up with competitors. For example, Mercedes-Benz recently announced the release of the latest E—class model with an internal combustion engine - there will be no more of them. But whether German brands, which gained fame thanks to discoveries in the field of mechanics made more than a hundred years ago, will be able to adapt to the new era of the automotive industry is a big question. Today, drivers are increasingly appreciating technical innovations and environmental friendliness, rather than the amount of horsepower and engine capacity. And digitalization has not yet become a strong side of the German economy.
Consequences of the pandemic
Another factor exerting pressure on the German economy is related to the consequences of the coronavirus pandemic, says Professor Sudekum. Border closures and lockdowns have seriously disrupted the global supply chain system. And it is necessary for the normal operation of the global economy, since almost nothing is completely produced in individual countries.
As a result, prices for cargo transportation rose sharply, to which companies reacted by increasing goods in warehouses, as they were afraid that prices could rise even more.
"The German industry still lives a little on old contracts received during the coronavirus. The companies still have enough goods in warehouses, as well as contracts for their supply, but they will be fulfilled soon," warns Sudekum. Consequently, he expects a further decline in GDP, because in a negative environment, companies are unlikely to start increasing supplies again, rather the opposite — they will reduce reserves. Analysts at the ifo Institute expect the economy to shrink by 0.4% by the end of the year. For comparison, last year the country's GDP grew by 1.8%.
At the same time, the country is facing many internal structural problems, and the most dangerous of them is the rapidly aging population. This factor can be compared to a ticking bomb laid under the foundation of the German economy.
Professor Sudekum believes that it is the aging of the population that is the key problem that requires an immediate solution. Here you can visually study the disturbing graphics of the generation pyramid in Germany.
"By 2035, about 13 million people will retire — the so-called baby boomers, that is, people who are now over 50 years old. But only nine million young people will replace them in the labor market due to a decrease in the birth rate. Accordingly, we have a gap of four million people, which cannot be closed by internal fertility alone. Therefore, Germany will need 400 thousand immigrants a year to compensate for this difference," the expert says.
This is not the first time Germany has faced a shortage of workers. During the post-war economic boom of the 1970s, the German government managed to solve the problem by attracting guest workers (Gastarbeiter) from Southern Europe and Turkey, many of whom settled in the country. After the fall of the Berlin Wall, many immigrants from the states of the former pro-Soviet Eastern Bloc also flooded into Germany. But now many of them are returning to their homeland, as the economies of these countries are actively growing, and the standard of living is rapidly approaching Western European.
What ways out of the crisis is the German government looking for
The German authorities are already taking the first steps to prevent or at least a quick exit from the economic crisis — although, according to experts, they are still too timid. The current motley ruling coalition was nicknamed "traffic light" in accordance with the colors of its parties: the red Social Democrats (SPD), the yellow Free Democrats (FDP) and the Greens (die Grüne). It is difficult for them to come to a consensus on simpler issues because of different political views - not to mention the strategic economic course.
Attracting professionals from abroad
One of the achievements of the coalition can be called the recently adopted law significantly liberalizing immigration legislation, which is aimed at closing the gap between generations.
"The new law on immigration of skilled workers is the most important of the measures taken by the government so far. The only thing that can be done in the short term is to close the gap by attracting qualified workers from abroad. Because in the absence of people, development will stop, and many investment projects will simply fail. It is already possible to observe that the construction of some new wind and solar power plants and other facilities is not possible due to a shortage of personnel," Professor Sudekum notes.
But it seems that not everyone will be happy with new neighbors. The popularity of the right-wing populist anti-migrant party Alternative for Germany (AdG) began to grow sharply. In a recent poll, it scored more than 22% — a quarter higher than Chancellor Scholz's SPD party (and only slightly less than the Christian Democrats — also right-wing, but not so much). AdG is especially popular in the less economically developed east of the country and consistently opposes the policy of "open doors".
The German authorities are also actively trying to attract foreign investors, including by allocating large subsidies. For example, the American processor manufacturer Intel received 10 billion euros from the German government for the construction of a semiconductor factory in East German Magdeburg. The total cost of the plant is 33 billion euros, which will be one of the largest investments in the German economy of all time.
With the help of subsidies, the German authorities are also trying to protect the future of the automotive industry, which is acutely dependent on semiconductors and batteries, in the conditions of economic confrontation between the West and China.
Following the results of the recent two-day retreat, the German Cabinet also adopted a number of policy measures aimed at reducing bureaucratic barriers and subsidizing industry.
Konstantin Kholodilin, senior researcher at the German Institute of Economic Research, explains the essence of the proposed measures:
- reduction of the bureaucratic and tax burden for enterprises (Wachstumschancengesetz — law on growth opportunities: investment premium, accelerated depreciation in housing construction, more generous tax deductions and reduction of bureaucratic procedures by raising the minimum size of the enterprise requiring such procedures);
- it is also planned to reduce bureaucracy by reducing the shelf life of invoices from 10 to eight years and canceling the registration of German citizens in hotels.
However, the parties failed to agree on the most anticipated measure — electricity subsidies for industrial companies.
"It seems to me that the direction of reforms has been chosen correctly. But it is difficult to judge how successful these measures will be. Sometimes it seems that they are more cosmetic. In addition, German society is now highly polarized. This is reflected in the current government coalition, which is known for its friction rather than successful actions. It is no coincidence that among developed countries, only Germany's index of economic policy uncertainty has grown significantly in the last couple of years," Kholodilin continues.
In his opinion, the country needs more radical measures in five directions at once:
- Investment promotion,
- Significant reduction of bureaucracy,
- Improving education,
- The solution of the energy problem.
For example, in the latter area there is confusion and staggering. In an effort to push through their program, the Greens are close to undermining the economy. They're breaking down an old house before they've built a new one.
Reduction of social spending
Against the background of rising defense spending, the government wants to reduce social spending in the budget for 2024. For example, it is proposed to cancel child benefit for families whose total income exceeds 150 thousand euros per year. In Germany, which is famous for its Sozialstaat (welfare state), even such seemingly not too radical measures are perceived very painfully.
Germany spends almost a third of GDP on social security — one of the highest levels among OECD countries. This is largely ensured by high taxes with a progressive rate, which grows in parallel with income. At the same time, this negatively affects the ambitions of the population to earn more — after all, wages will not increase much in real terms due to constantly increasing taxes. And many generally prefer generous benefits to everyday work.
So still: Is Germany the "sick man of Europe" again or not?
Germany got the nickname "the motor of Europe" for a reason: the economy of many European countries is closely connected with Germany, and in some cases depends on it altogether. Since the EU countries are highly interconnected — more than half of their trade takes place within the European Union, and Germany's share is large (almost a third in the Eurozone) — a recession in the country could hit the economies of other EU members.
"Are we the engine of Europe now? Of course not. And I don't believe that the situation will improve in the short term. But at some point it will happen - then growth will return to Europe. But now we are a burden on the European economy, this is quite clear," admits Professor Sudekum.
"We should not allow the importance of [the quality mark] Made in Germany to be downplayed," Bundesbank chief Joachim Nagel said in an interview with the Handelsblatt newspaper last week. "The German economic model is not outdated, but needs to be updated."
Jens Sudekum agrees: we have not yet become the sick man of Europe. Rather, we are a bit like the old man of Europe, who is sitting too comfortably in a chair and who urgently needs to get up and do sports. If we do not do this, we will become Europe's sick again — but so far this is not the case.