#How the German economy went from bad to worse#
*Things may look brighter next year, but the relief will be short-lived*
(Oct 15th 2024 | Berlin)
It was with Teutonic understatement that Robert Habeck noted economic conditions were “not satisfactory”. Germany’s economy minister was speaking on October 9th, just after official forecasts for the year had been revised from growth of 0.3% to a contraction of 0.2%. This would follow a 0.3% decline in output last year, meaning that Germany faces its first two-year recession in more than two decades.
In fact, Europe’s largest economy has barely advanced since covid-19 struck, lagging behind the rest of the rich world (see chart 1). Isabel Schnabel of the European Central Bank has noted that euro-zone growth excluding Germany has been “remarkably resilient” since 2021 and faster than that of many other big economies. But talking about the euro-zone economy without Germany is like talking about the American economy without California and Texas. The country, once a motor of European growth, has become a drag.
It is difficult to imagine a worse confluence of circumstances for the export-dependent and manufacturing-heavy German economy than those it has faced since 2021. Soaring energy prices followed Russia’s invasion of Ukraine; now China’s industrial overcapacity is causing havoc abroad. Comforting as it might be to blame economic weakness on external factors, however, Germany’s problems run deeper, with many of them homegrown. On top of this, a fractious three-way coalition is hampering the political response.
Industrial production has struggled in recent years. Energy-intensive industries, such as chemicals, metal-work and paper manufacturing, have been hit particularly hard (see chart 2). These sectors account for just 16% of German industrial output, but consume almost 80% of industrial energy. Many firms responded to higher energy costs by pausing production.
Shifting patterns in global demand are a bigger problem for most firms. As Pictet Wealth Management has noted, Germany’s economic relationship with China has shifted. In the 2010s the two countries’ growth was complementary: Germany sold cars, chemicals and machinery to China, and in turn bought consumer goods and intermediate inputs, such as batteries and electronic components. Now China is able to produce for itself much of what it once imported and, in some cases, has become a serious rival for export markets, not least in the old German staple of cars.
Yet the gloom about German industry can be overdone. Although manufacturing production has fallen since 2020, its gross value added has been remarkably stable. Manufacturing firms, in many cases, have been able to shift into producing higher-value items even as they have lost market share. And last year, as the overall economy contracted, trade continued to make a contribution to growth, something that looks set to repeat this year.
Higher real household incomes, as inflation comes down, have been slow to lead to greater demand, but they should eventually show up in consumer spending. The worst of industry’s energy squeeze is in the past, too. Most observers expect a pickup in growth next year. The government has pencilled in growth of 1.1% in 2025 and 1.6% in 2026, based on the assumption that private consumption will begin to rebound. To some scepticism, ministers assume this will happen in part owing to their own growth-inducing policies.
But an overdue upswing would not mean an escape from longer-running structural problems. In reality, Germany’s economic weakness predates recent geopolitical and economic shocks. As Ms Schnabel noted this month, German GDP at the end of 2021 was only 1% above its level of four years earlier, compared with 5% growth in the euro zone minus Germany and more than 10% in America.
German success in the 2010s reflected the country’s competitive advantage against the rest of Europe. At the start of the century, Germany was struggling with the aftermath of reunification. Its price level was higher than in the rest of the common-currency area (see chart 3). Then, in the early 2000s, the Hartz reforms, which included sweeping labour-market liberalisation, put a lid on costs by weakening labour’s bargaining power. At the same time, rapid, debt-fuelled growth in southern Europe drove the price level higher in the euro area as a whole.
Over time, though, this competitive edge has been eroded. After the sovereign-debt crisis of the early 2010s, peripheral European economies embarked on structural reform of their own. From 2015, after a decade of moderation, German wage costs began to grow at a faster pace. By 2019 the price-level gap between Germany and the rest of the euro area had narrowed. The energy squeeze, however, widened the gap again because Germany was more reliant on Russian gas than its neighbours were. For the first time in more than two decades, Germany does not have a cost advantage over its euro-zone peers.
As Germany deals with this loss of competitiveness, it must also contend with demographic shifts. In recent years the country’s ageing population has been balanced by high levels of immigration. But migrants are no longer arriving in vast numbers, leaving companies short of workers. All told, the IMF expects the German working-age population to shrink by 0.5% a year for the coming five years, the steepest decline of any big economy.
IMF officials have warned that, unless productivity improves sharply, German economic growth is likely to settle at 0.7% a year, about half its pre-pandemic level. More government spending could provide a boost, but ministers are constrained by self-imposed fiscal rules. Annual net public investment has fallen from around 1% of GDP in the early 1990s to zero. Although criticism of the so-called debt brake, which limits the federal structural deficit to just 0.35% of GDP a year, has become more common, few observers expect any change before next year’s federal election.
Germany’s recession is painful both for Germans themselves and the broader euro zone. An economic recovery next year, produced by lower inflation and lower energy costs, will not alleviate structural problems. Germany’s economy was showing signs of strain long before the pandemic struck, Russia invaded Ukraine and China began to throw money at struggling industries. It will continue to show signs of strain for some time to come. ■
Bokbreath on
Swimming pools to sausages …
YardOk9446 on
The time has come. Time to migrate in Greece to clean dishes.
attilla68 on
bad economy and a political surge to the right in germany, i think my history teacher once said something about that
ilrasso on
What is teutonic understatement?
[deleted] on
[deleted]
DunnoMouse on
Well, what can you do when most of your government and the opposition insist despite all evidence to the contrary that austerity is a good way to respond to economic crisis
Acrobatic-Paint7185 on
Just need to regulate more. Thats the solution to our economic problems. /s
I would make the joke that the EU is running out of things to regulate, so they should start regulating things that don’t exist yet. But they actually already started doing that with the AI Act. Keep it up!
epSos-DE on
German demographics is more dramatic than the economic shift.
Germany can solve the economic shifts and changes, but the demographic shift is too hard to solve.
Also. As in all places, the damn inflation of housing prices !
extopico on
In summary it was a foreign policy failure by successive governments. They caved in to short term interests of the largest manufactures and wedded themselves to Russian energy, and Chinese demand, neither of which is a democracy and are thus not subject to external or internal pressures.
Domestically they wrecked their own energy supply and never joined up the national grid so the manufacturing heartland, Bavaria, is still not fully connected to the rest of Germany resulting in ever increasing electricity costs.
Now they all say “there was no other way”. Some self reflection is in order.
Fandango_Jones on
With zero investment and no will to do anything otherwise, I’d say it’s going great. But still didn’t expect anything and still disappointed.
JJBoren on
I recommend “military Keynesianism” to stimulate the economy.
lovely_sombrero on
After the North Stream pipeline got destroyed, Germany was forced to import more expensive gas from the US, increasing their price of energy. Meanwhile, the US took advantage of high energy prices in Germany & EU more broadly and passed subsidies for manufacturing companies, enticing them to move to the US. Biden’s official statement was that the purpose of the subsidies was to “own the market on electric vehicles”, but the subsidies targeted a much broader range of industry.
The response from Germany and the EU to that seems to be: “Thank you”. They’ve really completely surrendered to the US, they don’t even seem to have any kind of self-preservation instinct!? The politicians maybe don’t care about the EU itself, but they probably care about their jobs and careers? What is going on in the EU?
13 Comments
#How the German economy went from bad to worse#
*Things may look brighter next year, but the relief will be short-lived*
(Oct 15th 2024 | Berlin)
It was with Teutonic understatement that Robert Habeck noted economic conditions were “not satisfactory”. Germany’s economy minister was speaking on October 9th, just after official forecasts for the year had been revised from growth of 0.3% to a contraction of 0.2%. This would follow a 0.3% decline in output last year, meaning that Germany faces its first two-year recession in more than two decades.
In fact, Europe’s largest economy has barely advanced since covid-19 struck, lagging behind the rest of the rich world (see chart 1). Isabel Schnabel of the European Central Bank has noted that euro-zone growth excluding Germany has been “remarkably resilient” since 2021 and faster than that of many other big economies. But talking about the euro-zone economy without Germany is like talking about the American economy without California and Texas. The country, once a motor of European growth, has become a drag.
It is difficult to imagine a worse confluence of circumstances for the export-dependent and manufacturing-heavy German economy than those it has faced since 2021. Soaring energy prices followed Russia’s invasion of Ukraine; now China’s industrial overcapacity is causing havoc abroad. Comforting as it might be to blame economic weakness on external factors, however, Germany’s problems run deeper, with many of them homegrown. On top of this, a fractious three-way coalition is hampering the political response.
Industrial production has struggled in recent years. Energy-intensive industries, such as chemicals, metal-work and paper manufacturing, have been hit particularly hard (see chart 2). These sectors account for just 16% of German industrial output, but consume almost 80% of industrial energy. Many firms responded to higher energy costs by pausing production.
Shifting patterns in global demand are a bigger problem for most firms. As Pictet Wealth Management has noted, Germany’s economic relationship with China has shifted. In the 2010s the two countries’ growth was complementary: Germany sold cars, chemicals and machinery to China, and in turn bought consumer goods and intermediate inputs, such as batteries and electronic components. Now China is able to produce for itself much of what it once imported and, in some cases, has become a serious rival for export markets, not least in the old German staple of cars.
Yet the gloom about German industry can be overdone. Although manufacturing production has fallen since 2020, its gross value added has been remarkably stable. Manufacturing firms, in many cases, have been able to shift into producing higher-value items even as they have lost market share. And last year, as the overall economy contracted, trade continued to make a contribution to growth, something that looks set to repeat this year.
Higher real household incomes, as inflation comes down, have been slow to lead to greater demand, but they should eventually show up in consumer spending. The worst of industry’s energy squeeze is in the past, too. Most observers expect a pickup in growth next year. The government has pencilled in growth of 1.1% in 2025 and 1.6% in 2026, based on the assumption that private consumption will begin to rebound. To some scepticism, ministers assume this will happen in part owing to their own growth-inducing policies.
But an overdue upswing would not mean an escape from longer-running structural problems. In reality, Germany’s economic weakness predates recent geopolitical and economic shocks. As Ms Schnabel noted this month, German GDP at the end of 2021 was only 1% above its level of four years earlier, compared with 5% growth in the euro zone minus Germany and more than 10% in America.
German success in the 2010s reflected the country’s competitive advantage against the rest of Europe. At the start of the century, Germany was struggling with the aftermath of reunification. Its price level was higher than in the rest of the common-currency area (see chart 3). Then, in the early 2000s, the Hartz reforms, which included sweeping labour-market liberalisation, put a lid on costs by weakening labour’s bargaining power. At the same time, rapid, debt-fuelled growth in southern Europe drove the price level higher in the euro area as a whole.
Over time, though, this competitive edge has been eroded. After the sovereign-debt crisis of the early 2010s, peripheral European economies embarked on structural reform of their own. From 2015, after a decade of moderation, German wage costs began to grow at a faster pace. By 2019 the price-level gap between Germany and the rest of the euro area had narrowed. The energy squeeze, however, widened the gap again because Germany was more reliant on Russian gas than its neighbours were. For the first time in more than two decades, Germany does not have a cost advantage over its euro-zone peers.
As Germany deals with this loss of competitiveness, it must also contend with demographic shifts. In recent years the country’s ageing population has been balanced by high levels of immigration. But migrants are no longer arriving in vast numbers, leaving companies short of workers. All told, the IMF expects the German working-age population to shrink by 0.5% a year for the coming five years, the steepest decline of any big economy.
IMF officials have warned that, unless productivity improves sharply, German economic growth is likely to settle at 0.7% a year, about half its pre-pandemic level. More government spending could provide a boost, but ministers are constrained by self-imposed fiscal rules. Annual net public investment has fallen from around 1% of GDP in the early 1990s to zero. Although criticism of the so-called debt brake, which limits the federal structural deficit to just 0.35% of GDP a year, has become more common, few observers expect any change before next year’s federal election.
Germany’s recession is painful both for Germans themselves and the broader euro zone. An economic recovery next year, produced by lower inflation and lower energy costs, will not alleviate structural problems. Germany’s economy was showing signs of strain long before the pandemic struck, Russia invaded Ukraine and China began to throw money at struggling industries. It will continue to show signs of strain for some time to come. ■
Swimming pools to sausages …
The time has come. Time to migrate in Greece to clean dishes.
bad economy and a political surge to the right in germany, i think my history teacher once said something about that
What is teutonic understatement?
[deleted]
Well, what can you do when most of your government and the opposition insist despite all evidence to the contrary that austerity is a good way to respond to economic crisis
Just need to regulate more. Thats the solution to our economic problems. /s
I would make the joke that the EU is running out of things to regulate, so they should start regulating things that don’t exist yet. But they actually already started doing that with the AI Act. Keep it up!
German demographics is more dramatic than the economic shift.
Germany can solve the economic shifts and changes, but the demographic shift is too hard to solve.
Also. As in all places, the damn inflation of housing prices !
In summary it was a foreign policy failure by successive governments. They caved in to short term interests of the largest manufactures and wedded themselves to Russian energy, and Chinese demand, neither of which is a democracy and are thus not subject to external or internal pressures.
Domestically they wrecked their own energy supply and never joined up the national grid so the manufacturing heartland, Bavaria, is still not fully connected to the rest of Germany resulting in ever increasing electricity costs.
Now they all say “there was no other way”. Some self reflection is in order.
With zero investment and no will to do anything otherwise, I’d say it’s going great. But still didn’t expect anything and still disappointed.
I recommend “military Keynesianism” to stimulate the economy.
After the North Stream pipeline got destroyed, Germany was forced to import more expensive gas from the US, increasing their price of energy. Meanwhile, the US took advantage of high energy prices in Germany & EU more broadly and passed subsidies for manufacturing companies, enticing them to move to the US. Biden’s official statement was that the purpose of the subsidies was to “own the market on electric vehicles”, but the subsidies targeted a much broader range of industry.
The response from Germany and the EU to that seems to be: “Thank you”. They’ve really completely surrendered to the US, they don’t even seem to have any kind of self-preservation instinct!? The politicians maybe don’t care about the EU itself, but they probably care about their jobs and careers? What is going on in the EU?