How Germany’s Economic Prowess Has Diminished

In a remarkable turn of events, Germany’s economy has experienced a dramatic downturn over the past four years, contrasting sharply with America’s economic boom. The nation has suffered its worst recession in decades, marked by the unexpected return of high inflation and falling real wages. Perhaps most striking is the reversal of fortunes within the Eurozone: while Southern European nations like Greece, Italy, and Spain—once criticised for their economic management—are now showing strong performance, Germany has unexpectedly become Europe’s weakest economic link.

This decline represents a significant departure from Germany’s historical position. For many decades, the nation was celebrated as an economic miracle, characterised by low inflation, high growth, and manufacturing excellence. Germans took justifiable pride in their economy and the quality of life it provided. However, a series of unforced errors—including misguided austerity measures, problematic energy policies, and overdependence on exports—has led to a markedly different economic landscape. The country now faces losing ground to China, whilst its prestigious automotive industry falls into crisis and the spectre of a global trade war looms.

The Energy Crisis and Its Aftermath

The surge in gas prices in 2022 proved particularly challenging for a German economy heavily dependent on cheap gas, contributing significantly to inflationary pressures. While these price increases have largely subsided, they alone cannot explain the fundamental drift in Germany’s economic performance. Instead, the nation appears to be entering a process of deindustrialisation similar to what the United Kingdom experienced in the early 1980s.

The Austerity Trap

By 2010, during the global recession, German economic orthodoxy had become dominated by the concept of “black zero”—an almost obsessive focus on achieving zero budget deficits. This devotion to austerity and fiscal frugality, while perhaps admirable in principle, has proved problematic in practice. As Keynes noted, government budgets differ fundamentally from household finances, particularly during periods of economic stagnation.

This pursuit of austerity has resulted in severe underinvestment across the economy. IMF data reveals that Germany’s public infrastructure spending has lagged behind many comparable nations, with the effects becoming increasingly visible. The German railway system, once renowned for its efficiency and punctuality, now suffers from critical shortages and deteriorating service quality, shocking the public as old certainties fade. Meanwhile, as American investment has soared, Germany has fallen behind, creating a widening gap between the two economies.

The Export Dilemma

One of post-war Germany’s economic pillars has been its success in manufacturing and exports. Since the mid-1990s, exports as a share of German GDP have doubled to 43%—four times the American share and twice that of China. While this might seem impressive, it has potentially crowded out other economic sectors. Unlike the UK and US, which experienced deindustrialisation due to Chinese competition, Germany initially succeeded by specialising in high-tech industries such as chemicals and automotive manufacturing.

However, this very success has perhaps blinded German policymakers to the need for economic diversification. The country’s current account surplus has reached 7% of GDP—a figure that, while potentially appealing from a simplistic perspective, actually indicates dangerous economic imbalances, including excessive capital outflows and insufficient domestic investment and consumer spending.

Untapped Potential

The situation isn’t entirely dire. Germany remains a wealthy nation with the highest savings rate in the developed world. If these substantial savings could be effectively channelled into meaningful infrastructure investment, they could catalyse broader economic recovery. The strong growth of the 1990s and 2000s was significantly bolstered by Chinese demand for German exports, but China’s current economic challenges and slowing demand create new headwinds for Germany.

Energy Policy Missteps

German energy policy has been marked by unfortunate decisions. Nuclear power, which provided a quarter of Germany’s energy in 1990, was scheduled for phase-out following the Fukushima disaster. The gap was filled partially by fossil fuels but primarily by Russian natural gas. Despite concerns about Russian foreign policy, German leaders hoped that trade would foster closer ties with Moscow. The 2022 invasion of Ukraine shattered this assumption and created significant energy security challenges for Germany’s electricity-intensive industrial sector.

While Germany has shown remarkable adaptability in reducing consumption and securing alternative supplies from Norway and American LNG, the economy remains vulnerable to future energy price spikes.

The Automotive Industry Crisis

The German automotive sector, long the world’s envy for its engineering excellence, design capability, and prestigious brands, now faces an unprecedented crisis. The industry has rapidly lost its leading position in the electric vehicle market to Chinese manufacturers, who benefit from substantial state subsidies and can undercut German prices. German manufacturers appear trapped in the internal combustion era, leading to job losses that reverberate through automobile-dependent communities.

The impact is particularly visible in places like Ingolstadt, Germany’s second-richest city and home to Audi. Following a 91% decline in profits and significant job cuts, the entire city’s economy has been affected, highlighting the risks of over-reliance on the automotive sector.

Broader Economic Challenges

Beyond these specific issues, German businesses face high taxes and regulations that increase costs and potentially hamper innovation. While American and Chinese tech firms demonstrate remarkable growth and stock market performance, German and European firms appear disconnected from this crucial sector of the modern economy. This can be attributed to several factors, including:

– A more regulated labour market that discourages flexible hiring practices
– The historical dominance of US tech firms and their economies of scale
– Europe’s focus on implementing costly regulations like GDPR
– Demographic challenges, including an aging population and low birth rates

Future Prospects

Despite these challenges, Germany’s economy isn’t destined for permanent decline. The country maintains significant strengths, including high savings levels, a skilled workforce, and a robust manufacturing base. The Euro has generally benefited German exports, and despite recent difficulties, German living standards remain among the world’s highest. When accounting for longer holidays and shorter working hours, German productivity per hour worked approaches US levels.

To address its current challenges, Germany could abandon its fiscal conservatism and address the costs of underinvestment. The country needs to prepare for potential deindustrialisation and work to rebalance its economy away from its heavy reliance on exports. However, the looming threat of a global trade war and increased tariffs poses significant challenges for Germany’s export-oriented economy, potentially complicating any attempted economic transformation.

Summary

• Germany has experienced its worst recession in decades over the past four years, while Southern European nations like Greece, Italy, and Spain have outperformed expectations – a striking reversal from previous economic dynamics

• The “black zero” policy (obsession with zero budget deficits) led to severe underinvestment in infrastructure, affecting services like the railway system that were once renowned for excellence

• Exports make up 43% of German GDP – four times higher than the US and twice China’s level – creating an unbalanced economy with excessive capital outflows and insufficient domestic investment

• The country’s energy strategy backfired – phasing out nuclear power led to dependence on Russian gas, creating vulnerabilities exposed by the Ukraine invasion in 2022

• Germany’s automotive industry is in crisis, losing ground to Chinese electric vehicle manufacturers who benefit from state subsidies. This affects entire communities built around car manufacturing

• The country faces significant demographic challenges with an aging population and low birth rates, likely leading to lower growth and innovation rates

• Business competitiveness is hampered by high taxes and regulations, while German firms have largely missed out on the tech boom dominated by US companies

• Despite these challenges, Germany retains considerable strengths:
– Highest savings rate in the developed world
– Highly skilled workforce
– Strong manufacturing base
– High living standards
– Competitive productivity per hour worked

• The threat of a global trade war and increased tariffs poses particular risks for Germany’s export-dependent economy