Video - Germany’s illness: in need of a catalyst for recovery
2 min
Once the graceful swan of the last decade, Germany has, in a few short years, reverted to the ugly duckling it was in the 1990s and early 2000s. Its resurgence had been initiated by Gerhard Schröder’s reforms in 2003, while its current regression stems from excessive cuts to public spending over the past decade and the country’s overreliance on foreign attachments.
Too many vulnerabilities
In the second quarter, the German economy shrank by 0.1% compared to the first three months of the year. The decline in the influential IFO index at the end of August indicates that no improvement is in sight. Germany has experienced stagnation for four years.
The reasons for this are varied. “Germany outsourced its security to the United States, its export needs to China, and its energy requirements to Russia,” said Constanze Stelzenmüller of the Brookings Institution in a speech. Russia’s invasion of Ukraine has highlighted these vulnerabilities. Since then, energy independence has become a top priority for Europe. Yet, the German government continues to procrastinate on energy reform, stalling investment in German businesses.
Now that China is exporting cars to Europe, Germany deeply regrets its dependency on the country. Volkswagen has been the first major casualty, struggling to stay afloat to the point of considering factory closures in Germany, despite promises to maintain job security until 2029. The once-thriving symbiosis, where Germany and Europe exported technology in exchange for access to a vast market, is now a distant memory.
Meanwhile, German automakers continue to invest in China, hoping that opening major factories there will allow them to maintain sales in Germany. However, this strategy carries risks. When it comes to competitively producing electric vehicles, German brands are still playing catch-up, making it difficult to compete with the leading players in the sector. Adding to these challenges are the growing political tensions between China and Europe.
In recent years, German exports have increasingly shifted towards the US driven partly by China’s sluggish growth. But this exposes Germany to potential import tariffs, a threat from US presidential candidate Donald Trump. On top of that, Germany will need to allocate a larger share of its budget to defence. Could this mean even less investment in its domestic economy?
Excessive cuts to public spending
Germany has itself to blame for its low level of domestic investment. After the 2007-2008 global financial crisis, the principle of the schwarze Null (black zero) was enshrined in the German constitution, limiting the permissible budget deficit to 0.35% of GDP from 2016 onwards. Such a restriction reduces the capacity for crisis management. This limitation was cleverly bypassed during the COVID-19 crisis, but it has now led to intensified budgetary savings.
More critically, Germany has invested far too little in infrastructure, education and other essential sectors over the past decade. The severe delays in its rail system and the poor quality of internet connections were painfully evident during the recent European football championships.
Additionally, the sharp rise in interest rates has significantly impacted Germany’s housing market and construction sector. A combination of higher mortgage rates (with the average term for mortgages in Germany, at 10-15 years, being much shorter than in countries like Belgium) and a significant decline in purchasing power has sharply curtailed building permit applications and construction activity.
Real consumption by the average German also remains far below pre-2019, pre-COVID levels. German consumers are more vulnerable to inflation than any other Europeans.
Cyclical problems vs structural challenges
These more recent issues are cyclical, and a recovery in real incomes due to falling inflation and rising wages, coupled with lower interest rates, will provide significant relief. However, tackling Germany’s excessive spending restrictions, its dependency issues, and structural problems requires additional catalysts.
Germany, like the European Union, has historically needed crises to trigger policy change. A return of Donald Trump to the White House might serve as a wake-up call. Increased pressure to ramp up defence spending, combined with the need to boost domestic consumption and investment, would render the schwarze Null policy unsustainable.
Germany may even back a new European investment vehicle, similar to the EU’s NextGeneration fund. A reformed Germany – the ugly duckling of Europe – could take the entire European Union along for the ride, benefiting everyone in the process.