(Bloomberg) -- At times when the European project ran into trouble — during the sovereign debt crisis of 2010-2012, or the pandemic a decade later — the region could usually rely on Germany’s deep pockets to help fix the problem.
Today, Europe’s biggest economy faces a confluence of challenges that threaten its own future. An energy crisis is ravaging its power-hungry industries; Chinese companies have acquired the knowhow to compete with its manufacturers; China’s consumers are turning away from German brands; and now a protectionist shift by the US under Donald Trump threatens Germany’s crucial exports.
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Critics of the country’s coalition government say it spent too much time arguing over fiscal borrowing rules when it should have been fixing Germany’s structural problems, such as its aging infrastructure and burdensome bureaucracy.
The chances of a rapid and radical policy response to the crisis are thin. The government collapsed in November and a new administration can’t take office until after fresh elections at the end of February.
What went wrong?
Germany’s economy has flatlined for two years and there’s little sign of an improvement, with companies expecting another 12 months of zero growth. Manufacturing output has been trending downward since 2017, and the decline is accelerating. Unemployment has climbed steadily for the past two years, reaching 6.1% in November. Corporate insolvencies grew by 24% to 22,400 in 2024 — the highest since 2015, according to a study by credit management company Creditreform.
The country remains a manufacturing powerhouse: Its exports represent around four fifths of those of the US, even though Germany has about a quarter of its population. Technical education holds a cachet that’s lacking in other developed nations, ensuring many of the country’s brightest choose a career in industry. Germany still has a deep pool of small, agile manufacturers, and deindustrialization remains a distant prospect.
However, Russia’s full-scale invasion of Ukraine in 2022 underscored another vital ingredient to Germany’s industrial strength of recent decades: An abundance of cheap Russian gas that helped to keep its manufacturers globally competitive. With those gas supplies largely cut off by sanctions, industries such as chemicals and steel making are in trouble. The country’s ongoing shift toward renewable power promises abundant cheap energy, but will take years to come to fruition.
What about China?
China was long a voracious buyer of what Germany had to sell: from Adidas shoes to machine tools for its factories and status-symbol car brands like BMW and Porsche. German companies struck up local business ventures to get better access to the world’s biggest population in exchange for sharing their expertise with Chinese partners. More recently, China has shifted its economic model from lower-cost manufacturing to promoting the kind of high-value goods that were traditionally Germany’s strength.
The challenge is most stark when it comes to electric vehicles: German carmakers fumbled the transition to EVs, and Chinese drivers have been switching to better-equipped models made by local companies such as BYD Co. and Nio Inc.
What were the seeds of the crisis?
Economists see Germany’s problems as partly of its own making: Red tape is a drag on investment and innovation, there’s not enough spending on national infrastructure and the country has been slow to adopt digital technologies that could improve productivity.
An economic boom that followed an overhaul of the welfare system and the labor market in the early 2000s made it easier for successive governments to avoid dealing with these problems. The reforms lowered labor costs and boosted the competitiveness of German industry, just as China arrived in the global trading system with an insatiable demand for capital and consumer goods.
Germany’s exports boomed, but spending to modernize infrastructure, previously one of the strengths of the German economy, was neglected.
Public investment since the 1990s has barely been enough to offset depreciation, according to the International Monetary Fund, and Germany sits near the bottom of advanced economies in public investment. “Money budgeted for investment is routinely underspent, often because of staff shortages in municipalities,” the IMF said in a March report.
The government’s capacity to increase investment is constrained partly by a limit on net borrowing introduced in 2009 under former chancellor Angela Merkel to keep public debt in check.
Germany also has a demographic problem. Growth in its labor force is set to slow by the most in the Group of Seven industrialized nations over the next five years, according to the IMF. An aging population will require more care, drawing workers away from other industries and potentially causing labor shortages.
What’s the government doing to fix things?
At 60% of gross domestic product, Germany’s debt load is far below France’s 110% and Italy’s 140% — theoretically giving it more margin to borrow and spend to boost the economy.
February’s elections look set usher in a government led by the Christian Democratic Union, whose head Friedrich Merz is campaigning on a business-friendly, liberal platform that promises fewer regulations and lower taxes. He’s also flagged an openness to tweaking the Merkel-era debt brake and increasing public investments.
Merz has said it’s time for “fundamental change.” Success may hinge on a new administration’s resolve to scrap the government spending limits and pursue work begun by current Chancellor Olaf Scholz to boost skilled labor and cut back bureaucracy.
“There’s no way around but to invest,” Siemens Chief Executive Officer Roland Busch told Bloomberg TV.
A dwindling population means more immigrants need to be integrated and educated to shore up the labor force. The far-right Alternative for Germany party, or AfD — now Germany’s second-biggest political force — will be determined to ensure that doesn’t happen.
How’s German industry coping?
The hardest hit sectors are energy-intensive ones such as metals and chemicals, which are also struggling to adapt to stricter environmental rules. Steelmakers including Thyssenkrupp and Salzgitter AG are cutting jobs. According to an EY study, one in three German industrial firms plans to outsource roles abroad. Manufacturers of solar panels are shuttering operations and cutting staff as they struggle to compete with state-supported Chinese rivals.
Some German companies have adapted to higher energy costs by shifting where possible to producing high-value goods in lower volume.
The small and medium-sized manufacturers that make up more than 90% of Germany’s corporate landscape have suffered some of the worst effects of the crisis as they don’t have the same access to interim financing as their bigger peers.
Massive industrial brands are feeling the heat too. Europe’s biggest carmaker, Volkswagen, is discussing closing factories for the first time in its 87-year history. Elon Musk’s EV maker Tesla is now worth more than four times Germany’s entire auto industry.
--With assistance from Jana Randow.
©2024 Bloomberg L.P.