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European Behemoth in Turmoil: Where is the German Economy Heading?

Agoston Sikos is a second-year student studying History, Politics and Economics at UCL. He interned at the Special Analyses Department of the State Audit Office of Hungary and in M&A at MBH Bank.

The Economist Articles of August 2023

 On the 17th of August 2023, The Economist published three articles on the German economy (Is Germany once again the sick man of Europe?The German economy: from European leader to laggardGermany is becoming an expert at defeating itself). The newspaper argued that Germany is facing the dire economic outlook of the sick man of Europe. This was the second time that The Economist had attributed this unflattering title to the most populous country in the European Union. In 1999, in its article, ‘The Sick Man of the Euro’, it identified the economic difficulties of the reunification, a sclerotic job market, slowing export demand and high unemployment as the four weights making it difficult for the German economy to keep its head above water. At that time the political dimension of a high unemployment rate induced Chancellor Schröder and his coalition government to undertake extensive reforms, which ensued a golden age of the German economy lasting until the end of the 2010s. Whether Germany will emerge from its present recession triumphant again, or the economic reality of Europe is about to change, is the topic of numerous debates. According to The Economist today, German triumph is a near impossibility for five large groups of reasons: inefficient state bureaucracy and legal framework, suboptimal public investment, geopolitical dependency, a peculiarly difficult energy transition outlook, and a shortage of skilled labour. Is The Economist correct? Has Germany become the sick man of Europe?


Ancient Methods and No Leeway

 “Obtaining a licence to operate a business takes 120 days—twice as long as the OECD average”, writes The Economist to illustrate German bureaucratic inefficiency. The most pressing issue of this kind, however, according to The Economist, is the low level of digitisation in government and services. Having said that, Eurostat data seems to lighten the matter: Germany stands firmly on the EU average in ‘enterprises having received orders online‘the Germans are above the EU average by 8 units in ‘internet purchases by individuals’, purchasing through the internet 67.52 times annually per capita. Germany also has one of the lowest levels of ‘problems experienced when using e-government websites’. That said, Germany is indeed just below the EU average in ‘e-government activities of individuals via websites’, and it underperforms the EU average in conducting financial activities through the internet, but the overall picture is not as dire as The Economist paints it. For the largest economy of the EU, these data are less than satisfactory, but far from fatal.


 The Economist criticised Germany for its legal rigidity and the institution of the ‘debt brake’, but even it could not foresee the coming of the Autumn budgetary crisis, a matter that questions whether the existing trade-off between financial soundness and investment levels is sustainable. The crisis came after Germany’s constitutional court blocked government plans to transfer 60 billion euros worth of borrowing capacity from the emergency pandemic budget into its federal budget. As a result of the crisis, Germany had to cut investment in transport, green projects and industry, all three highly in need of funds. The ‘debt brake’ is a fine tool for blocking excess spending and creating debt sustainability, but its static implementation has become a destabilising factor for the German budgetary system, and most importantly, a barrier to crucial investment.



Germany’s Dependencies in a Changing World

 Germany, in the last decade, was highly dependent on two countries, China and Russia. China was and remains crucial for the German economy for its markets, to which Germany exports cars and electronic equipment. However, The Economist is right to highlight that, increasingly, Chinese manufacturers are taking over their domestic markets. There is a loss of market share for Germany in Chinese imports (4.2% of Chinese imports over the last 12 months to July 2023, when they were almost 1 percentage point higher two years earlier), while the share of China in German imports has remained stable at 12% (on the same points of comparison). This forced decoupling from Chinese markets may be strengthened in the future by the trend of Western powers to undertake ‘de-risking’ policies. Today, however, Germany’s largest trading partner is still the People’s Republic of China, even though it is experiencing a slow recovery from its economic contraction caused by the COVID-19 pandemic and the consequences of the disastrous government policies to counter it. The slow recovery of its key trading partner severely harms Germany, but only in the short run. The main problem remains China’s development, eliminating lucrative German export opportunities and creating competition, especially in the automobile industry. Germany will need to find new opportunities in emerging markets and prepare for Chinese competition.


 Russia for its cheap natural gas was crucial for the German economy. It was appealing for firms to allocate industrial facilities in Germany, a country with the attractive attributes of an educated labour force and cheap energy. Germany was partially cut off Russian gas in June and completely in August 2022. This latter development eliminates one of the pillars of German industrial appeal, cheap energy. For example, average electricity wholesale prices in November 2023, although less than a quarter of the prices during August 2022, are more than twice as high as prices were in November 2019. Unlike in the Chinese case, Russian dependency is a matter of the past, but at a high cost.



Energy Transition and the Chaos of German Policy

  One important lesson Germany learned from the Russian decoupling, whether Russian gas would return in the medium to long run to German factories or not, is that the country needs to achieve a higher level of energy independence. A very successful model of a European country, lacking all natural resources for energy creation, that has achieved energy independence, is that of France. France reacted to the 1973 oil crisis with the build-up of its fleet of nuclear power plants. More than 70% of the nation’s energy comes from nuclear power due to this long-standing energy policy. Not only that, but the second Macron government in 2023 decided to abandon any plans regarding the closure of old plants, shortly after the decision in 2022 to construct six more and to consider the construction of eight more nuclear power plants. Mr Macron’s plan to build those six plants in addition to the decision to invest in the upkeep of existing ones is estimated to cost 52 billion euros. France is willing to undertake such a costly venture because the existing nuclear power plant fleet not only allows France the luxury of not being dependent on energy imports but also makes it the world’s largest net exporter of electricity, gaining over three billion dollars per annum in revenues


 Germany is spending no 52 billion euros on nuclear power. In fact, On the 15th of April 2023, anti-nuclear supporters gathered near Munich to celebrate the shutdown of Germany’s last nuclear power plants (Emsland, Isar II, and Neckarwestheim II). The largest economy of the European Union decided to completely free its energy production of nuclear power plants in 2011, following the Fukushima Daiichi disaster in Japan. The decision was the culmination of three decades of political polemic, when the last important opponent of the closure of the nuclear power plants, Chancellor Merkel, demonstrated a complete turnaround on her previous beliefs in light of the catastrophe.


 Without nuclear power and cheap Russian gas, Germany’s main source of energy became the highly polluting coal. If Germany seeks to achieve its net-zero goals, coal cannot continue in its present role in Germany. Windmills, solar panels and other renewable energy sources may be the only viable sources of domestic energy production. However, this would require a constitutional reform of the federal net borrowing limit to enable the government to finance investment in these fields. 



The Lack of Public Investment

 Underinvestment is most evident in the new industries, however, the scope of the problem encompasses even larger terrains. Twenty years ago, if one would have asked a widely travelled European about which train system was most punctual on the continent, she would have answered: the German. Today, ‘Deutsche Bahn’ is regularly late. “Trains now run so serially behind the clock that Switzerland has barred late ones from its network”, writes The Economist. Trains are only a part of the problem. All over the federal republic bridges are crumbling and transportation on roads is made slower by everlasting roadworks. It is far from the image of the immaculate German system that the world has become used to in the last two decades, but this does not mean that German infrastructure is falling behind that of the whole of Europe. In fact, even though German rail and roads face a downturn, Germany remains one of the most developed countries in terms of infrastructure with 229 600 kilometres of road and 40 000 kilometres of railway lines. Nevertheless, for these capabilities to be optimally used, public investment is needed, providing another impetus for constitutional reform regarding the ‘debt brake’. To worsen the image, Germany’s capital stock, which has been declining for decades, is rapidly ageing.



The Need for Skilled Workers

 Germany is not only affected by an ageing industrial base but by an ageing population as well. It is estimated by the World Economic Forum that by the end of the century, more than 30% of the EU will be 65 years or olderFor Germany, this number is projected to be achieved already by 2050. That is, because a great number of workers, born during the post-World War II baby boom, are on the verge of retirement. This realisation comes as firms and public institutions are already struggling to find skilled employees. Immigration, technological progress, education of non-skilled labour and the entrance of older people and more women into the workforce might ease the problem. 



What The Economist Failed to See

 The Economist paints a picture of a decline over the medium to long run but fails to examine the forecasted upturn in the short run. Firstly, as real wages adjust to the environment following the double shocks of the pandemic and the energy crisis, domestic demand strengthens, easing the effect of the worsening trade outlook. German productivity growth will not reach the levels of the 2010s, but this adjustment will push real GDP  upwards. Secondly, although exports are suffering from the weakness of the global economy, the still high order backlog is providing support for German production. Thirdly, unlike in 1999, the German labour market is robust, which continues to stabilise the German economy.



Conclusion

 Germany is not the sick man of Europe, but it faces potential long-term economic problems of a very serious nature. In short, The Economist is exaggerating, but right to sound the alarm bells. Germany needs constitutional reform to allow higher levels of net borrowing to finance public investment, needs to adapt to changing global supply chains and needs to address the rising labour market tightness. Most importantly, however, Germany must start an internal discussion on its energy security. With a lack of investment standing in the way of the construction of windmills and solar panel plants, the absolute rejection of nuclear power plants and the long-term irreconcilability of coal burning with the country’s net-zero goals, Germany is in the cul-de-sac of a failed energy policy. All of these problems need to be addressed if Germany wants to avoid the prophecy of The Economist.






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