The Strategist

Rust in the engine room

Europe's largest economy is mired in a prolonged crisis. The deep economic slump caused by the Covid-19 pandemic in 2020 was followed by a hoped-for recovery, but this ended abruptly with the Russian invasion of Ukraine. Since then, the German economy has stagnated - in fact, it has contracted slightly compared to Q1 2022. Here we take a look at the challenges facing the German economy and politics.

Date
Author
Dr. Felix Kapfhammer, Economist
Reading time
10 minutes
Strategist Rust
© Shutterstock

Germany lurches from crisis to crisis

As a result of Russia's invasion of Ukraine, Germany has reduced its trade with Russia by 87%. In particular, gas imports from Russia, which accounted for 52% of total gas consumption in 2021, have been halted completely. The rapid shift away from Russian energy supplies hit the German economy hard in the form of temporarily exorbitantly high gas and electricity prices. To date, electricity prices in Germany are more than 50% higher than in 2019, severely limiting the competitiveness of German industry. 

As a result of the energy price crisis and additional supply chain problems caused by the pandemic, consumer prices in Germany and the eurozone peaked at 11.6% and 10.6% respectively, prompting the ECB to tighten monetary policy. This not only had a significant impact on household consumption, but also weighed on Germany's capital-intensive industry. Many of Germany's trading partners suffered similarly, with exports from the trade-dependent economy falling by 5% since February 2022. 

But that's not all. In February 2022, the German government diverted EUR 60 billion in approved loans, originally intended to mitigate the effects of the pandemic, into a climate and transformation fund to facilitate the energy transition. However, in mid-November 2023, the Federal Constitutional Court declared the misappropriation of the loans null and void, following an appeal by the opposition. As an emergency solution, the government suspended the debt brake for 2023 to bring the budget back into balance, but the government is still struggling to find a solution for the 2024 budget. 

Long-term challenges

As if the acute crises were not enough, Europe's strongest economy faces many long-term challenges. Germany is firmly in the grip of demographic change and baby boomers have recently started to leave the labour market, exacerbating a structural skills shortage in the German economy. In addition to the skills shortage, German companies have been burdened for more than a decade by high energy prices due to the nuclear phase-out and energy transition, as well as increasing bureaucracy and slow digitalisation.

In addition, too little has been invested in public infrastructure and defence over the past two decades. The gaps left in the form of manpower and equipment shortages in the Bundeswehr, cancelled political visits abroad due to aircraft breakdowns, a lack of power lines and more delayed than punctual trains are now discussed in the media on an almost daily basis. In addition, one of the driving forces of German industry, the automotive sector, is lagging behind the competition from China when it comes to electric mobility. This example shows that many companies have been too reluctant to invest in emerging technologies in the past. 

A way out of the crisis

Germany's economic situation is currently difficult, but not hopeless. Inflation is rapidly approaching its target of 2%, which means that the ECB's restrictive monetary policy could soon be eased. The expected interest rate cuts and declining inflation will boost consumption and give households, companies and the government new financial leeway for future investments. The wrangling over the budget will also come to an end soon, as the political parties want to avoid a break-up of the coalition. An economic stimulus package that provides targeted support for ailing companies and encourages investment would provide additional help in the face of acute problems. Politicians have already put together skilful aid packages during the financial crisis and the pandemic - they can do it again. The shortage of skilled labour could also be alleviated by more targeted immigration, and the government has already agreed on the key points of a new law to cut red tape. Germany can pull itself out of the economic doldrums again, as it did in the 1990s. But it will take a lot of patience, a lot of energy and the abolition of the fax machine.

 

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