The sense of decline in Germany is palpable

Olaf Scholz promised an economic miracle – but Germany is now facing a very different reality
Olaf Scholz promised an economic miracle – but Germany is now facing a very different reality - FILIP SINGER/Shutterstock

Someone always has to be the “sick man of Europe”, and more often than not in the 78 years since the end of the Second World War, it is Britain.

Just occasionally, however, it is the very beating heart of the European economy itself, Germany, that takes the wooden spoon. The last time was in the late 1990s, when Germany was struggling with the challenges of reunification.

Unemployment soared, and the economy was never far away from outright recession.

Yet all that changed after a series of bold labour market reforms coincided with the launch of the euro.

During what for everyone else were the famine years of the great recession and eurozone debt crisis, the German economy thrived anew, buoyed by a highly competitive manufacturing sector that seemed tailor-made for the opportunities of monetary union and the fast growing economies of the developing world.

Unfortunately the worm has turned again, and right now it is once more the industrial heartlands of the Rhine that look like claiming the “sick man” title.

Things are obviously completely different from the last time Germany was in such a fix, and in any case it never pays to underestimate Germany’s ability to adapt when it needs to.

Clemens Fuest, president of Munich’s Ifo Institute economic research organisation, thinks the “sick man” description is an exaggeration, but he agrees that the structural challenges facing Germany are daunting in the extreme, with little appetite among voters for the required change.

In its monthly economic update last week, the Deutsche Bundesbank insisted that businesses have coped relatively well with the economic headwinds of first the pandemic and then the energy shock.

There were few signs of the manufacturing sector’s imminent demise. But the report said there was “a broad need for action” to adapt to seminal change, and though the politicians are doing some of the right things, progress is slow.

The OECD, the IMF, the European Commission, the Bundesbank – you name the forecaster, they are all predicting that virtually alone in the G20, the German economy will contract this year, and then do little more than stagnate the year after.

Over the next five years, according to IMF forecasts, the German economy will grow more slowly than any other G7 economy bar Italy – and that includes the UK, which is still recovering from Liz Truss’s reckless “dash for growth” and is meant to have the extra handicap of Brexit to contend with.

The differences are admittedly not that big; weighed down by demographic change and ballooning debt, all advanced economies are struggling to show meaningful growth.

But as the world economy transitions away from fossil fuels and divides into competing and increasingly hostile geopolitical trading blocs, the structural challenges faced by Germany are far greater.

Germany’s economic strengths have transmogrified into its biggest weaknesses.

Those strengths are largely based around the country’s manufacturing prowess, and particularly its world leading position in the automotive, chemicals and machines tools industries.

Nearly a fifth of the German economy is still accounted for by manufacturing, which alongside Japan makes it exceptional among major advanced economies, where typically the proportion is 10pc or less.

There are other strengths too, notably very low unemployment, and a public sector balance sheet which is the envy of the UK Treasury. All the same, the sense of decline, and of an economy which no longer works as it should, is palpable.

A country once famous for discipline and punctiliousness has given way to one of growing self-doubt, ageing infrastructure, crushing bureaucracy, and underinvestment in new industries where even the trains no longer run on time.

‘Broken Britain” finds its mirror image in ‘broken Germany”, but the latter is worse because Berlin doesn’t yet grasp the magnitude of its predicament.

The warning signs have been there for years, with industrial production peaking in 2018 and falling more or less ever since.

We’ve obviously had the economic shocks of the pandemic and war in Ukraine since then, but tellingly, German industrial production has yet to recover to former glories, unlike much of the rest of Europe.

Particularly affected is car production, which has been badly hit by the slowdown in China, and is struggling with the transition to EVs, where the value lies as much in the software as the core manufacturing.

But there are also other energy intensive industries, from chemicals to ceramics, paper and glass.

BASF’s Ludwigshafen Verbund site, the largest such chemicals plant in the world, is reckoned to consume as much natural gas in a year as the whole of Switzerland, yet today must contend with both much higher prices and a determination to phase out gas entirely over coming decades.

When Olaf Scholz became Chancellor as part of a three-party coalition at the end of 2021, he committed his government to the goal of climate neutrality by 2045, accompanied by the promise of a new “Wirtschaftswunder” – economic miracle – similar to the one West Germany experienced after the Second World War.

Climate change goals would help Germany “achieve growth rates last seen in the 1950s and 1960s”, Scholz said as recently as March.

Goodbye to the car industry, with its dependence on increasingly hostile export markets; hello to huge levels of domestic demand for renewables and their accoutrements. That was his message.

We see similar claims of industrial rejuvenation in Britain, but thus far little evidence of it. When Scholz appeared at this month’s Munich motor show wearing a black eye patch, it seemed symbolic of an economic dream already badly damaged by its collision with reality.

It’s not just German households tearing their hair out at Scholz’s particularly aggressive approach to net zero; a once thriving mittelstand also faces crippling levels of investment to meet new environmental standards, with few obvious sources of capital to pay for it.

Most Germans accept the need for the planned transition, but few are under any illusions about its costs, both to wealth and livelihoods.

“It’s like being forced to pull down your perfectly serviceable house to build an entirely new one you don’t obviously need; it’s bound to leave you poorer”, says Ifo’s Fuest.

Culturally and politically, Germany is finding it particularly hard to come to terms with the idea of a more service-based economy built around a digital future rather than a manufacturing past.

In this respect at least, Britain enjoys some advantage, since it’s a transition already made. Britain’s challenge is instead to somewhat re-grow its manufacturing capacity, so as to make the economy less reliant on others for core needs. This is likely to be a rather less politically fraught task than shrinking it.

No doubt Germany will find a way, but as demonstrated by the rise of once-fringe political elements such as Alternative for Germany – now regularly polling ahead of the ruling Social Democratic Party – it won’t be a happy passage.

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