Germany: The return of the 'sick man' of Europe?

It was just before the turn of the millennium that the British business magazine The Economist passed a verdict on the German economy, referring to the country as the sick man of Europe. Such an assessment served as a wake-up call for German politics, which, still intoxicated by the economically strong years after reunification, had been dragging its feet on reforms. The government of Chancellor Gerhard Schröder then reformed the labor market, which finally paid off: In 2014, a group of economists from Berlin and London wrote that Germany had developed"From sick man of Europe to an economic superstar."

The German economy is again struggling. For two quarters in a row, its economic output has declined — something economists label a "technical recession." In the most recent quarter, Germany's gross domestic product (GDP) has stagnated at the level of the previous quarter, and all the important economic indicators show a decline.

"Germany's economic situation is darkening," was the conclusion of the president of the ifo Institute, the Leibniz Institute for Economic Research at the University of Munich, Clemens Fuest. The ifo Institute surveys 9,000 executives each month about the current state of their businesses and their expectations for the next six months. The resulting ifo Business Climate Index (July 2023) has fallen for the third month in a row. The ifo researchers expect Germany's GDP to decline again during the current quarter.

The situation is also clear to Commerzbank chief economist Jörg Krämer: "Unfortunately, there is no improvement in sight," Krämer told the Reuters news agency. "The worldwide interest rate increases are taking their toll, especially since German businesses are already unsettled due to the eroding quality of their location."

Industry is no longer the showpiece

Compared with other industrialized nations, Germany is performing exceptionally poorly — and according to an estimate by the International Monetary Fund (IMF) will be the only large country to have a shrinking economic output. The country's industrial sector, the showpiece of its economy, is causing the most concern. It accounts for a relatively large portion of Germany's gross value added (GVA), about 24%, and hasbeen suffering through a global economic slump. The engineering and automotive sectors, which are heavily reliant on exports, are particularly feeling the effects of foreign customers holding back.

Companies in the manufacturing industries are still saving themselves thanks to the large backlog of orders that accumulated during the COVID-19 pandemic because of signifcant supply chain problems. But these orders will soon be fulfilled — and new ones are coming in more sparsely: From March until May, the number of orders received was just over 6% down on the three months prior.

Germany's economic decline has many causes. One of them is the monetary policy of central banks. The Federal Reserve, European Central Bank and others want to curb inflation via significant interest rate increases. That makes credit more expensive for companies and consumers, which has a slowing effect on another important economic sector in Germany — construction — as well as dampening companies' willingness to invest.

This "stalling" of economic dynamism is the whole point of increasing interest rates. But other Eurozone countries, such as France or Spain, have coped with this much better. "All of our European neighbors have higher economic momentum," stated Moritz Schularick, the new President of the Kiel Institute for the World Economy (IfW).

So, structural problems are holding Germany back. The country's economic model used to be based on importing cheap — primarily Russian — energy and cheap raw materials and semi-finished goods, processing them and exporting them as high-value, expensive goods. But that is not working anymore. The multiple crises of recent years have ruthlessly laid bare Germany's weaknesses. Energy-intensive enterprises are suffering under the high energy costs, and those who have relocated their production are not coming back. But Germany's problems do not end there.

How to turn things around?

A current study by DZ Bank, the second-largest bank in Germany, has concluded that small and medium-sized enterprises, commonly described as the "backbone of the German economy," are in danger.

The authors note a veritable cocktail of locational disadvantages: Aside from the energy prices, they listed the latent skills shortage, but also excessive bureaucracy, high taxes, and ailing infrastructure, including struggles in implementing digitalization. In addition, Germany has an aging population. "Large parts of our economy are lacking confidence that investments in Germany as a business location, in light of the high costs and in some parts contradictory regulations, will pay off," Peter Adrian, president of the Association of German Chambers of Commerce and Industry recently told German news agency dpa.

Kiel Institute (ifW) President Moritz Schularick outlined a possible way out of this dilemma in a piece on the website of his Institute: "If Germany does not want to become the 'sick man of Europe' once again, it must now courageously turn its attention to the growth sectors of tomorrow instead of fearfully spending billions to preserve yesterday's energy-intensive industries." 

Germany must, Schularick continued, quickly address the shortcomings and missed opportunities of the past decade: "The sometimes bizarre backwardness in all things digital, the sharp decline in state capacity and public infrastructure, as well as the lack of a meaningful strategy to improve the shortage of housing and increase immigration to deal with the effects of an aging workforce."

This article was originally written in German.

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