Europe’s locomotive is turning into a drag. Germany, the European Union’s largest economy and its traditional growth engine, is headed towards a contraction this year. The country’s top economic institutes see output shrinking by 0.6% in 2023, before a slight rebound next year to 1.3%. The slump has immediate causes that also affect the rest of the EU. But it is also throwing a stark light on decades of domestic under-investment, both public and private. Berlin can’t afford not to tackle the problem.
Selling goods abroad, for so long the country’s key growth driver, has turned into a weakness. Exports account for more than half of Germany’s GDP, compared to just a third in France and 37% in Italy, according to the World Bank. But an unexpected slowdown in China – a major trading partner – and sluggish European growth have reduced foreign demand for German cars, washing machines and other goods.
The latest data on industrial production show a year-on-year slump of 1.8% in July, worse than the average 1.1% fall in the EU and in contrast to small upticks in France and Spain. German industry has adapted quickly to higher energy prices – although the hit was severe on energy-intensive sectors such as chemicals and aluminium – and yet the shock could end up shrinking the country’s potential output by 1.25%, according to a recent paper by the International Monetary Fund. A hit of that size would wipe out most of the country’s estimated growth for 2024.
These are just the short-term problems. Failure to boost investment, and to implement deep reforms of the byzantine government bureaucracy, will put a drag on growth for years, German economists have warned. Crumbling bridges and shoddy autobahns have become part of German lore. Europe’s largest economic power does not even have proper internet connections. Because of obsolete government software, builders of wind turbines have to wait for months before they obtain the needed authorisations to transport their equipment on German roads, Reuters recently revealed.
The need to repair the wounds of the past adds to the massive investments needed to help Germany through the transition to a greener economy. Hubertus Bardt, from the German Economic Institute, estimates at between 450 and 500 billion euros - more than 1% of annual GDP - the amount of additional spending required in the coming decade to make up for what he calls Germany’s “investment gap”.
In the past 10 years, according to the IMF, total investment in Germany has amounted to an average of 22% of GDP. That’s two percentage points less than in neighbouring France. Of this, public investment has consistently been below the EU average in the last 20 years - it is estimated at 2.7% of GDP this year, against 3.4% for the EU.
The country’s obsession with fiscal discipline – a legacy of the hyperinflation of the Weimar Republic in the 1920s - may have played a role in the dearth of investment, notes ING economist Carsten Brzeski. Because of political and constitutional restraints, the reluctance to spend explains why the government has failed to provide the necessary public goods in infrastructure, education or the digital economy. Public finances have remained in the black every year between 2011 and 2019. But constrained by its constitutional rule known as the “debt brake”, which limits structural budget deficits to 0.35% of GDP, the government didn’t dare invest more.
As public investment often acts as a catalyst for private spending on capital goods, companies followed suit, and may have been further constrained by a tight labour market. German CEOs have long complained that they can’t find the skilled workers needed to make the high-end goods they sell on world markets. So they may prefer to invest abroad to make sure they will at least be able to hire, notes Oliver Rakau from Oxford Economics. The current unemployment rate of 2.9% – less than half the EU average – during a period of economic weakness is a clear indication of labour market flaws, starting with low female participation in the labour force.
Meanwhile, the heavyweights of Germany’s energy-intensive industry, where production is down 11% over last year, are beginning to seek investment opportunities abroad on fears that higher energy prices are here to stay. Weaning themselves off the dependence on cheap Russian gas has a cost for the giants of the aluminium, chemicals, ammonia, and steel industries. BASF (BASFn.DE), the 38 billion euros chemical group, is investing 10 billion euros in a site in China - even building a wind farm to provide it with energy.
The crucial question is whether under-investment is a natural state of things considering the demographics of an ageing country where 30% of the population is over 60. Without an influx of nearly 1.5 million refugees from Ukraine last year, Germany’s population would have declined for the second year in a row.
The centre-left coalition government of Chancellor Olaf Scholz makes all the right noises about the need to invest more and cut crippling red tape but it doesn’t seem able to deliver on its promises or focus on the right priorities - as shown by Finance Minister Christian Lindner’s push for a return as soon as next year to the debt brake which was suspended during the Covid-19 pandemic.
Looser entry rules for qualified immigrants and faster bureaucratic authorisations to allow them to work would go a long way to alleviate labour market tensions and put the country on a healthier growth path. Labour productivity has been barely growing since 2020, because firms prefer to keep employees on their payrolls in the downtime, fearing they won’t be able to hire again if and when business picks up, notes economist Sebastian Dullien, research director of the Macroeconomic Policy Institute.
Addressing demographic tensions in the labour market will require a more decisive push to favour the immigration of skilled non-EU workers. Germany’s growth potential is estimated at an annual 0.7% over the medium term by the Scope rating agency, about half the euro zone average. That could rise to 1% a year if some 400,000 immigrants are allowed in. A sound economic decision would however be fraught with political risk: the far-right party Alternative for Germany, polling at around 21%, is now Germany’s second-largest behind the mainstream conservative Christian Democrats.
Scholz has his work cut out. Exempting net public investment from the debt brake rule would help to reverse years of underspending. And shrinking the bureaucracy at federal, regional and local levels would help remove unnecessary brakes to growth.
The question is whether a government coalition of three parties with different, and sometimes divergent, priorities can look beyond the short term and take the tough decisions needed after decades of relative inaction. Unless they do, Europe’s leading economy risks letting a good crisis go to waste.
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(The author is a Reuters Breakingviews columnist. The opinions expressed are their own.)
CONTEXT NEWS
Germany’s GDP will shrink by 0.6% this year, according to a joint forecast of the country’s five leading economic institutes published on Sept. 28. The experts had predicted the economy would grow by 0.3% in their spring forecast.
German exports to non-EU countries fell by 1.7% month-on-month in July and by 4.3% compared to the same month of 2022, statistics institute Destatis said on Sept. 21. Industrial production declined by 0.8% in the same month in real terms (price adjusted) compared to June, and by 2.1% since July 2022, the statistics body had said on Sept. 7.
