For decades, Germany has been the steam engine of the European economy, and not a few times – with compensation, of course – it managed to prevent various crises, but also to come out of difficult situations unscathed. However, this dynamic appears to be breaking down, posing risks for the entire continent.
The country is facing its biggest threat since reunification in a time very different from the 1990s: decades of misguided energy policy, a strong car industry built on internal combustion engines, and the slow transition to new technologies they are gnawing at the country’s competitiveness.
Overcoming crises
While Berlin has shown an ability in the past to rise above crises, the question now is whether it can pursue a sustainable strategy.
The prospect seems distant. Chancellor Olaf Solz’s motley coalition is consumed by petty infighting over everything from debt and spending to heat pumps and speed limits.
Data released Thursday showed the economy has actually been contracting since October and has grown only twice in the past five quarters (please read also the analysis titled “Germany cannot escape from the brink of Recession“). Economists see German growth lagging behind the rest of the region for years to come, and the International Monetary Fund estimates Germany will be the worst-performing G-7 economy this year. Despite this, Soltz remains optimistic.
Difficult days are ahead
Currently, Berlin appears unable to sustainably serve the energy needs of its industrial base. In fact, there are not a few who accuse it of being significantly dependent on old-school mechanics. and lacks the political and commercial flexibility to shift to faster growing sectors.
To their credit, industrial giants such as Volkswagen AG, Siemens AG and Bayer AG are flanked by thousands of smaller Mittelstand companies, and the country’s conservative spending habits put it on a stronger fiscal footing than its peers to support future transformation. But he has little time to waste.
The difficulty in the energy transition
Affordable energy is a key condition for industrial competitiveness, and even before the end of Russian gas supplies, Germany had some of the highest electricity costs in Europe.
Berlin is responding to concerns by seeking a cap on electricity prices for some energy-intensive industries such as chemicals by 2030 – a plan that could cost taxpayers up to 30 billion euros ($32 billion). But this would be a temporary measure, “a Band-Aid” and shows Germany’s desperate supply situation.
After shutting down its last nuclear reactors this spring and pledging to phase out coal by 2030, the country installed about 10 gigawatts of wind and solar capacity last year – half the pace it needs to meet its climate goals.
Also, the Solz government aims to connect around 625 million solar panels and 19,000 wind turbines by 2030.
The harsh reality is that the resources to produce such clean energy are limited in Germany due to its relatively small coastline and lack of sun. In response, the country is seeking to build a massive infrastructure to import hydrogen from countries such as Australia, Canada and Saudi Arabia — relying on technology that has not been tested on this scale.
High voltage networks
At the same time, Germany should speed up the construction of high-voltage grids that connect wind farms on the northern coast to power-hungry factories and cities further south. And there is little in the way of storage to ensure the country can weather the holidays.
Promoting innovation
Europe’s economy appears to have a well-funded and well-established system for generating ideas to keep its economy on the cutting edge. Spending on research and development is the fourth highest in the world behind only the US, China and Japan. And according to the World Patent Office, about a third of patents filed in Europe come from Germany.
However, much of the innovation power is embedded in large companies such as Siemens and Volkswagen and is concentrated in established industries. While small manufacturers are still thriving, the number of new startups is declining in Germany — in contrast to the growth seen in other developed economies, according to the OECD.
The reasons include excessive bureaucracy and a cultural aversion to risk. Funding is also an issue. Venture capital investment in Germany totaled $11.7 billion in 2022 compared to $234.5 billion in the US, according to DealRoom. Germany also labors under a heavy academic system and does not have a single university in the top 25 of the latest Times Higher Education rankings.
Patent data shows that Germany’s ability to remain at the forefront is weakening. In 2000, the country was among the top three for world-class patents in 43 of 58 key technology categories, but in 2019 it achieved that ranking in less than half of the sectors, according to a recent study by the Bertelsmann Stiftung.
The real picture in the automotive industry
The weakening of Germany’s technological advantage is particularly evident in the automotive sector. While brands like Porsche and BMW defined the era of internal combustion engines, Germany’s electric cars have struggled. BYD Co. overtook VW to become the best-selling car brand in China last quarter. Key to its push was an electric model that costs about a third of VW’s ID3 but offers greater range and connectivity with third-party apps.
Much of Germany’s wealth and social class is based on a vibrant manufacturing sector that provides well-paying jobs. But that power has led to dangerous dependencies on overseas markets for orders and raw materials – above all China. Like other democracies in the wake of Russia’s invasion of Ukraine, Berlin is now trying to ease its reliance on the Asian superpower, but Germany’s biggest companies aren’t paying attention.
Economics and technology
Much of Germans’ money is held in a network of around 360 public sector savings banks, so-called Sparkassen. These institutions are controlled by local communities, causing potential conflicts of interest while at the same time reducing the country’s economic power.
Germany’s two biggest listed banks – Deutsche Bank AG and Commerzbank AG – have been mired in controversy for years and while they are on the mend, they are still dwarfed by their Wall Street counterparts. Their combined market capitalization is less than one-tenth that of JPMorgan Chase & Co.
In technology, Germany’s biggest player is SAP SE, which dates back to the 1970s and makes complex software that helps companies manage their operations. There are few obstacles for new national champions on the horizon. Digital payments company Wirecard AG briefly filled that role before collapsing in a shocking accounting scandal.
Few investments
The lack of investment in Germany is particularly acute in digital technology. Despite infrastructure that ranked it 51st in the world for fixed-line Internet speeds, it had the fourth lowest spending among OECD countries relative to the size of the economy.
To speed up a long-delayed development, the government has unveiled a plan to overhaul the planning process for the installation of fiber optic cables and mobile communications infrastructure.
Pressures and recession
Europe’s largest economy has come under considerable pressure, particularly after Russia’s invasion of Ukraine and the subsequent decision by European leaders to cut economic and trade relations with Moscow in a broad and key area of activity for European economies, as part of the imposition sanctions for the intervention in Ukraine.
The data
According to Germany’s statistics office, households spent much less in the first quarter, with final consumption spending falling 1.2% over the period as consumers cut back on purchases of clothes, furniture, cars and more.
It is unlikely that German GDP will continue to decline in the coming quarters, but a strong recovery is not foreseen either.
The latest figures for Germany are part of the wider context of high inflation and high interest rates across the eurozone. The European Central Bank is expected to raise interest rates once again at its next meeting on June 15. As the head of Germany’s central bank, Joachim Nagel, said last week, the bank will have to proceed with several more interest rate increases.
The challenges
In a recent report, the OECD put the scale of the challenges in stark terms: “No major industrial economy has ever had the very basis of its competitiveness and resilience so systematically challenged by changing social, environmental and regulatory pressures.”
This in turn will have implications across the continent, as the course of the German economy is vital to the wider European economy and the bloc’s harmony and solidarity.
