Germany: From Wunderkind to the Sick Man of Europe

By Desmond Lachman

Wednesday, April 10, 2024

 

Economic troubles are coming to Germany, Europe’s largest economy, not as single spies but in battalions. They are also doing so at a time of domestic political weakness when the country lacks a coherent plan to restore its former economic strength. This does not bode well for Germany’s long-run economic prospects. It also will make it difficult for the euro zone’s economic periphery in general, and Italy and Spain in particular, to grow itself out from under its public-debt mountain.

 

Anyone doubting that the German economy is in trouble has not been paying attention to the fact that last year Germany was the world’s worst-performing major economy. According to the International Monetary Fund, last year, at a time when the world’s advanced economies grew by an average 1.6 percent, Germany’s economy contracted by 0.3 percent. Adding to the gloom, at the end of last month, five leading German economic-research institutes forecast that this year the country’s economy would grow by only 0.1 percent.

 

To a large degree, Germany’s current economic troubles are the result of past major errors of economic-policy judgment. They also have been compounded by political drift, underinvestment, too much red tape, and poor demographics. As such, they could turn out to be intractable and return Germany to the time in the 1990s when it was the sick man of Europe rather than the continent’s economic wunderkind.

 

Among the more serious economic-policy errors that Germany made was to become over-reliant on cheap Russian energy to fuel its industrial machine. This error was exposed when Russia invaded Ukraine and the period of cheap Russian natural gas came to an end. Along with Italy’s, the German economy was the hardest hit by the Russian energy shock.

 

Another major policy error was to build an economy that was overly dependent on the Chinese export market. With China being Germany’s largest export market, buying around $125 billion of its goods, the German economy has been among the hardest hit by the bursting of the Chinese housing and credit-market bubble. As a very open economy, Germany is also very exposed to a world economic slowdown. Whereas trade accounts for around 20 percent of the U.S. economy, in Germany it contributes almost 50 percent.

 

Compounding Germany’s economic malaise has been its infrastructural underinvestment and its bureaucratic impediments to growth. According to the IMF, Germany has been near the bottom of the major countries in terms of public investment. Meanwhile, it has an aging digital infrastructure with a broadband ranking lower than Turkey’s. It has also been among the slowest to approve new enterprises. For example, it takes about five years to get permission to build an onshore wind farm. And it takes 120 days to obtain a business license, more than double the OECD average.

 

Germany’s poor demographics are yet another impediment to its long-term growth prospects. Over the past decade, Germany’s working-age population was buoyed by migrants escaping regional conflicts. As this migrant wave ends and the generation born after the war retires over the next five years, the growth rate of Germany’s labor force will drop by more than in any other G-7 country.

 

In the 1990s, after its reunification, Germany displayed remarkable political will to undertake the painful structural measures to transform its economy. Unfortunately, today the political prospects for repeating that feat do not appear good. The three-way governing coalition is at daggers drawn over everything. Meanwhile the two great political groupings of German post-war democracy, the Social Democrats and the center-right CDU/CSU, can no longer hold the center as the political system splinters with the rise of extreme right- and left-wing parties.

 

Germany’s economic stumbling comes at a bad time for the euro zone economy as it struggles with record-high interest rates and higher public debt levels in its periphery than at the time of the 2010 euro zone sovereign-debt crisis. It also comes at an inopportune time for the global economy. Both Japan and the United Kingdom are already in recession, and China’s own version of post-war West Germany’s Wirtschaftswunder has ground to a halt. The last thing the global economy needs now is to have Germany, the world’s third-largest economy, go through a prolonged period of economic stagnation.