In 2024, Germany experienced its second consecutive year of recession (-0.2% after -0.3% in 2023). The economy that has long been Europe's locomotive now seems to be bogged down. Since the start of the war in Ukraine almost three years ago to the day, everything that made the German model so strong seems to have evaporated.
The end of a golden age
Germany built its prosperity on the strength of its industry (notably automobiles, chemicals and machine tools). Two factors in particular made German industry so successful: cheap energy from Russia (mainly gas) and the booming Chinese market, which provided export outlets.
But since 2022, Russia's invasion of Ukraine has caused energy prices to soar. Russian imports have been replaced by more expensive LNG from Norway and the United States. Moreover, electricity prices are closely linked to gas prices.
Source: Trading economics
Secondly, the Chinese market is no longer the El Dorado it once was. Since 2022, China has been experiencing a marked economic slowdown. What's more, German companies are facing increasing competition from Chinese firms. The automotive industry is a prime example. Chinese manufacturers, who have taken the lead in electric vehicles, are now taking market share from the Germans, both in China and in Europe, where they hope to sell their excess capacity.
As a result, German manufacturers find themselves caught in a vice between reduced competitiveness and increased competition. The result is plant closures and relocations. As a symbol of this crisis, Volkswagen, the flagship of German industry, announced in December that it was cutting 35,000 jobs, or almost a third of its workforce. For the economy as a whole, the unemployment rate has risen by one point, from 5 to 6.1%, compared with 2022.
Unemployment rate - Germany
Source: Bloomberg
Structural challenges
You'd almost forget that Germany's success has long been praised and even envied on this side of the Rhine. But in the space of just a few years, Germany has gone from being a good pupil to the sick man of Europe. More generally, we are witnessing a reversal in the dynamic between the heart of Europe (France, Germany), which is experiencing both political and economic difficulties, and the periphery, which is regaining its strength. Countries such as Spain, Portugal and even Greece, which suffered greatly from the stigma of the 2008 crisis and then of the eurozone, have gradually cleaned up their public finances and are currently enjoying dynamic growth, driven by funds from the post-Covid stimulus plan, Next Generation EU.
Germany, for its part, has often been cited as an example of sound public finances. But extreme budgetary rigor is having negative long-term consequences. In fact, the country is now paying for its lack of investment in infrastructure, which can be seen in the poor quality of its roads, bridges and rail network (and consequent punctuality of trains). Germany is also lagging far behind in the deployment of fiber. Ultimately, this lag in infrastructure development is a drag on both the country's attractiveness and competitiveness.
Another key issue is demographics. Germany's population is aging, which means a greater burden on social spending, as well as shortages of labor, particularly skilled labor. The situation is likely to worsen in the years ahead, as the fertility rate is currently around 1.5, well below the 2.1 threshold that ensures the renewal of generations. Over the past decade, immigration has helped stabilize the population, but given the political dynamics, the trend is more towards closed borders and therefore less immigration.
Germany now needs to rethink its model. The good news is that there is financial room for maneuver. With public debt at around 60% of GDP and a deficit of less than 3%, Germany has the means to stimulate the budget. But culturally, spending more is not quite in the German DNA. The trauma of the hyperinflation of the 1920s is still with us.
Secondly, spending more will require reform of the debt brake, a principle enshrined in the German constitution in 2009, in the wake of the financial crisis, limiting the federal government's structural deficit to 0.35% of GDP and prohibiting the Länder from taking on debt. However, constitutional reform (in the same way as the creation of a special fund) requires a two-thirds majority, which Friedrich Merz will not have with the support of the SPD and the Greens alone.
Merz's program includes tax cuts for businesses, but it is also necessary to invest more in defense. With the return of Donald Trump, the Germans finally seem to have understood that they can no longer rely solely on the American guarantee of security. And although military spending has been on the rise again in recent years, it has barely returned to its 1990 level in real terms.
