The German economic model in question

Long viewed as a model, the German economy is now slowing. After the elections, can it regain its competitive edge?

Between 2005 and 2017, when most Eurozone economies saw declines in both the weight of their industries and their export market shares, Germany stood out for its powerful industry, strong market shares... and its fiscal rigor. Over this period, German GDP grew 10% faster than the rest of the zone.[1] Germany and its social co-management model (Mitbestimmung) have long been held up as the example.

Yet, as early as the mid-2000s, questions were already arising over the future of Rhineland capitalism. The findings of F. Pesin and C. Strassel,[2] among others, were severe: Industrial success in "trompe-l'œil", competitiveness without growth, pupils whose performance has fallen below the OECD average, and an apprenticeship system showing serious signs of running out of steam.

Twenty years on, the situation is even more worrying. The German economy is stagnating and even seems to be falling behind its European partners. While most Eurozone countries have returned to their pre-Covid growth trends, Germany's GDP is more than 6%[3] below. In real terms, it has not grown since 2019! Household consumption has stalled, residential investment has contracted by 10%, and despite a 10% rise in investment in intellectual property rights (R&D), total business investment has nonetheless fallen by some 5%. Exports, the mainstay of the German economy, have been at a standstill since... 2017. Worse still, like Italy, France, and Spain before it, Germany is losing export market shares.

The industry in slow motion

Germany’s growth engine, the industrial sector, is broken. The automotive sector, representing close to 5% of GDP and 16% of exports of goods[4] and already reeling from the dieselgate scandal, is facing sluggish demand in Europe: For many consumers, high-end versions are too expensive and in major cities, they are less and less popular due to traffic restrictions. The sector is also facing a slowdown in demand in China, and competition from Chinese manufacturers whose prices are much more competitive -- and who are now competing with German manufacturers on their own soil, particularly in electric vehicles. Rising energy prices have not helped. Since the beginning of 2022, industrial production in energy-intensive sectors -- particularly chemicals, which account for almost 4% of GDP and 17% of exports[5] -- has fallen by almost 20%.

A pressing need for investment

The conclusions of a recent report by the BDI -- the Federation of German Industry -- aptly sum up the disarray into which German industry has plunged. Without an investment effort of 1,400 billion euros by 2030 -- an amount almost twice that of the European "Next Generation EU" plan – the German industry will not be able to regain its competitiveness. This cry of alarm, coming from an organization traditionally in favour of free trade and free competition, is all the more astonishing given that the report suggests that a third of the funds should be provided by the public sector! Is this call for massive investment over the next few years likely to be heeded by Germany's leaders? Will Germany's industrial woes prompt it to loosen its debt brake and invest more at home to help the country regain its lustre? The fact that Chancellor Olaf Scholz has finally decided to part company with his Finance Minister, Christian Lindner (who is adamant about defending the budget brake), might suggest that at least part of the German political class is willing to go down this road.

Economic policy, a key issue in the upcoming elections?

Both the Bundesbank and the Sachverständigenrat -- the Economic Council of the Wise Men – also seem in favour of a reform that would slightly increase the flexibility of fiscal policy, without jeopardizing the sustainability of public debt. However, the window of opportunity to achieve this is narrow. The political process in Germany is set to culminate in early elections (scheduled for 23 February, 2025), which according to the latest polls would give the FDP, AFD and BSW, all opposed to any reform, a blocking minority. Aware of the risk of failing to muster a qualified two-thirds majority in the new Bundestag, Friedrich Merz, President of the current opposition party Christian Democratic Union (CDU), seems increasingly willing to discuss a reform of the debt brake before the elections. This would undeniably provide a little more breathing space to the next government, which, according to the latest polls, could be led by the CDU! It could also prevent an unnecessarily restrictive fiscal policy from depressing an already-sluggish economy.

It remains to be seen whether the Germans will have the wisdom to bring to power parties prepared to invest in the physical and social infrastructures that could enable Germany to return to competitiveness in the future. We must hope so, for Germany of course, but also for Europe...

[1] Source: Eurostat
[2] F. Pesin and C. Strassel, Le modèle allemand en question, Economica, 2006.
[3] Source: Eurostat (all data in this paragraph)
[4] Source: Eurostat
[5] Source: Eurostat