Germany – the economic engine of Europe for decades, helping the region escape many crises, is now entering a recession.
Decades of mistakes in energy policy, the decline of fossil fuel-powered cars, and the sluggishness in transitioning to new technologies are posing the biggest threat to Germany since reunification. However, unlike in 1990, Germany currently lacks leadership to address these structural issues, according to Bloomberg.
“We have been too complacent because everything seemed to look good,” said BASF CEO Martin Brudermüller. “The problems in Germany are accumulating. We will have to go through a period of change ahead. I don’t know if people realize this,” he added.
While Berlin has shown the ability to overcome many past crises, the current question is whether they can pursue a sustainable strategy. This prospect seems distant. Just as the risk of energy shortages eased, Germany’s coalition government led by Chancellor Olaf Scholz has had to contend with a range of issues, from public debt and spending on heat pumps to speed limits on highways.
However, the warning signs cannot be ignored. In January, Scholz stated on Bloomberg that Germany would overcome the energy shortages this year without a recession. However, the data released on May 25 showed that Europe’s largest economy contracted for two consecutive quarters and fell into recession.
Economists predict that Germany’s growth will be lower than that of other countries in the region in the coming years. The International Monetary Fund (IMF) also estimates that Germany will have the worst economic performance among the G7 countries this year.
Scholz remains optimistic. “The prospects for the German economy are very good,” he said to the press in Berlin after the recent data was released. “By unleashing market participants and reducing bureaucratic procedures, we will address the challenges we face,” he added.
However, the recent figures are not just temporary. They are signals of what is about to happen.
Germany has not yet found a sustainable solution to the energy needs of its massive industrial sector. They are also overly dependent on outdated manufacturing technologies, lacking political determination and trade flexibility to transition to fast-growing sectors. These are structural challenges and a wake-up call for Europe’s largest economy.
Industrial giants such as Volkswagen, Siemens, and Bayer are being threatened by thousands of small companies. While cautious spending habits have helped Germany have a better financial foundation for economic transition than other countries, they no longer have much time to waste.
The most pressing issue at present is the transition to energy on the right track. Cheap energy is a key prerequisite for creating competitiveness for the country’s industry. Even before the disappearance of Russian gas supplies, Germany had the highest electricity costs in Europe. If this situation is not stabilized, manufacturing companies will leave.
To address this concern, Berlin has planned to impose a price ceiling on electricity for industries that consume a lot of energy, such as chemicals. However, this is only a temporary solution, highlighting Germany’s difficulties in terms of energy supply.
Germany shut down its last nuclear reactor earlier this year and has pushed for a reduction in coal-fired power generation until 2030. Last year, they installed additional wind and solar power facilities with a total capacity of 10 gigawatts. However, this figure is only half the speed they need to achieve climate targets.
The German government aims to install 625 million solar panels and 19,000 wind turbines by 2030. However, accelerating this process remains unrealized. Meanwhile, the demand is projected to surge due to the electrification of all activities, from heating to transportation and steel production.
“We have to think about which industries can cope with rising fuel prices, which cannot, and focus on the future,” said Siemens CEO Roland Busch in an interview with Bloomberg.
The reality is that Germany lacks resources to generate a significant amount of clean energy due to its small coastline and lack of sunlight. To address this issue, they have been exploring ways to build infrastructure to import hydrogen gas from countries like Australia, Canada, and Saudi Arabia, betting on untested technologies on such a large scale.
Additionally, Germany needs to accelerate the construction of high-voltage grids connecting offshore wind farms in the north to power plants and cities in the south. They also lack storage capacity to ensure resilience during energy disruptions.
“Germany needs unity among parties to accelerate the expansion of renewable energy infrastructure. However, after the 2025 elections, conflicts between parties may slow down the energy transition process again. This is not beneficial for Germany as a business location,” noted Claudia Kemfert, an energy economist at the DIW research institute.
As the economic powerhouse of Europe, Germany has been investing heavily in initiatives to maintain the country’s advantage. It ranks fourth globally in research and development spending, following the United States, China, and Japan. Around one-third of patents filed in Europe come from Germany, according to data from the World Patent Office.
However, most of this activity takes place in large companies such as Siemens and Volkswagen, or in traditional industries. The number of startups in Germany is declining, contrary to the trend in other developed countries, according to the Organization for Economic Cooperation and Development (OECD).
There are several reasons for this, including excessive administrative procedures. Companies often have to submit paper documents to register their establishment. Germany also has a risk-averse culture. Finance is also an issue. Venture capital investment in Germany reached a total of $11.7 billion in 2022, significantly lower than the $234.5 billion in the United States, according to data from DealRoom.
Furthermore, Germany’s technological prowess is gradually diminishing, especially in the automotive industry. While brands like Porsche and BMW remain leading names in fuel-powered vehicles, the German electric vehicle segment is facing challenges.
BYD surpassed Volkswagen to become the best-selling brand in China last quarter. BYD’s key is offering electric vehicles at a price only one-third of VW’s, with longer driving range and the ability to connect with third-party applications.
Much of Germany’s prosperity comes from manufacturing, which creates high-paying office jobs. However, this strength is creating a dangerous dependency on foreign markets for orders and raw materials, especially China. After the Russia-Ukraine conflict erupted, Berlin is seeking ways to reduce reliance on China. However, Germany’s largest companies have yet to prioritize this issue.
There are two main areas in which Germany is underperforming but has the potential to leverage for economic development: finance and technology.
Most of the money in Germany is within the system of 360 small banks managed by local authorities, collectively known as Sparkassen. This increases the likelihood of conflicting interests and reduces the country’s financial strength.
The two largest listed banks in Germany, Deutsche Bank and Commerzbank, have been troubled for many years. Although these banks are undergoing changes, their scale is still small compared to banks on Wall Street. The combined market capitalization of these two banks is still less than one-tenth of JPMorgan Chase.
In terms of technology, the largest player in Germany is SAP, founded in 1970 and producing complex software to help companies manage their operations. Currently, there is no replacement for this segment. Electronic payment company Wirecard came close to reaching this position before collapsing due to an accounting scandal.
Germany also lacks investment in digital technology. Although it ranks 51st globally in fixed broadband speed, the country’s investment in internet infrastructure is among the lowest in the OECD. “Years of weak investment have left Germany behind,” said Jamie Rush, European economist at Bloomberg Economics.
Germany needs to address its issues with a long-term strategy. However, this is challenging to implement. Mr. Scholz was elected with the lowest level of support in decades. The current coalition government also faces significant disagreements. The German political landscape is at risk of instability.
This rift is particularly concerning given the aging population and concerns among young people about the future. The German industrial sector feels the strongest impact from this demographic shift. Recent surveys have shown that 50% of companies have had to reduce production due to labor shortages. This has resulted in an annual economic loss of $85 billion.
In a recent report, the OECD commented on the German economy, stating, “No major industrial country has witnessed such a threat to competitiveness from systemic issues spanning from social and environmental challenges to management pressures like Germany.”
The troubles in Germany will have a ripple effect throughout the region, as noted by Dana Allin, a professor at SAIS Europe. “The health of the German economy is important not only for the European economy as a whole but also for harmony and unity within the bloc,” he stated.