Sebastian Płóciennik
Director, Member of the Board
The Polish-German Cooperation Foundation
Poland
The past year in Germany has been marked by ongoing stagnation. The crisis, which has dragged on for around ten quarters, has dispelled the last hopes that it was merely an unfavorable economic cycle aggravated by shocks of the pandemic and the war in Ukraine. The EU's largest economy is facing structural problems that emerged many years ago and will not be resolved quickly.
This is well illustrated by data related to so-called potential growth, which roughly reflects the economy's ability to expand its production capabilities after being adjusted for cyclical fluctuations and external factors. From the mid-1990s until the pandemic, this potential averaged 1.2% annually. In this decade – as the leading German economic think-tanks predict in a joint assessment - only a 0.4% increase is expected. Over the long term, there will be no spectacular improvement: according to the renowned Council of Economic Experts, the average potential growth by 2070 will be 0.7%, meaning that the economy will grow by barely 40% during this period.
Where should the causes be sought? A major factor is the worsening demographic situation. By 2050, Germany's population could shrink by 16%, with much steeper declines in the working-age groups. Society will age rapidly: as Handelsblatt warns, by 2035, the ratio of people over 65 to those in the working age (20-64 years) will exceed 50%—twice as much as in 2000. This means that fewer and fewer workers will have to support a growing number of retirees. As a result, labor costs will rise, partly due to the increasing burden of funding the overburdened social security system.
Another often-discussed factor is energy. Although Germany survived the shock of cutting off Russian supplies in 2022, the situation is far from ideal. Competitors in other parts of the world enjoy lower prices, which puts many industrial sectors in Germany in a challenging situation. It won’t be a marginal difference: according to Dezernat Zukunft, by 2045, electricity prices for industry could be up to 75% higher than in comparable countries. The problems are not just due to the lack of nuclear energy and the cutoff from cheap Russian hydrocarbons: the pace and efficiency of the energy transition leave much to be desired.
Another source of Germany's weakness lies in an investment lag—particularly in those by the state for infrastructure. For the past few years, the ratio has remained steady at around 2.6% of GDP, which is about 1 percentage point lower than in France, the main European competitor. Local governments have particularly struggled, cutting spending on modernizing schools, roads, and housing. At the federal level, the underinvestment is symbolized by the condition of Deutsche Bahn, plagued by deteriorating infrastructure, as well as delays in digitalization. The austerity course taken in the previous decade by Angela Merkel's government, which imposed a "debt brake" limiting the permissible structural deficit to 0.35%, is now taking its toll. It was easier to cut investment spending than to reduce social expenditures and subsidies. Unfortunately, companies also followed this trend, resting on their laurels and neglecting the IT sector, while automotive companies, for example, missed the revolution in electromobility.
Germany's international environment is not helping either. The prosperity of previous decades was built on the benefits of globalization and an increasingly open global economy. Germany particularly benefited from access to cheap energy from Russia, China's large and rapidly growing market, and the fact that the U.S. bore the main costs of stabilizing the system. This favorable constellation has now fallen apart. Economic liberalism is out of fashion: many countries are resorting to protectionism and industrial policy. War and geopolitical tensions are forcing Germany to diversify its trade streams and investment, while increasing spending on security. It seems likely that the post-war heyday of a "Handelsstaat" is nearing its end.
In light of these unfavorable trends, Germany's incremental decline is likely, but—as it must be emphasized—not inevitable. There are still significant, untapped resources within the economy. For example, restricting access to early retirement, supporting female labor participation, and encouraging longer working lives could improve the labor market situation. Similarly, reducing bureaucracy and accelerating investments—thanks to reforms to the debt brake—could boost the energy transition and lower energy costs. Rising public investment could also encourage very high private savings to switch from low-return bank accounts to supporting new technologies and start-ups. It is also important not to forget about Germany's strengths. It still has outstanding research and development potential—R&D spending exceeds 3.0% of GDP—and a strong industrial base. Economic reforms, which are a key task for the current and future governments, could awaken the economy from its crisis-induced slumber. If they succeed, we will soon forget about the pessimistic forecasts for the coming decades.