What’s Ailing The German Economy?

Despite Germany's reputation for economic prowess, an undercurrent is becoming increasingly apparent. Preliminary data released by the German Federal Statistical (Destatis) Office paints a worrisome picture: a deepening deficit of 42.1 billion euros in the country's state budget during the first half of this year. This surpasses even the figures observed at the peak of the Covid-19 pandemic in 2021.

“I think the situation of the German economy is simply not looking well,” Carsten Brzeski, head of global macro at ING, told BQ Prime. The challenges facing Germany's economy are not solely cyclical but run deeper, according to him. These structural issues, which are not solely attributed to the pandemic or the Ukraine conflict, have been brewing long before these recent crises, he said.

Germany's gross domestic product paints a similar picture. In the second quarter of this year, GDP stagnated at 0%, shattering hopes of a revival during the spring months. This trend follows a series of disappointing data, with the country experiencing a 0.2% contraction in the first quarter of 2023 and a 0.4% contraction in the fourth quarter of 2022. The situation is exacerbated by a fall in demand for German goods and services, which saw a 1.1% drop in the second quarter of 2023.

Dr Moritz Kraemer, chief economist at LBBW, highlighted the juncture at which Germany's economy stands. Net exports played a significant role in the country's growth history, but this engine of growth—once powered by trade with China—is now faltering, he said. While he expects the German economy to grow in the coming quarters, he agrees that Europe's largest economy needs to “find a new growth model because the old one has run its course”.

Escalating energy costs are driving companies to move their production abroad, especially to the United States, where the federal government introduced the U.S. Inflation Reduction Act last year, making it an attractive destination for companies seeking escape from high energy costs.

And given the recent economic data, the government has come under criticism for inaction.

“The government did not invest; we have not seen any big public investments for (the) last 15 years,” Brzeski said. “We saw before the pandemic that the German car industry began to suffer. The suffering, plus lack of future-oriented investments are the main drivers why international competitiveness has deteriorated prior to the pandemic and has continued.”

Red Tape—A Big Burden

Dr Kraemer highlighted another hurdle that's holding Germany back—bureaucratic red tape.

 “When I speak to entrepreneurs in the country, what they complain (about) first and foremost, other than lack of qualified labour, is bureaucracy, red tape.” Kraemer attributes the country's economic success to its small and medium-sized enterprises and “for them, it (red tape) is a big burden”. So, “deregulation, removal of red tape is very high up on the wish list of many companies and that is entirely doable,” he said.

Despite the downturn in high-energy intensive businesses, unemployment rates in Germany are among the lowest in Europe. In June, the country's joblessness rate stood at 5.6%. This may be one of the reasons behind the lack of political action, Brzeski said. “We do not have the pressure from labour markets, so I am (a) bit afraid that the German political system has not yet this high sense of urgency. There are still many people hoping that things will go over and Germany is still strong enough.”

According to Kraemer, the current three-party coalition government helmed by Chancellor Olaf Scholz had, in fact, agreed to pursue the much-needed reforms agenda, but that got derailed due to the Russia-Ukraine conflict.

Lack Of Qualified Skilled Labour

Another cause for concern and one of the reasons behind the low unemployment rate is the changing demographics and the lack of qualified skilled labour.

Kraemer said that loss of workforce due to demography “will dampen the growth potential of the economy”. However, it is “desirable” for companies to “relocate”, as it would reorient the people to “work in those areas where we have competitive advantage”, he said. “I see this in less and less energy intensive business and I think (it) is going to happen.”

As "one the fastest aging economy" in the world, Germany can tackle the issue by allowing more high qualified immigration, according to Brzeski.

In terms of the need for a comprehensive transformation, Brzeski has called for an 'Agenda 2030', that includes sizable public investments in infrastructure, digitisation, clean energy and tax reforms to attract foreign direct investment.

While challenges persist, Kraemer doesn't recommend "extreme pessimism”. Germany still maintains a sizable current account and trade surplus, signifying its competitive edge, despite the hardships, he said.

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