Germany in between hope and fear: Aufbruch of Untergang

Germany is in a deep slump. The industrial sector, in particular, is suffering from geopolitical tensions, growing Chinese competition, bureaucracy, and high tax burdens. Yet the stock market shows significant gains due to announced reforms and an infrastructure fund that could give the economy a boost.

There seems to be no end to the negative reporting on the German economy. Everywhere, in print and online media, ominous headlines abound: “Wave of bankruptcies continues.” “German industry sees competitiveness at a record low.” “The knockout draws near: chemical sector production declines further.” “Yesterday king, today crisis: the state of German car companies.” “Pension contributions rise, prosperity falls: shock study reveals bleak outlook.”

Add to that the bumpy roads, stalled train services, the inadequate electricity grid, and the thousands of homeless beggars wandering the big cities, and a picture quickly emerges of a country in decline, a mere shadow of the industrial powerhouse it once was.

"Five years without growth—that hasn’t happened since World War II."

The macroeconomic facts also do not speak in Germany’s favor. Since COVID-19, the economy has hardly grown. Five years without growth—that hasn’t happened since World War II.

No investments

A few weeks ago, President Clemens Fuest of the Munich-based economic research institute Ifo (a kind of Central Planning Bureau) summarized the situation using three simple charts: one shows government consumption, a second shows gross national product, and a third shows private investments.

The first line has risen by 32% since 2015. The second is almost horizontal, and the third is plummeting.

The government is therefore spending more and more on things that do not generate growth, while the economy stagnates and companies are no longer willing to invest, or prefer to do so abroad.

Government consumption usually refers to expenditures that do not directly lead to more production or productivity. Examples include healthcare costs and state pensions. In itself, there’s nothing wrong with that, but according to Fuest, the emphasis in the coming years should shift much more toward government investments.

€500 billion for infrastructure

Fuest, like many other economists, is therefore pleased with the Sondervermögen für Infrastruktur und Klimaneutralität. More investment in good infrastructure makes life significantly easier for both people and businesses. It improves the investment climate and can boost economic growth.

With the €500 billion infrastructure fund on top of the regular budget, spread over a period of more than 10 years, backlog maintenance can be addressed in roads, railways, digitalization, and the power grid. In addition, there is the partly already spent special defense fund of €100 billion. This will certainly create jobs in, for example, construction and engineering firms. But more importantly, it fosters long-term growth. The fact that the debt-to-GDP ratio will rise from just over 60% toward 90% is unfortunate, but not disastrous provided that the growth actually materializes.

The Sachverständigenrat

The Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung sees it the same way. This council of economic experts is an important advisory body for the federal government and released a comprehensive annual report last week titled Perspektiven für morgen schaffen – Chancen nicht verspielen (“Creating Perspectives for Tomorrow – Don’t Squander Opportunities”).

They also see the infrastructure fund as a major opportunity, though one that risks being wasted. “The direction is right, but the implementation is mediocre,” stated Chairwoman Monika Schnitzer, professor at Ludwig-Maximilians-Universität Munich, last week.

According to her, the infrastructure fund will certainly contribute to more growth. Next year, the increase could reach 0.9%, with the economic experts still remaining fairly cautious. Other economists expect even more.

Aging population

But one year is nothing—everything is about the long term, especially considering that Germany’s population is not getting any younger. “Germany needs to become more productive and innovative,” says Schnitzer. “But for that to happen, the money from the infrastructure fund must be spent on the right things and must actually go toward additional investments. Right now, a large portion disappears into the regular budget to fill gaps, diluting the effect and preventing a sustainable growth boost.”

The economic experts therefore see a great need for improvement, because the money can only be spent once.

Too many rules

Another huge problem that needs to be addressed is bureaucracy. Virtually all economists agree that companies—and also households—face unclear and often excessive regulations, which are frequently scattered across different ministries, as well as central and regional authorities, often for unclear reasons.

Fortunately, the German government has recognized the seriousness of this problem. A special minister has even been appointed to ensure better regulation and digitalization. According to the Sachverständigen, this has occasionally led to some improvements, but the big leap forward still needs to be made. The Ifo Institute believes that, in this way, an annual gain of €146 billion could be achieved.

“A special minister has even been appointed to ensure better regulation.”

Too high corporate taxes

Furthermore—and here most economists also agree—the tax burden on companies needs to be reduced. With the so-called Industriestrom, the federal government has taken a step to at least give industrial companies a helping hand. In addition, adjustments are being made to the tax system, for example, different depreciation rules for capital goods and the possibility for retirees to continue working in a tax-friendly way.

But here too, the rating from the Sachverständigen is rather insufficient. Germany’s corporate tax burden stands at around 28.5%, which is high compared to other major industrial countries. This undermines competitiveness abroad. According to the economic experts, more than minor tweaks is needed.

“Fifteen years of underinvestment, a lack of structural reforms, and the rise of China as a formidable competitor have hollowed out the German economic model,” was the reaction of economist Carsten Brzeski of ING to the economic experts’ report.

Investors are more optimistic

In short, there is still a lot of work to be done for the federal government of Friedrich Merz. The infrastructure fund must deliver more “real” investments. Bureaucracy should encourage companies to invest, not deter them. The tax system needs an overhaul. And the pension and healthcare systems must be prepared for a future with an increasing number of elderly people and fewer workers.

But is that a reason to be extremely negative? Not really. There are certainly bright spots, otherwise stock indices like the DAX, MDAX, and SDAX would not have risen so sharply over the past 12 months. Over the last five years, the DAX has even increased by more than 80%, which doesn’t sound like a mood of doom, but rather one of optimism, a sense of Aufbruch in a rapidly changing world.

Everything depends on implementation

Among economists, sentiment is divided. The aforementioned Fuest of the Ifo Institute sometimes takes a gloomy view. Speaking recently to Bild Zeitung, he described the economy as being in a dramatic Lage (situation). “Without a major reform agenda, the decline of the German economy cannot be stopped.” He gives the Merz government until next spring to come up with a solid concept for the future. Otherwise, it won’t work.

Jari Stehn, Chief Economist at Goldman Sachs, is much more optimistic. He is confident that Merz will get the economy back on track, with the infrastructure fund and reforms among other measures. He expects growth of 1.4% next year. “The times when Germany slowed down the eurozone will then be over.”

To quote the Sachverständigen: everything depends on the political willingness to implement reforms. Companies need to be motivated to invest again, and the government needs an overhaul. This applies to the European level as well, as too little has been done in recent years to remove internal trade barriers within the EU, something that is especially needed now.

Sources: iexprofs.nl, Maurits Kuypers, Christian Lue (picture), ChatGPT (translation)