How did it go so wrong for Germany?
The former economic superpower is mired in a deep structural slump.
There are three types of economic crisis. The first responds to stimulus. The second responds to reforms. And then there is the type of crisis that the people of Germany are experiencing right now: a crisis about who they are, who they are in partnership with, what they are good at, and their role in the world. The Germans have always told themselves that theirs is an old-fashioned industrial economy, that they must run trade surpluses against the rest of the world, and they must resist the pernicious influence of a US-dominated digital world. But this decade has brutally undermined the German world-view and the economic model on which it is based. The political gridlock in the European Union, and its inability to carve out an ecosphere in a world dominated by geopolitical bullies, has a lot to do with Germany’s structural slump.
It has only recently been noted in the UK, but this crisis started a while ago. When the UK voted for Brexit in 2016, Germany was still regarded as the economic power on the continent. Angela Merkel was seen as Europe’s most powerful leader. The Economist called her “the indispensable European”. What only few saw was that all the fateful decisions had already been taken by then: the close relationship of successive German chancellors with Vladimir Putin that led to Germany’s growing dependence on Russian gas; the overreliance on China for the supply chains of German companies; and Merkel’s unilateral decision in 2011 to close nuclear plants. Another problem that did not appear on people’s radar back then as much as it does now is Germany’s chronic under-investment in digitalisation. China and Russia had become Germany’s strategic partners and I still remember my shock when a fellow columnist in Berlin ten years ago said: “We Berliners are looking east, towards Moscow and Warsaw. Paris and London are yesterday’s cities.”
I had never heard this expressed with such brutality. That was Germany in the age of Merkel. The German-Russian relationship had become the most important bilateral axis in Europe. Its symbols were the Nord Stream gas pipelines through the Baltic Sea. It brought cheap gas for German companies, but eastern Europeans regarded it as a threat to their national security. Germany’s delusions ended overnight with Putin’s invasion of Ukraine in February 2022 and the decision by the chancellor, Olaf Scholz, to re-anchor his country firmly within the Western alliance.
Scholz talked about an epochal change in German foreign policy. I think he meant it, but the German economy could not support such a change in direction. The great bet of German industry had been that the age of globalisation would continue; the new cold war was a shock for which the country was not prepared.
The way companies are dealing with this problem now is to close factories and offshore production to the US and to eastern and southern Europe. Volkswagen (VW) recently announced the closure of at least three factories in Germany and massive job losses, marking the first domestic plant closures in the company’s history. This year, the German economy will be stuck in a second year of near-zero growth. A German business association just came out with a forecast that 2026 will be much the same. This is what a structural slump looks like.
Russia’s story is similar in some respects to that of Germany. Both countries have made themselves dependent on just a few economic sectors – Russia on raw materials, Germany on engineering and chemicals. They also made themselves dependent on each other. The Social Democratic Party (SPD), the party of Schröder and Scholz, was the political group that took ownership of the bilateral relationship with Russia. Many senior SPD politicians invested into this relationship – and they are often the same politicians who express scepticism about Scholz’s support for Ukraine. It seems as if that, at some point in the past, they had told themselves that Germans and Russians would never again find themselves on opposing sides of an international conflict.
Scholz himself was not a member of his party’s pro-Putin sect, but he was the leader of the pro-China club. The Chinese courted him early. During 2011 and 2018, when he was mayor of Hamburg, Scholz went on increasingly frequent visits there. When the EU recently voted to impose tariffs on Chinese cars, Germany was the only large member state that voted against them. Scholz is obsessed with tariffs. He is currently whipping up a strong anti-EU sentiment in Germany over this decision. Germany has made itself so dependent on China that it has left itself without sufficient political freedom, especially in trade policy. This is what trade surpluses do. You earn money, but then you become dependent.
Many of Germany’s largest companies have over-exposed themselves to the Chinese market. VW and Mercedes-Benz derive more than 30 per cent of their sales from China. BASF, the German chemical company, has increased its dependence on China, which it regards as its most important future market.
But China has become a huge problem for Germany. China has crowded into previously German-dominated markets, such as cars. The Chinese are hyper-competitive. Unlike Germany, China also invested in 21st-century digital technologies. Chinese electric cars are not only cheaper than their German competitors but are also more advanced.
This is what makes Germany’s economic decline a structural slump, rather than a normal economic crisis. Right now, the policy is to double-down on what they did before. No one in Germany talks about diversification, the only known remedy for excessive dependence. Scholz wants to address the problem through more subsidies to save jobs. I would expect the next German government to push for an extension of the 2035 deadline for the EU’s ban on fuel-driven cars. This would be another short-sighted response. The reasons German car makers are in so much trouble is the loss of market share outside of Europe and especially in China. This is happening now, not in 2035.
Comparing Germany’s industrial decline to the five stages of grief, the country can be seen to have been stuck in the first stage – denial – for a very long time. But now Germany is transitioning to the second phase: anger. This is the stage in which factories close and jobs go, and where everybody blames one another – with particular blame reserved for the EU. Brexit, too, was preceded by decades of verbal and written abuse directed at the EU. I am not predicting a German exit from the EU, but I see progressive disengagement. People blame EU regulation; Scholz is blaming EU tariffs. The Franco-German relationship is also not nearly as good as it used to be under Helmut Kohl and François Mitterrand. Emmanuel Macron and Olaf Scholz are polite to each other, but they are not close.
Germany is also becoming less willing to bankroll the EU. During the eurozone’s sovereign debt crisis, Germany did the minimum required to stop the break-up of the monetary union. Germany is by far the biggest contributor to the EU’s budget. It was the biggest contributor to the EU’s recovery fund, which it set up during the pandemic. Successive German chancellors tried to keep a lid on the EU budget, with some success, but they never managed to roll back Germany’s net contributions. Right now, they stand at around €30bn (£25bn) a year. At a time of austerity, this is a lot of money that is not being spent on German motorways, roads and trains.
The EU’s budget is negotiated for seven-year periods. The current period ends in 2027. By that time, we may be at a different stage in the structural slump, but the crisis will not be over. I don’t think that Friedrich Merz, the leader of the Christian Democratic Union (CDU) and potentially the next chancellor after next year’s elections, would call for the money back, as Margaret Thatcher once did. But I doubt that he will agree to an increase in the German contribution either. But without an increase, it is hard to see how Ukraine’s accession to the EU could be financed. It would depend on other eastern European countries, particularly Poland, to accept that they, too, would need to become net contributors.
Perhaps the biggest foreseeable crisis could be between Germany and the US. I struggle to see how Germany can remain economically intertwined with China to the degree it is today and also remain dependent on the US for its national security. The transatlantic alliance, and the US-German relationship in particular, will face a monumental test if it ever comes to a military confrontation between the US and China over Taiwan. The Dutch have already bowed to US pressure to end the export to China of lithography machines that produce high-performance semiconductors. It is relatively easy for the US to lean on a small country like the Netherlands; Germany would not be nearly as compliant. Germany’s structural slump is also a European political crisis.
The decline is also a cautionary tale about how close economic success can be to economic failure. The Germans were extremely lucky in the first two decades of this century. Everything aligned for them perfectly. In the early 2000s, they improved their price competitiveness through economic reforms; globalisation opened up new markets; cheap container shipping allowed companies to run global supply chains; Russia brought cheap gas; and China needed German plants and machinery for its economic expansion.
Gamblers know about lucky and unlucky streaks. Germany’s luck started to run out soon after the UK voted for Brexit. German exports to the UK dropped sharply. The pandemic damaged supply chains. Russia’s invasion of Ukraine upended the country’s energy policies. Germany’s main trading partners today are the US and China. This is not a great position to be in, but it is symptomatic of an underlying problem: a general denial of geopolitics. Had Germany chosen to open up to new technologies, to detach itself from its many dependencies on companies, countries and technologies, it would be in a very different place today: more pro-European, more secure, less extreme in its political discourse, and clearer about its position in the world.
Successive German governments have found out the hard way that the corporate interests they defended are not the same as the national interest. It would have been in the national interest to diversify away from the companies upon which the country relied too much. Now it is the companies that are diversifying away from Germany.
Wolfgang Münchau’s book “Kaput: The End of the German Miracle” is published by Swift Press