Germany’s Economic Moment of Reckoning

Behind the collapse of Germany’s ruling coalition this month were the country’s stark economic challenges and the limits those challenges are forcing on Berlin’s political choices. 

The coalition’s members had been arguing for months over how to balance commitments to boost defense outlays, climate investments, and social benefits. The squabbling grew shrill after finance minister Christian Lindner staked out a position contrary to Chancellor Olaf Scholz, calling for modest cuts to social spending.

Outrage ensued, and on November 6, Scholz fired Lindner, whose pro-business party left the coalition, leaving Berlin under minority government. Friedrich Merz of the opposition Christian Democrats is favored to be the next Chancellor after elections now set for February 23.

The next government faces a moment of reckoning: Germany’s weak economy—and strict constitutional limits on debt financing—have failed to generate the revenues required to meet a long and urgent list of priorities, from childcare to infrastructure to support for the war in Ukraine. Parties don’t agree on where to start, and those divisions are deepening as the economy stagnates.

Annual GDP, this year, is poised to shrink for the second year in a row. Industrial production has been weak, falling 10% in the past two years alone. Berlin closed Russia’s natural gas spigots over the Ukraine war, driving up energy costs to industry, just as German export markets from the U.S. to China are growing less welcoming. Public investments are weak. 

As Europe’s largest economy and its traditional engine of growth, Germany is critical to ties between Europe and the U.S., an $8.7 trillion commercial relationship supporting millions of jobs on both sides of the Atlantic, according to U.S. Chamber of Commerce research.

“A prosperous Europe is good for American business,” said Marjorie Chorlins, Senior Vice President for Europe at the Chamber. “But the EU’s competitiveness challenges are real and threaten to undermine this relationship.” 

Germany, while an example of those challenges, also has significant strengths. The world’s third-largest economy lies at the center of Europe, the world’s second-largest consumer market. It has a world-class industrial base with a skilled innovative workforce that creates products widely known for quality.

Perhaps the biggest hidden strength, however, is massive amounts of bureaucratic red tape that could be cut to spur growth. Both the U.S. Chamber and former central banker Mario Draghi have identified “excessive regulation” as endemic to all of the European continent.

The International Monetary Fund says it takes 120 days to get a business license in Germany—more than double the OECD average—and five to six years to obtain permission to build on onshore wind farm. Last week, a release by the Ifo Institute, a Munich-based research outfit, found “excessive bureaucracy” cost German businesses Euro146 billion a year in lost output.

Frequent stoppages of public transportation and other economically vital infrastructure have hampered growth. Public investment has lagged levels in other developed countries. Germany— again, the world’s third-largest economy—has an average broadband download speed that ranks 60th in the world, according to Dataquest. 

Trade friction and flagging domestic demand are driving some industrial production abroad in search of profits. "German companies are currently achieving stronger growth and profits primarily at their production sites abroad," said Siegfried Russwurm, president of the German business federation BDI, speaking at a news conference earlier this year.

Germany’s automobile production last year was 4.1 million units, down a quarter from the 2016 peak, according to VDA, Germany’s automotive industry association. Since 2018, 64,000 jobs have been lost in the industry—nearly 8 percent of the country’s automotive workforce—and the German media is rife with speculation of more cuts.

Unemployment remains low. But that has as much to do with a shrinking workforce amid Germany’s rapid aging. A backlash against immigration is animating local elections in particularly poorer states, and the contentious issue contributes to a polarization of the voting public into sharply divergent visions for Germany’s future.  

Ultimately, Germany will have to choose between keeping its strict caps on debt financing—at 63%, its debt-to-GDP ratios is by far the lowest in the G7—and its other priorities. It is a decision that it cannot afford to put off any longer, said Judy Dempsey, senior fellow at Carnegie Europe. 

“Germany has lived on borrowed time,” Dempsey said.

About the authors

Jay Sapsford

Jay Sapsford is Senior Vice President for Global Risk Analysis and helps lead the Chamber’s efforts in assessing geopolitical and economic risks that impact the business community. He plays a key role in identifying global trends, risks, and opportunities on behalf of the Chamber’s membership.

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