Mighty Germany is in Decline

Germany is the third largest economy in the world with a nominal GDP of 4.7 trillion dollars in 2024 as per the estimate of the International Monetary Fund. Its population is 84 million. The fourth largest economy is Japan at 4.07 trillion with a population of 124 million.  India is fifth with 3.9 trillion dollars and 1.4 billion people.  Japan’s population is shrinking by half a percent every year, while for Germany the population has been rising at about 0.8 to 1 percent per year for the past few years. It is mainly due to the influx of immigrants, many fleeing wars in Ukraine, Africa or Syria.  But among the top five economies of the world (in nominal dollar terms), only Germany is stagnant as compared to the level five years ago.

The United States economy is 10 percent larger than the pre-pandemic level, even Japan is about 3 percent larger, China is about 25 percent bigger and India by about 30 percent.  Germany is close to zero. And for 2024 and 2025 its economy will shrink. This is a two-year recession.

It is a big geopolitical story for the third largest economy and the world. It has already had political ramifications within Germany. The government led by Chancellor Olaf Scholz has fallen. It failed to get a vote of confidence from Parliament last month. This means there will be early elections in February instead of the scheduled one in September. The loss of the vote of confidence was inevitable after the three-party ruling coalition had collapsed a month earlier. That breakup was because the third member of the coalition, the pro-business rightist FDP decided to break away from the other two, SDP and Green party.

There was friction anyway, but the last straw was the surging popularity of the ultra-right wing and anti-immigrant party AfD (Alternative for Germany). The AfD showed huge gains in the elections in the two provinces of Saxony and Thuringia. The AfD is right-wing, populist, Euroskeptic, anti-climate change action and opposes immigration. It is a young party born in 2013 but its rise is very fast and is part of a global trend of the rise of populist politics combined with a clear xenophobic sentiment.

How did Germany get to this situation, and does it have lessons for others? Firstly, there is the China impact. Well into the twenty-first century it was the biggest exporting economy, even ahead of China. The two countries had a symbiotic trade relationship, with Germany exporting high value capital goods, machinery, automobiles and chemicals and China sending back consumer goods. But China subsequently became Germany’s competitor, and even German luxury brand cars are now produced in China.  Secondly, there was the impact of the sovereign debt crisis of 2011 in Europe. This was following the Lehman crash of 2008. In this second wave the governments of Portugal, Ireland, Italy, Spain and especially Greece were saved by a mega rescue led mainly by the fiscal and banking might of Germany. That rescue became necessary to prevent a widespread banking collapse, and more so since German banks were heavily exposed to sovereign debt of the Southern European countries.

It could also be said that it was payback time. Germany had enjoyed the benefits of Euro currency unification since 1999. Since the erstwhile German currency mark was much stronger, in the Euro regime, Germany had a de facto undervalued currency. This helped its exports hugely, and no wonder it became a powerhouse with a large trade surplus. That surplus in turn was capital outflow into banking assets in Europe, which went sour during the 2011 debt crisis. So, Germany had to spend its own fiscal resources to bail out other European governments. The third big reason behind Germany’s predicament, was the Ukraine war and its fallout. The cozy relationship with Russia for cheap gas has ended, after the Nord Stream gas pipeline was destroyed. This has been causing energy costs to soar and also gas shortages in Germany. Chinese overcapacity is leading to global dumping of goods, undermining German export prospects.

It is possible that manufacturing exports will revive at least in value terms if not in volumes. But Germany faces longer term serious challenges which push productivity growth downward. As per a research report from the IMF the real problems for Germany arise from its ageing population, its very low public investment, red tape and unreformed bureaucracy. Germany’s working age population will decline by nearly 1 percent in the next five years, unless offset by immigrants, to which the AfD is vigorously opposed. The public investment to GDP ratio over the last few years is one of the lowest among OECD and European countries. This is partly due to the fact that the federal government is tied by a rather strict fiscal discipline law and the provincial and municipal governments are not investing enough.  But this has a negative impact on productivity and growth.

German exports to the United States, which are robust as of now, run the risk of high tariffs from the Trump government.  The markets for German goods are shrinking due to global competition led by China. Even Volkswagen is closing three factories within Germany. Most importantly Germany is a laggard when it comes to digital tech, artificial intelligence and software services. A well-known German economist and columnist Wolfgang Munchau has written a book called “Kaput”, which says that the growth model is fundamentally broken, and it is the end of the German miracle. He attributes the decline to the mercantilist policies followed by the industrial and political elite, overreliance on Russia and China and a failure to take leadership in new sectors and digital technologies.

This year is one of increased uncertainty. What will be the economic and trade policies of President Trump? More protectionist and mercantile, hurting everyone? How will Russia come out of the huge burden of the cost of war? Interest rates are at 21 percent in Russia and inflation is soaring. Will China be able to arrest its slowdown? This is the geopolitical and geoeconomic landscape against which the German economy must show its resilience. Is the gloom talk about its decline overdone? Only time will tell.

(Dr. Ajit Ranade is a noted economist). (Syndicate: The Billion Press)