Germany’s economic stagnation and lessons for the EU
Germany’s economic slowdown, marked by declining productivity, signals potential risks for the European Union’s future.
In a nutshell
- Germany’s productivity decline undermines its traditional economic driver
- Increased regulation and lower education standards deepen the malaise
- The EU faces an uncertain future amid Germany’s waning leadership
Until not long ago, the German recipe for economic success seemed unbeatable. Its foundations were a skilled and motivated labor force, fast technological growth and a focus on high-quality products propelled by continuous improvements in productivity. Attractive margins followed. At the same time, considerable trade surpluses translated into a high savings rate that would generate significant investments on a global scale. What could possibly go wrong? As it turns out, a lot.
In fact, over the past five years, the recipe has failed to generate the expected results, and Germany has stagnated. Poor investments have often been singled out as the major culprit. Yet, investments are not the problem. Although they have been waning from historic highs in 2022 relative to gross domestic product (GDP), they are still elevated (about 22 percent of GDP in 2024) and close to the long-term average.
Its foundations were a skilled and motivated labor force, fast technological growth and a focus on high-quality products.
Instead, the more consequential issue is labor productivity (real GDP per hour worked): It rose steadily until the end of 2008 but is now 8 percent below that peak level. Thus, it seems that Germany’s workers are becoming less effective, perhaps because the quality of their labor has deteriorated, or because their skills are not as valuable (they are employed in industries or functional areas where productivity is stagnant and possibly declining), or because the country’s entrepreneurial spirit is fading. Most probably, all these factors have contributed to the crisis.
The historical driver of German prosperity is losing its sheen
German growth has traditionally depended on the strength of its manufacturing industry, which evolved by acquiring, transforming and developing production facilities in low-cost countries while keeping the high-value-added stages of production at home. However, within this new framework of decline, educational attainments, or lack thereof, have also likely played an important role in the negative trend.
Today, German society features an increasingly high share of poorly educated youth and migrants, many of whom are also struggling with the German language. While youth unemployment is low (less than 6 percent), the labor market has started to absorb an increasing number of low-skilled individuals.
Within this new framework of decline, educational attainments, or lack thereof, have likely played an important role.
Over the past decade, the educational system in Europe’s biggest economy has arguably failed to provide adequate responses or opportunities to young people whose families have become heavily dependent on the welfare state and to those with a migrant background. Measures introduced during the Covid-19 period lowered educational standards and surely made things worse.
The increasingly pervasive role of regulation has also played a role. Regulation hampers competition, creates higher costs for incumbent and prospective entrepreneurs and absorbs large numbers of highly educated individuals, who are thus directed away from productive activities. Industry has also been hit by higher energy costs, exacerbating problems.
Last but not least, globalization has made it easier for Asian producers to catch up with Western technological leaders. Asian businesses now frequently outcompete the front-runners of the past, including the Germans.
Are solutions within reach?
All these phenomena will not be easily reversed in the near future, even if the cost of energy were to drop further. In particular, educational standards will not improve any time soon and regulation will not be dismantled. To restart growth, some advocate more (debt-financed?) public investments and still more immigrant workers to offset the demographic trends of an aging population.
These recipes will not work. Public investments have often been a source of waste, technocrats are a bad substitute for entrepreneurs and the benefits associated with the recent waves of low-skilled migrants are by no means evident. Instead, the productivity decline could accelerate unless some grand continental regulatory projects, such as the European Green Deal or the bloc’s supply chain guidelines, are scrapped or deeply revised and the role of government shrinks.
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As noted above, Germany’s economic performance is disappointing. For example, over the past four quarters, the average rate of GDP growth or contraction compared with the same quarter of the previous year has averaged -0.2 percent. The same measure elsewhere, however, shows modest positive growth: in France (1.2 percent), Italy (0.7 percent) and the entire European Union (0.5 percent). Many wonder whether Germany will eventually adjust and catch up with its European partners or whether the EU and its member states will follow Germany into stagnation or even recession.
Regardless of the answer, there is not much to celebrate if a country eventually ends up with meager annual growth of just 0.5 percent. Rather than debating about a few decimal points and boasting about “having performed better than Germany,” Europeans should start thinking about their future. Although the EU economic context will still be dominated by the sheer weight of the German economy – it accounts for about 24 percent of total EU GDP – Germany will no longer be the leader.
Facts on the ground in Europe today
The economic outlook for Europe is not encouraging, and the options are limited. To be sure, Germany will no longer be a semi-protected market where European manufacturers can find increasingly affluent customers willing to buy their products. Rather, there is a need to create suitable conditions that enhance European production to compete in truly global markets. Such conditions, however, do not include subsidies, regulation and more public expenditure.
Doing nothing is not a solution, either. That would result in the dismantlement of the EU in its present shape, as member states would intensify current efforts to find non–EU counterparts to replace Germany as their primary trading partner. Such a trend does not herald reassuring geopolitical consequences.
Strengthening “Fortress Europe” will neither save Germany nor its medium- and large-sized EU suppliers. While spreading out the weaknesses of one country to its neighbors may mask the consequences of unfortunate policy choices in Brussels and Berlin, ultimately, it will not strengthen the EU bloc.
Scenarios
Three different outcomes are possible, and one is certain. All four envision that the global economy keeps expanding at the current pace (slightly above 3 percent annually), that growth is led by a selected number of developing countries (mainly in Asia) and that international trade keeps expanding despite the presence of significant tariff and non-tariff barriers.
Possible: German malaise spreads throughout the EU
In one possible scenario, the framework outlined above would characterize the next few years. This means business as usual for several small EU economies, which will probably be able to expand their market shares (exports) in Germany regardless of its overall poor performance. However, medium-sized and larger EU countries will face greater problems.
Except for some niches, Germany, where disposable incomes are stagnant, will be neither willing nor able to absorb much larger imports from within the common market while, in tandem, EU suppliers become less competitive. The United States and a relatively large number of Asian-based producers are currently better positioned to outcompete European manufacturers in most manufacturing sectors – with the possible exceptions of capital-intensive industries like pharmaceuticals and chemical products.
In fact, some countries had better learn the German lesson soon, since they might be outgamed both in their domestic markets and on the global stage. If left unchecked, labor-market rigidities, systematic violations of private property rights, extensive regulation and high taxation will likely accelerate de-industrialization in larger EU countries.
Possible: Fortress Europe is bolstered amid stagnation without a leader
A second scenario is characterized by efforts to develop EU strategies to further protect Fortress Europe, perhaps behind the veil of industrial policies (subsidies), fair trade (protectionism), concerns for resilience and geopolitical positioning (partial nationalizations).
In this light, the German decline would be the kiss of death for efforts aimed at enhancing Europe’s role as a major actor in a globalized world. That earlier design would be replaced by fragmented policies striving to make stagnation without a leader bearable. Surely, there is no escape from stagnation by increasing the role of government expenditure and expanding centralized regulation.
Future German pressure to expand the role of government – industrial policies on a continental scale – possibly with an emphasis on intermediate manufactured goods, will not change the nature of the game. It could temporarily boost revenues for selected suppliers of German manufacturers, but it will also make the EU even more dependent on the German economy. This is not necessarily desirable.
Possible: Non-EU countries replace Germany as engines of continental growth
If EU economies fail to develop a new approach, others will do so in their stead. This possibility shapes a third scenario in which non-EU countries replace Germany as the locomotive of continental growth. At least some EU economies will turn to India and China (among others) for growth opportunities, to strike preferential trade deals and offer privileged conditions to attract their investments and technologies.
Of course, this will come with strings attached, as Hungary and Italy are currently finding out. Unintended consequences on a broader and more dramatic scale could also follow if such strings and privileges turned out to be in contrast with Brussels’ rules of the game.
Certain: Globalization and the rise of non-EU players will continue
There can be no doubt that globalization is on the rise. Although the Chinese economy is facing some troubles and global growth is modest, world trade in intermediate imports is intensifying. The new demand will be met by more productive, skilled and agile extra-EU competitors. At the same time, the burden on the EU welfare states will become heavier and pressures to increase public expenditures unavoidable.
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