The German economy has stalled – it’s not the first time it’s been the sick man of Europe.
This article appeared in the Business Post on January 19th.
The German economy, for long the locomotive of growth in Europe, has stalled. This week data confirmed that the economy had contracted for a second consecutive year under the weight of higher interest rates, high energy prices and greater competition in export markets.
The outlook remains grim. In December the Bundesbank slashed its growth forecast for 2025 to just 0.1%.
And it could get worse. If incoming US President Trump follows through on his threat to impose tariffs it would likely push the economy further into recession.
With elections looming, Germany faces a trifecta of economic, political and geopolitical challenges. The question now facing Germany isn’t just whether it can regain momentum; it’s whether a new model is required for the evolving international order.
A Model Under Siege
For years, the German economy was built on strong exports, fiscal prudence and collective bargaining. Now, structural headwinds are dismantling these pillars of stability.
Take Volkswagen for example. In November, it announced plans to close three plants and cut thousands of jobs. The announcement prompted walkouts at VW plants across Germany.
The problems at VW are symptomatic of wider challenges facing German industry.
China, for long an export destination for capital goods from Germany’s industrial champions and Mittelstand, has become a competitor in high value sectors such as solar panels, EVs and wind turbines.
Meanwhile, the war in Ukraine exposed Germany’s dependence on cheap natural gas from Russia. Higher natural gas prices have made some industries such as chemical production untenable and forced manufacturers in other sectors to consider redomiciling to the US where energy costs are much lower.
If external challenges weren’t enough, Germany faces growing internal pressures. An aging population is straining public finances, with fewer workers supporting a growing base of dependents—a trend that threatens both tax revenues and welfare spending
This demographic trap has a political dimension. To sustain its welfare state, Germany needs more foreign workers. But the far-right Alternative for Germany (AfD) party is surging in the polls capitalizing on public unease about immigration.
A Crossroads for Fiscal Policy
Germany’s fiscal conservatism, may now be compounding its problems.
Like many economies, Germany needs to invest in infrastructure, green technology and defence. With a debt/GDP ratio of just over 60%, and relatively low bond yields, in theory, Germany has more room to manoeuvre than most.
However, the philosophy of fiscal prudence, partially stemming from the collective memory of hyperinflation in the 1920s, remains embedded in the German psyche. Former Chancellor Merkel was fond of pointing to the Swabian housewife who insisted on living within her means, as an example of sensible policymaking. Merkel cemented this cautious approach with the “debt brake” in 2009, which restricts government borrowing.
While many, even the fiscally conservative Bundesbank, see the need for some softening of the debt brake, there remains a latent fear of deficit spending. The fiscal wavering evokes Keynes’ observation that “practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist” .
The Road Ahead
It’s not the first time Germany has been the sick man of Europe After unification the economy stagnated before Gerhard Schroeder’s Agenda 2010 reforms saw the economy regain its footing. Germany benefited from accessing cheap labour in Eastern Europe and a fast growing China as an export market.
But that belonged to a different era. Today, globalization is receding, China is becoming a technological and industrial powerhouse, and the incoming U.S. administration plans to target nations with trade surpluses; the need for a new German playbook has become undeniable.
For investors, Germany’s challenges are a reminder of the importance of monitoring not just the daily headlines but the underlying structural shifts. How Germany navigates this inflection point will have implications for eurozone monetary policy (and Ireland), for global trade and investment flows and for eurozone stability.
The path forward isn’t clear but the election offers the opportunity for something of policy rethink. A shift to an acceptance of greater deficits could initially be a negative for bond markets but could pave the way for stronger growth over the medium term, particularly if investment could propel stronger productivity.
Without decisive action, Germany risks following Japan’s path of chronic stagnation—an outcome with profound implications for Europe and beyond.
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