German Economic Malaise More than just an Energy Crisis

German Economic Hopes after Election Fade

Germany entered 2025 with renewed optimism after Friedrich Merz won the chancellorship promising pro-growth reforms and a €500bn fund to rebuild infrastructure and boost defence. Early hopes have faded: Q3 GDP confirms sluggish growth, unemployment has risen, and industrial output fell. While the budget is approved and some projects are ready, critics say funding may be diverted to recurrent spending, state capacity to deploy funds is limited, and the coalition has watered down ambitious reforms. To deliver a genuine recovery Merz must use fiscal firepower wisely, pursue deeper structural reforms to boost industrial agility and innovation, and resist piecemeal measures — failure risks political fallout and weak European leadership.

Key points

• Economic picture: IMF expects only ~0.2% growth for 2025, unemployment near 3m (14-year high), and industrial production falling.
• Fiscal actions: Parliament eased the “debt brake” to allow a €500bn fund; budget approved, but practical deployment and project starts will take time.
• Criticisms: Signs funding may cover day-to-day spending; state capacity to implement productivity-boosting projects is questioned; higher defence spending yields limited long-term growth.
• Political constraints: Coalition compromises have blunted promised “autumn reforms,” focusing on welfare tweaks rather than deep structural change.
• What’s needed: Measures to cut energy costs, reduce red tape, attract investment and talent, and deepen EU internal market reforms — targeted industrial and innovation policies to revive growth and preserve Germany’s and Europe’s stability.

German Industrial Problems hit Tax Revenues

Germany’s industrial heartland is facing a deep structural crisis as once-dominant engineering and capital-goods firms struggle with falling demand, rising foreign competition (especially from China), and new trade barriers (notably US tariffs). Major Mittelstand companies and blue‑chip manufacturers have cut sales, jobs and investment, leaving local governments and municipalities with collapsing tax revenues. Policymakers are debating a mix of protection, industrial policy and large public investment (including defence spending) to stabilise manufacturing, but results are uncertain, and many local projects are being postponed.

Key points

• Trumpf’s, The machine tool manufacturer, first loss since 2008 and an 80% collapse in the wealthy town of Ditzingen’s business-tax receipts symbolise the wider regional shock; German industrial production is roughly at 2005 levels.
• Two structural shocks: US trade measures and China’s rapid rise in cheaper, improving-quality capital goods (China now runs a trade surplus vs Germany in capital goods for the first time).
• Companies face faster Chinese product cycles and much lower prices, squeezing margins; many firms (including carmakers and suppliers) have announced large job cuts.
• Policy responses split between protectionist measures, OECD/EU rules, and proposals to “reverse‑engineer” China’s industrial strategy or boost EU industrial policy; pure protectionism remains politically fraught.
• Germany plans big debt-financed investment (incl. defence) to revive growth, but municipalities face limited benefit and immediate local budget shortfalls force project cancellations.

German Economic Slump Puzzle vs the European Union Countries

Since 2021 German manufacturing volumes have fallen much more than the rest of Europe, while exports have not fallen as much — an apparent disconnect. Reader responses suggest explanations including measurement differences (production volumes down but manufacturing value added stable), sectoral shifts (big declines in autos and related domestic demand weakness), structural change and offshoring within cross‑border supply chains, high energy/labour costs, demographics, and investment patterns. A plausible interpretation is that Germany is undergoing Schumpeterian restructuring toward higher‑value goods and services (raising productivity but reducing domestic manufacturing employment), combined with insufficient domestic demand. Policy lessons: protectionism isn’t the answer; targeted industrial policy to promote higher‑tech investment and public inputs may help, but even a revived manufacturing sector will create fewer jobs because of automation.

Thus Germany’s unusually severe industrial decline cannnot be just explained by common theories like export dependence, energy shocks, or interest rates because other European countries faced similar shocks without comparable downturns. Alternative explanations — weak domestic demand, sectoral vulnerabilities (energy-intensive industries, high foreign value-added content), and slow adaptation to technological change — and suggests policy responses, notably fiscal stimulus and coordinated European demand-boosting measures (e.g., “buy European” EV policies, joint public investment), could help revive German manufacturing.

The effect of issues in Germany will also impact Europe.  Recently in and FT article, Christine Lagarde, ECB President, warned that Europe’s traditional export-led growth model is outdated and vulnerable, urging EU policymakers to act after “years of inaction.” She highlighted stagnant exports, falling industrial production in manufacturing-heavy countries, and internal market barriers that function like steep tariffs (≈100% on services, ≈65% on goods).

Lagarde called for strengthening the domestic economy and removing trade obstacles to avoid slow, cumulative decline. Bundesbank president Joachim Nagel offered a milder view, saying Europe’s living standards relative to the US may not be as dire as often portrayed.

In short, Europe’s export-dependent growth model is losing effectiveness; euro-area exports have not grown as forecast.  There is a manufacturing slump especially in countries with large manufacturing sectors (notably Germany) face prolonged industrial weakness.

Key points

• Germany’s manufacturing slump is uniquely deep compared with other large EU economies; the crisis looks German-specific rather than pan-European. Puzzle: German manufacturing volumes fell sharply post‑2021 while exports declined less, unlike the rest of Europe.
• Standard explanations (weaker exports, energy price shocks, higher interest rates) don’t fully account for Germany’s relative underperformance.
• Possible drivers include weak domestic demand, structural sectoral weaknesses (energy intensity, import exposure via foreign value-added), and slower adaptation to technological shifts. Structural shifts: parts of production have moved abroad within cross‑border supply chains, and Germany may be shifting to higher‑value activities (Schumpeterian restructuring).
• Other contributors: high energy/labour costs, demographics, low investment share of GDP, and weak domestic demand.
• Policy implications: fiscal stimulus targeted at boosting domestic demand, coordinated European industrial demand and procurement policies, and investment-led restructuring could help revive German industry and benefit the broader EU economy. In short, avoid protectionism; use smart industrial policies to foster high‑tech investment and public inputs — but expect fewer manufacturing jobs due to automation.
• Policy urgency: Six years of inaction risk long-term, quiet erosion of growth and productivity; policymakers must remove internal trade barriers (equivalent to very high tariffs on goods and services.

Prior Energy Policy Choices and Current German Economic Issues

We can criticize Germany’s recent energy policy, arguing that decisions—especially heavy reliance on Russian gas, phasing out nuclear power, and an ambitious but incompletely planned renewable transition (Energiewende)—have raised energy costs, weakened industrial competitiveness, and increased import dependence. Intermittency, inadequate storage and transmission infrastructure, and political ideology driving policy have amplified system costs and grid reliability problems. These dynamics contributed to economic underperformance, corporate relocation, and political backlash, with broader implications for Europe.

Key points

• Russia dependence and policy choices: Long reliance on Russian pipeline gas and the simultaneous nuclear phase-out left Germany vulnerable after Russia’s attack on Ukraine, forcing extended coal use and greater import reliance (LNG, Norway, Netherlands).
• Limits of renewables alone: Wind and solar intermittency, insufficient long-duration storage, and the need for dispatchable backup (gas/coal/batteries) mean levelized-cost comparisons understate true system costs; large transmission upgrades are also required and politically difficult.
• Economic and industrial effects: High energy prices and structural constraints (labor costs, supply-chain gaps) have harmed energy-intensive industry, spurred relocation and investment abroad, and threaten Germany’s manufacturing competitiveness (notably auto and chemical sectors).
• Political consequences: Green-party–driven policies and perceived economic pain have strengthened populist opposition (AfD) and fostered broader public dissatisfaction, with potential EU-wide repercussions given Germany’s central economic role.
• Trade-offs and realism: Germany’s actions deliver limited global emissions benefit relative to economic cost, and that nuclear power and diversified fuel portfolios could have offered more reliable, lower-emission options during the transition.