A worker on a washing machine assembly line at AEG's factory in Nuremberg, Germany.Sean Gallup (Getty Images)
Germany, the great European power, is losing momentum. The economy that all of Europe looked at with admiration for its strength and wealth has entered a slump called recession. It remains to be seen if it is a stumble from which it will emerge without major shocks or if, as many analysts maintain, the European locomotive is accusing problems of greater depth, structural weaknesses that call into question the economic foundations of the country. While the diagnosis is being resolved, in the rest of the euro area there is widespread concern.
Germany is by far the bloc's largest economy, with nearly 30% of gross domestic product (GDP). It is also the most important trading partner of almost all other countries. A stagnation of the giant is bad news for the rest, although the situation is far from the one that, in the early 2000s, led Germany to earn the nickname of "the sick man of Europe". "Because of the great weight it has, a weak Germany means a weak eurozone, and in large part of that comes the stagnation of growth in recent quarters, but it is still too early to know if we are facing a structural decline in German industry," says Angel Talavera, chief economist for Europe at Oxford Economics.
Until just a few days ago it looked like Germany was going to dodge the much-feared winter recession. The first quarter of the year was going to close with a stagnation, but Destatis, the German statistics office, revised the figures downwards and the surprise jumped: GDP contracted by 0.3%. Economists such as Veronika Grimm, a member of the German Council of Economic Experts (popularly known as "the five wise men"), stress that the data "is a little worse, but not dramatically worse than expected." Enough, of course, to be a technical recession as it is the second quarter of decline, after -0.5% at the end of 2022.
The drivers of the contraction are the weakness of private consumption due to inflation and the weakness of industrial activity. High energy prices from Russia's invasion of Ukraine and uncertainty have hit Germany especially hard. Grimm also highlights the role being played by the European Central Bank: "Rising interest rates are slowing demand. This is what is intended: monetary policy aims to dampen demand to lower inflation. So we're in a phase of great challenges because it's starting to take effect and slow down the economy."
Asked whether this is a temporary setback or something more worrying, Carsten Brzeski, chief economist at ING Germany, responds bluntly: "Germany has fallen into a more prolonged structural stagnation." In the short term, it lists as headwinds that will continue to weigh on growth the slow recovery in China, the imminent recession in the United States and the rise in interest rates. But at the same time there are "structural challenges that are undermining Germany's growth potential": the energy transition, deglobalisation and demography. "Over time, they could also become opportunities, but in the first years no country has managed to face so many challenges without losing economic strength," he says.
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Germany was one of the latest European countries to return to pre-COVID-19 levels. The recovery was slower because it is much more dependent on world trade than most of its eurozone partners. Marcel Fratzscher, president of the Berlin Institute for Economic Research (DIW), points out that the main factor of this winter's recession has not been industry, but low private consumption, but that this should not make us forget the enormous challenge for the future of industrial sectors such as the automotive sector, which lags far behind its competitors. "Volkswagen or BMW's electric car market share is minuscule in China. They have not been able to manage the transition and that is a huge risk for the next 10 or 15 years if they do not make the necessary investment," he says.
The threat of deindustrialization is the main headache for the authorities. As Brzeski points out, "no other country has benefited so much from cheap energy imports and globalization." Cheap Russian gas, largely responsible for the German economic success of the last two decades and with which it was going to move towards a decarbonized economy, is history. Germany is paying for energy much more expensive than elsewhere in the world, and that paves the way for a loss of competitiveness. "It's really scary for Germany, which already has to face competition from China and face the effects of laws like the American IRA (Anti-Inflation Act), which gives huge subsidies to clean technologies, electric vehicles, batteries," said Gregory Claeys, a senior fellow at the Bruegel think tank.
Attracting investment is key to the future of Germany's powerful industry, which despite the recession is holding up well, Fratzscher recalls: "Industrial companies are still profitable, profits are high and the order book is relatively full." The economist, professor of macroeconomics at the Humboldt University of Berlin, points out two main obstacles: bureaucracy – "in addition to European regulations we have national, cumbersome, expensive and slowing down investment" – and the lack of qualified labor.
The shortage of skilled workers is so acute that the coalition government of Social Democrats, Greens and Liberals is preparing a series of legal changes to attract labour from outside the EU. There are currently two million jobs vacant in Germany, from IT and engineering to health and social services, hospitality and tourism. "Demography is a huge problem for Germany," Fratzscher stresses. The country faces a massive loss of workforce due to retirement over the next 10 years of five million more people than the young people who are going to join.
In the short term, concern is contained, although the Ifo index, which measures business confidence, has fallen for the first time after six months of consecutive increases. "I don't expect an endless recession. The economy might even record a brief rebound in the second quarter, but the overall story of moderate growth remains," Brzeski said. The latest Bundesbank report also predicts that economic output will increase again in the second quarter.
One of the keys will be the recovery of consumption. Although inflation is still very high (it fell to 6.1% in May, after 7.2% in April and exceeded double digits in October) households should begin to notice the strong wage increases that unions and employers have been agreeing in recent months, explains Claeys. After the strikes that have paralyzed transport in Germany and protests in different sectors, wage increases begin to close the gap.
Chancellor Olaf Scholz is not worried. "The outlook is very good," he replied on the day the revised first-quarter data was released. "We will solve the challenges we face," he said with a smile. But all eyes are on the management that the government is going to do, in constant tension due to the differences of opinion of the three parties that form it, of a recession that, however brief it may be, is interpreted as a symptom of a less temporary evil.
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