Germany once more 'the sick person of Europe'

Germany's Gross Domestic Production, or GDP, contracted by 0.3% in 2023, compared with a 0.5% growth for the whole euro area, which includes 19 other countries that use the euro currency. With a contraction of 0.3% in Q4, the country narrowly skirted a technical recession due to an upward revision to its reading for Q3 at 0%.

Newly released macroeconomic data has confirmed that the German economy is still struggling. Industrial production declined by 1.6% in December on a monthly basis, and was down 1.5% in 2023 overall compared to the previous year. Exports — a key driver of the German economy — fell by 4.6% in December. Overall exports were down 1.4%, or 1.562 trillion euros (US$1.68 trillion) in 2023.

Germany was first labeled as “the sick person of Europe” in the late 1990s and the early 2000s. Germany’s economic growth averaged only about 1.2% per year from 1998 to 2005, with a recession in 2003. In contrast, the European Union (EU) as a whole grew by 2.32% annually in the same period; and even in 2003, the EU economy logged a growth of 0.91%. Unemployment rates in Germany rose from 9.2% in 1998 to 11.1% in 2005.

Politically a great victory, unification with the former East Germany turned out to be a huge shock to the German economy in the 1990s, with huge fiscal burden weighing heavily on its economic development. Other factors for the laggard performance were the decline in its construction sector and a rigid labor market in Germany.

Two decades later, Germany was once again mired in economic contraction, only this time for totally different reasons. High energy prices contribute immensely to the decline of the German economy. Germany and Russia used to have complimentary bilateral trade ties: Russia provided Germany with cheap energy and Russia imported a great deal of German industrial output.

Russian oil, coal, and natural gas not only provided cheap energy to German households, but also served as the major energy source for many industrial sectors in Germany. In 2021, Russia supplied 34.1% of all oil consumed in Germany, and Germany imported 55% of its natural gas and almost 50% of its hard coal from Russia.

Since the start of the war in Ukraine, Germany has opted to phase out its energy dependence on Russia and switched to much more costly sources. Take natural gas for instance: Germany has stopped using pipelines that cost tens of billions of euros to build, and has then switched to expensive liquefied natural gas (LNG) imports from the U.S., United Arab Emirates, and other countries.

High energy bills bite into German households’ consumption, and high energy costs cause many businesses to lose money or become less profitable. Inflation in Germany has been running more rampant than in most of its European neighbors. High financing costs resulting from high interest rates also cost the private sector much of its purchasing power.

The public sector is not faring better. High energy subsidies strip the government of enormous funds that could have been better allocated, into infrastructure, high technology, or social welfare. Germany’s energy support measures came into effect at the start of 2023 and will last until this April with a hefty price tag of 99 billion euros.

War and defense spending are also taking a toll on the German economy. Three days after the Ukrainian war started in 2022, Chancellor Olaf Scholz proposed the famous 100-billion-euro Zeitenwende special fund dedicated to bulking up German military and defense capabilities. German defense budget for 2024 is 51.8 billion euros, at least 2% of its GDP.

Funding the war in Ukraine is a costly political and military maneuver. The war in Ukraine has already siphoned over 27.8 billion euros from Germany’s federal budget, according to the information released by its foreign affairs office.

Politicians in Berlin, as well as through their spokespersons in Brussels, prioritize the display of political and military prowess in the international limelight over the demands and needs of German citizens and businesses.

Export is a key driver of the German economy. High energy costs lead to high prices of finished German industrial products, making them less competitive in the international markets. Prior to the war in Ukraine, Russia imported 26.7 billion euros worth of goods and services from Germany in 2021. Due to its own sanctions, Germany saw its exports to Russia decrease by 66.7% to only 8.9 billion euros in 2023.

Demand from Germany’s main trading partner, China, has also been subdued. German industrial counterparts and competitors in China are catching up quickly in terms of technology and manufacturing. Although premium German brands, such as those of automakers, still have a loyal customer base in China, more and more Chinese consumers have been attracted to the functionality and value-for-money proposal of their domestic champions.

There are also other underlying problems that are hard to fix. Germany has an aging population, at one of the fastest paces in the whole world. The share of people of working age (15-64 years old) has rapidly declined from 69% to 64% in the decade up to 2021. The high corporate tax rate is another structural issue that will persist in its economy. Looking ahead, none of the aforementioned headwinds against the German economy are going to recede quickly. Commerzbank chief economist Jörg Krämer and his team forecast that “the German economy will shrink by 0.3% in 2024 as a whole.”

(The author is an independent financial investor.)