Germany 2025

The Make or Break Decade

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Angela Merkel and ECB president Mario Draghi have performed a tricky balancing act to keep Germany's economy ticking over.
  • Why it matters

    Why it matters

    Germany is Europe’s industrial and economic powerhouse so a slowdown could have serious consequences for the E.U. and global economy.

  • Facts

    Facts

    • Germany currently enjoys almost full employment, a balanced budget and industrial strength.
    • But much of this has been built on low interest rates, high rates of immigration and falling oil prices.
    • If these variables change for the worse, the country’s economy could be at risk.
  • Audio

    Audio

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Half of Europe is still battling its way out of recession, former Asian powerhouses China and India are getting used to modest growth and even the world’s biggest economy, the United States, has suffered setbacks. Germany, by contrast, seems to be enjoying economic bliss.

Full employment is in reach, state finances are recovering at an astonishing rate and German businesses are bursting with strength. Neither the euro zone’s debt crisis nor the recent confrontations with Russia – nor the advance of IS fighters in the Middle East – have caused any serious harm to the country’s economic power.

No other country in the G7 group of leading industrial nations has raised employment levels by 12 percent in the past ten years. No other country has kept the share of manufacturing in its total economic output above 30 percent. And no other G7 country has managed to improve its annual government budget balance by 4 percent in relation to GDP over that period.

Within the G7, only Canada and the United States have recorded stronger growth over the past decade, calculated in U.S. dollars. Germany has actually managed to reduce its primary energy consumption by 10 percent, and thus decoupling energy from economic growth to a large extent.

Germany’s industry-based business model, which was regarded at the beginning of the century as outdated and vulnerable, is now attracting worldwide recognition and often even admiration. The Anglo-Saxon alternative of an economy dominated by the financial sector and private consumption, often financed by debt, proved in the global financial crisis in 2008 to be a dead end.

There is no doubt about it: Germany is currently top of the class among leading industrialized nations.

To return to sustainable growth, the United States and United Kingdom have even committed themselves to a process of re-industrialization, with explicit reference to the example set by Germany. The European Union has also set itself the target of raising the share of manufacturing in economic output, or GDP, to at least 20 percent again.

There is no doubt about it: Germany is currently top of the class among leading industrialized nations. This was most recently symbolized by the G7 summit in Elmau, when Chancellor Angela Merkel played the part of the proud host in the Bavarian Alpine idyll.

But how long will it continue to enjoy the best of all worlds? Is the government doing enough to continue this success story? And what are the greatest risks to this success?

The first cracks are starting to appear in the new Germany. They are barely discernible as yet, but if you look for them, you’ll find them. Germany has recently slipped down the international rankings for competitiveness. In the highly respected ranking of the IMD Swiss business school, it fell from sixth to tenth place and is now behind Norway, Denmark and Canada.

The Organization for Economic Co-operation and Development, or OECD, recently complained that German politicians were tired of reforms and believes that growing inequality in the distribution of wealth could curb growth. And the International Monetary Fund called on the German government to invest more in infrastructure, deregulate the services sector and make better use of the potential of the female workforce.

 

Top of the Class in Germany-01

 

It’s not only international observers who are looking more critically at Germany; domestic business representatives are also warning against too much complacency.

“We’re currently seeing a borrowed or ‘doped’ upturn,” warns Martin Wansleben, chief executive of the German chamber of industry and commerce, or DIHK.

He rightly points out that the current strong economic data is taking place in a time where conditions could hardly have been more favorable. Interest rates have been close to zero for years thanks to the extremely loose monetary policy of the European Central Bank, the euro is almost 20 percent lower against the dollar than a year ago and the price of oil is down more than 40 percent.

A difference in wealth of more than €4,000 ($4,525) per citizen is at stake.

Against this backdrop, Germany’s current economic success no longer looks quite so brilliant. A growth rate of just under 2 percent this year is actually quite poor for an economy enjoying such ideal conditions. The economy minister Sigmar Gabriel recently admitted this, telling business people in Berlin in March: “We mustn’t rely on the situation staying as good as it currently is.”

He added that the positive economic environment is currently being supported not only by domestic demand, but also by low oil prices and the euro exchange rate. “At least two of these are not certain in the long term,” Mr. Gabriel warned.

So what do the prospects for Europe’s biggest economy really look like? Following the recent warnings, the Handelsblatt Research Institute calculated the effects on the German economy of an anticipated deterioration in the extremely favorable conditions.

Based on a forecast model created by the National Institute of Economic and Social Research in London, the HRI has drawn up three projections: A positive projection, which assumes that the ECB’s base rates and the oil price will stay at their current levels; a negative projection, which anticipates a significant increase in both figures as well as increased government spending for reasons associated with security policy; and a baseline projection that presumes a return to more “normal” levels. The positive variation also includes higher immigration figures than the negative one.

 

Projections for Germany-01 (4)

 

The calculations showed that if interest rates and oil prices were to soon return to the levels they were at before the global financial and economic crisis, the average annual growth rate for GDP would drop to 1.1 percent in the next 10 years, compared with 1.5 percent in the basic projection.

If, however, interest rates and oil prices remain at their current low levels for another 10 years, Germany could expect an average growth rate of 2.3 percent. A gap of €340 billion, adjusted for inflation, will exist between the positive and the negative projections by 2025. That means a difference in wealth of more than €4,000 ($4,525) per citizen is at stake.

However, Germany is not without defense against these changes in the outside economic conditions. It can take its fate into its own hands. The country may have benefited considerably in recent years from the fact that interest rates and the euro rate were far too low for its strong economy, but it has benefited even more from clever political decisions made in the past.

The so-called “red-green” coalition formed by the left-leaning Social Democratic Party, the SPD, and the Green Party under Chancellor Gerhard Schröder in 1998 laid the foundations for Germany’s current status as an example for many countries to follow. It was the product of labor market and social reforms implemented under Mr. Schröder’s “Agenda 2010” plan, as well as the promotion of renewable energies.

Nor can we forget the contribution of trade unions, who were restrained in their wage demands between 1997 and 2007 and therefore helped improve Germany’s price competitiveness compared to its global rivals.

The results of these reforms were protected when Chancellor Angela Merkel and her Christian Democrats came to power in 2005, leading a grand coalition with the SPD until 2009. They also prevailed with rigorous crisis management during the 2008 financial crisis.

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Winning hands down: Germany is outperforming all the other G7 countries, leaders of which are pictured here with the E.U.’s two top officials. Source:Xinhua/Polaris/Studio X

 

Since then, however, the chancellor has won elections by putting Germans into a kind of feel-good mode in which the world’s crises are merely background noise. The word “reform” rarely crops up in the government’s vocabulary, and when it does it is used to dress up social benefits to benefit particular voting lobbies and which the majority of the population has not even asked for.

Examples of these include the option to draw a full pension at 63 for people who have been paying into a pension scheme for 45 years, and a childcare subsidy for people who look after their children at home instead of sending them to a day-care center.

At the same time, there is no money for investment in infrastructure, which is crumbling, and the government is using a new debt brake as a superficial excuse not to find the extra funds necessary. This policy undermines one of Germany’s traditional strengths as an investment location. However, the current grand coalition under Ms. Merkel has ruled out reforms that would adapt the economy for the future and secure the country’s global competitiveness.

The consequences of this feel-good policy, which is geared towards the present, are not yet reflected in economic data, other than in the fact that economic growth might have been even higher given the extremely favorable conditions.

But the cracks will soon become apparent, at latest when the current auspicious conditions of low interest rates and cheap oil return to normal.

Contrary to earlier official estimates, Germany's population has risen rather than declined since 2011, due to increased immigration.

The “normalizing” of economic conditions will also coincide with the end of a period of favorable demographics, which Germany has enjoyed for some time.

Two factors are currently at work. The first is that almost 43 million people are in employment, more than at any time in history. Unemployment has fallen accordingly.

Second, the number of people drawing pensions, currently around 25 million, is barely rising. This is because the people who are now entering retirement are those born in the post-war period, when birth rates were low. This has led to surpluses in social security funds.

Contrary to initial estimates, Germany’s population has risen rather than declined since 2011, due to increased immigration. The statistical office Destatis currently predicts that this trend will continue for about another five years. After that, however, the population will shrink by eight million to 73 million by 2060, even in the more optimistic scenario of an annual net immigration of 230,000 people on average.

By then there will be 11.3 million fewer 20- to 64-year-olds and 2.7 million fewer under-20s in Germany. Instead, there will be 6.3 million more people aged 65 and over. And this is the more favorable scenario: With lower net immigration of an average of 130,000 people per year, the population will age even more quickly and contract to less than 68 million.

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Angela Merkel is one of Germany’s most popular chancellors. Source: Action Press

 

The shrinking labor force not only threatens to lead to a shortage of skilled workers, but also means the German economy will no longer have the option of improving its competitiveness by keeping wages down.

Increasingly, confrontational pay disputes and the rising number of strike days show what direction things are heading: Workers who no longer need to worry about their jobs, not least because of the demographic reasons, will in future demand higher pay increases than in the past two decades.

The government should be preparing society for this inevitable demographic change. This won’t be achieved with demographic summits, but only with further reforms. These will need to go well beyond the social security system and must aim to generate fresh economic momentum – to find answers to a decline in productivity growth that has been ongoing for some time.

Economic growth is also necessary in an aging and shrinking society in order to solve problems with distribution, which tend to increase as the population ages. Growth can be achieved in three ways: Through increased use of labor and/or capital, or through more effective use of these factors in combination, i.e. an increase in productivity.

In the past 10 years, more capital has generated the greatest momentum, with gross investment rising by 28 percent. The number of hours worked has risen by about 5 percent and has thus grown much more slowly than the number of people in employment. Labor productivity, i.e. GDP per paid hour worked, has increased by only about 7 percent in the past decade.

In future, all three drivers of growth will have to play a bigger part in furthering the German economy. Shrinking labor forces must be accompanied by increased capital expenditure and greater advances in productivity. This is need to keep growth chugging along. It will ease the brake on growth being applied by the aging population and allow decent increases in GDP to be achieved even under less favorable general conditions.

Could the German growth model really lose its sparkle just when it has reached the pinnacle of international esteem?

This is an enormous policy challenge in an environment in which all established industrial nations are suffering from diminishing growth prospects and even emerging economic powers such as China and Brazil have lost momentum.

The Handelsblatt Research Institute has identified 10 factors to watch over the next 10 years. They include issues that affect the availability and use of labor: The demographic development (factor 1) and, closely related to this, changes in labor costs (factor 2).

Interest rate policy (factor 3) will have a direct impact on companies’ capital expenditure and investment decisions in the coming years. Energy costs (factor 4) are also important, both oil prices on the global market and national electricity prices, which are being pushed up by Germany’s much-heralded transition to renewable energy sources.

The education system (factor 5) will have a considerable impact on productivity as another driver of growth. Digitalization (factor 6) could also become an important driver. Encouraging start-up businesses  (factor 7) should not be overlooked; many still struggle to get beyond the initial concept stage. Increasing inequalities in wealth distribution (factor 8) and insufficient social mobility (9) could have a negative effect on growth.

Finally, Germany’s growing role on the international stage will likely involve higher spending on defense and security. This, too, will influence the overall economic situation.

 

Projections for Germany2-01 (4)

 

All of these developments show that significant action is required to ensure that Germany remains competitive. A large economy such as Germany is like a supertanker, which responds to a change of course only after several kilometers. It took several years for the results of Mr. Schröders Agenda 2010 plan to become visible.

However, this means that it will also be some time before the poor political course taken by the current government takes full effect. Instead, the impact will be felt at a time where outside economic conditions have deteriorated and demographic challenges facing Germany start to take hold.

For Ms. Merkel, all is still right with the world. “We can be proud of what we have achieved,” she said earlier this month.

She listed the reasons: “We have a strong industrial base. We have strong entrepreneurs. We have strong social partners in the form of trade unions and works councils. We want to use these assets to make sure we stay ahead in the 21st century.”

A plan to keep Germany competitiveness sounds different.

Could the German growth model really be losing its sparkle just when it has reached the pinnacle of international esteem? That’s what happened in Japan in the late 1980s. The country’s unstoppable rise to become the world’s leading economic power ended when its property bubble burst in 1990.

It was also the case in the United States and United Kingdom, where it emerged from 2007 onwards that an unfettered financial industry was not a growth engine but a producer of financial “weapons of mass destruction”, as legendary investor Warren Buffett put it.

With its sustainable growth model, built on industrial expertise, Germany has a good chance of long-term success. We just need to make sure we don’t fall into collective complacency.

 

Dirk Heilmann manages the Handelsblatt Research Institute, which produces reports and books on finance and economics. Bert Rürup has been the Institute’s president since 2013. He chaired the government’s economics experts council from 2005 to 2009. To contact the authors: heilmann@handelsblatt.com and info@handelsblatt-research.com

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