Europe’s Growth Engine Is Broken
Germany’s economy shrank last year and new challenges point to more pain ahead
Germany is stuck in a rut, and there is no quick way out.
The European powerhouse’s economy, the largest on the continent and the world’s fourth biggest, shrank last year, extending a six-year slump that is raising fears of deindustrialization and sapping support for governments across the region.
Output in the country likely shrank by 0.3% in the three months through December from the previous quarter, the German federal statistics agency said Monday. For 2023 as a whole, it contracted by 0.3%, leaving it only 0.7% larger than in 2019, before the Covid-19 pandemic, the agency said. Other large eurozone economies likely grew last year, including France, Italy and Spain, according to European Union estimates.
The downturn reflects a confluence of headwinds that are upending the country’s export-focused business model, from slower growth in China to higher energy prices and interest rates, mounting tensions around global trade, and a tricky transition to green energy. And with no sign that any of these cyclical and structural factors are about to improve, Germany’s prospects aren’t looking good.
“I’ve never been so worried about the medium-term outlook for Germany,” said Dirk Schumacher, an economist with Natixis in Frankfurt who has been tracking the German economy for decades.
The country’s gross domestic product is only 1% larger than it was at the end of 2017 after adjusting for inflation. By contrast, the U.S. economy has grown by an inflation-adjusted 13% over the same period, according to data from Eurostat and the Bureau of Economic Analysis.
This year, Germany faces new economic threats, from a collapsing real-estate market to conflict in the Middle East that is disrupting the Asia-Europe trade route. Despite an uptick in unemployment and record immigration, businesses complain of labor shortages. The government’s spending plans have been thrown into disarray by a constitutional court ruling limiting the use of off-budget funds.
The malaise is feeding broader resentment. Farmers blockaded roads in Berlin on Monday to protest subsidy cuts. Polls suggest that the far-right Alternative for Germany could emerge as Germany’s biggest political force in European Parliament elections in June and at state elections later this year.
All that is reviving the “sick man of Europe” label that was attached to the country in the late 1990s and early 2000s as it lost competitiveness in the aftermath of reunification between East and West Germany.
“The threat of deindustrialization is real,” said Max Jankowsky, chief executive of GL Giesserei Lössnitz, a 175-year-old foundry in the east German state of Saxony.
The company sits at the heart of Germany’s flagship auto industry, which employs around 800,000 people and exports about three-quarters of what it produces. Its clients include BMW, Daimler and Volkswagen.
While energy prices have come down, Jankowsky says he is still paying three or four times as much for electricity than before Russia invaded Ukraine—and more than five times what American competitors pay. “We still don’t see a full strategy” from the government to address the issue, he said.
Jankowsky plans to invest €10 million, equivalent to around $10.9 million, to build an electric-powered furnace that will replace his large coal-burning furnace, which is being squeezed by higher carbon taxes. But with electricity prices so high, and no clear plan from the government to reduce them, the new furnace won’t be competitive, he said.
“We can’t pass higher costs to car manufacturers, they say they will move to Turkey or China,” Jankowsky said.
Germany’s storied auto industry is struggling with competition from Tesla and upstart Chinese rivals, which are ramping up electric-vehicle sales in Europe. Car production in Germany is more than 25% below its mid-2010s level, according to the German Association of the Automotive Industry, a lobby group. German manufacturing output as a whole is smaller than in 2019 and shrinking, according to the Organization for Economic Cooperation and Development, a club of mainly rich countries.
Now, the conflict in the Red Sea is disrupting shipping and raising the specter of a new supply-chain crisis for European manufacturers. Tesla said Friday that it would stop nearly all production at its biggest factory in Europe, just outside Berlin, from Jan. 29 to Feb. 12 because of a lack of components.
Some economists are sanguine, pointing to Germany’s still-low unemployment rate and low government debt.
Germany might already have adjusted to higher energy costs and slower growth in China and could receive a disproportionate boost when global trade recovers, said Holger Schmieding, chief economist at Berenberg Bank.
Still, a recent German Chamber of Industry and Commerce poll asking more than 2,200 German industrial companies to assess business conditions posted its worst result since the survey started in 2008.
“Germany is rapidly becoming less attractive for industry and its partner sectors. The result is that necessary investments are not made or are made at other locations,” said the chamber’s general manager, Martin Wansleben.
The Bank of America last week cut its growth forecasts for Germany and the eurozone and now expects Germany’s economy to shrink by 0.1% this year, having previously forecast growth of 0.3%.
The pains aren’t contained to the economy. Only 19% of voters are satisfied with Chancellor Olaf Scholz—the lowest figure for any chancellor since 1997—according to an Infratest dimap poll for the ARD public-sector broadcaster published this month. Gripes range from the government’s decision to speed up its green transition agenda to its failure to curb a sharp rise in illegal immigration.
Ratings for Scholz’s coalition partners have also collapsed. Earlier this month, members of the pro-business FDP, the smallest party in the ruling alliance, forced a ballot about whether it should exit the government, with a slim majority of 52% deciding that it should remain.
“The wind is blowing in our faces,” said Ralph Wiechers, chief economist at the German Mechanical Engineering Industry Association. Orders in the mechanical engineering sector—which employs more than a million people in Germany—declined by 13% in November year over year after adjusting for inflation, according to the lobby group.
“We are living on order backlogs and they are disappearing,” Wiechers said. “We haven’t hit the bottom.”
It isn’t just manufacturing. Investment and private consumption have also fallen below 2019 levels and are badly lagging behind growth in other major European countries, including France and Spain, according to data from Natixis. Germany’s labor market is starting to crack too. Unemployment rose to 5.9% last month from a 5% low in 2022.
“German customers are spending less, you feel it,” said Joern Brinkmann, owner of the Staendige Vertretung, a restaurant and tourist spot in central Berlin.
Value-added tax on restaurant meals this month increased to 19% from 7% when a pandemic-era cut expired. That is likely to reduce demand further, Brinkmann said. To save money, he is buying energy in the spot market, and the only reason he hasn’t raised prices yet to reflect higher VAT is the high cost of reprinting menus.
Several high-street retailers have recently filed for insolvency including Galeria Karstadt Kaufhof, a chain of department stores with over 15,000 employees.
“It’s one crisis after another…Consumer sentiment is falling again at the start of the year because everything is so uncertain,” said Alexander Grosse, the managing director of Wiederholdt, an office and school-supply store with 18 employees in the university city of Göttingen.
The Christmas trading season was disappointing, Grosse said, with revenue down from the previous year after adjusting for inflation.
The last time Germany’s economy was in a protracted downturn, in the late 1990s and early 2000s, the government enacted unpopular labor-law overhauls, helping businesses cut costs and restore competitiveness. This time, it isn’t clear how Germany can emerge, said Natixis’s Schumacher.
China, which helped to pull Germany out of past recessions, is growing too weakly right now and its companies are increasingly competing with German manufacturers.
Back in Berlin, the combination of higher costs, fewer business travelers and a poor economic outlook is encouraging many restaurant owners to sell up, said Brinkmann. He said he plans to join the farmers’ protests on Monday alongside hundreds of other restaurant workers.