The Openness That Powered Germany’s Economy Is Now Its Biggest Weakness
The country that once led the world in exports has been stuck in neutral since before the Covid-19 pandemic
- Germany’s open economy, once an asset, is now a liability amid China’s rise, protectionism and other external shocks.
- The economy faces underperformance, with GDP growth expected at 1% or less, and manufacturing jobs at a 10-year low.
- Chancellor Friedrich Merz’s government has tried tax relief and energy price cuts, but efforts have not borne fruit.
BERLIN—Germany’s famously open economy was its greatest economic asset, delivering almost 20 years of uninterrupted growth and turning it into one of the biggest winners of globalization.
Now that openness has become its biggest liability.
China, once a glutton for goods made in Germany, has turned into a mercantilist superpower. It produces many of the same things at a fraction of the price and often with equivalent—if not better—quality. Chinese imports aren’t only flooding Europe but also crowding out German companies in other countries.
Germany has found it is vulnerable to protectionist measures that have cut its companies off from critical resources and technology. Its economy is, meanwhile, being buffeted by external shocks beyond its control—from the rise in energy prices caused by the Iran war to President Trump’s tariffs.
“Germany was certainly a globalization winner,” said Dirk Schumacher, chief economist at the state-owned KfW development bank. “But interdependencies can be weaponized. In a world where the rule-based order is no longer guaranteed, being highly integrated in the global economy can make you more vulnerable.”
The latest illustration came earlier in June when the U.S. stopped the export of artificial-intelligence company Anthropic’s latest large language models on national-security grounds, leaving business AI users in Europe at a competitive disadvantage.
Beijing’s decision to restrict rare-earth exports in the midst of its trade dispute with Washington was another blow, affecting production across Germany in sectors ranging from automobiles to weapon manufacturing.
The government of Chancellor Friedrich Merz has tried to prime the growth pump with tax relief for business and cuts in energy prices, and has ramped up defense and infrastructure spending—but the efforts have yet to bear fruit amid the global headwinds. Berlin recently said it would gradually raise the retirement age to 70 from 67—a move that could eventually improve competitiveness by pruning a system that is funded by employers and employees.
Apart from unemployment and public debt, both of which remain comparatively low, Germany’s economic vitals look decidedly unhealthy. Most economists and the government expect gross domestic product to grow by 1% or less this year. GDP growth has underperformed that of the eurozone since 2019.
Investments have fallen since 2020 while they have risen in France, Italy and Spain. The number of manufacturing jobs in the economy has dropped to 6.6 million, its lowest in 10 years, according to a study published this month by the German Economic Institute, a think tank.
The external shocks have disrupted the government’s economic policy. When the Iran war broke out, it had to shelve work on overhauling its cash-starved welfare system and pivot to gas subsidies for commuters. A welfare-system reform project was scaled down so much that the government canceled the media blitz it had planned, according to a senior official. A more ambitious package of measures should be unveiled in the coming weeks.
The last time Germany’s economy was in a comparable rut was in the early 2000s. It was struggling to absorb the cost of reunification and unemployment was almost twice its current level, pushed up by rigid labor laws and the second-highest labor costs in the world.
In 2003, the government of then-Chancellor Gerhard Schröder took an ax to unemployment benefits, gave employers more say in setting wages and lowered taxes. Within two years, unemployment was falling, exports soaring and public coffers filling up. For six years in a row, Germany was the world’s largest exporter of goods, not just per capita but in absolute terms.
Economists say Germany has lost competitiveness since. But even if it recoups it, this may not suffice to persuade foreigners to buy German cars, medical equipment or tunnel-boring machines they no longer need. It would be like tapping a well that has long dried up.
“Schröder didn’t have to worry about the second China shock,” said Michael Hüther, director of the German Economic Institute.
Cutting the red tape that is stifling the economy could help. Survey after survey shows businesses consider bureaucracy the biggest drag on their activities, even ahead of the U.S. tariffs. Berlin has made some headway in this area but is still resisting calls from business to relax rigid labor laws that make it difficult to hire and fire to match demand.
“Let’s imagine the federal government announced that all business reporting requirements that cannot be re-justified will be eliminated on Jan. 1, 2027,” said Hüther. “That would have an enormous impact. Sometimes we need signals like these.”
Meanwhile, the Anthropic episode shows how German—and European—dependencies aren’t limited to rare earths. Europeans have become adept at building AI applications, but the foundational models, infrastructure and computing capacities underlying them are largely in U.S. hands.
AI “is no longer a simple input into our value chains, but something that will influence all areas of the economy,” said Katharina Erhardt, head of the Industrial Policy Lab at the Kiel Institute for the World Economy think tank. “We have to make sure that this technology is developed here locally. That is much more important than protecting old industries.”
For Schumacher, the KfW chief economist, Berlin faces three priorities as it tries to protect strategic industries while still creating new ones: It should secure more sources of critical raw materials, boost the amount of capital available to grow startups into bigger companies and shield itself against cheap Chinese imports.
Between 10% and 30% of the value of products made by German manufacturers depends on raw materials, such as copper and lithium, that are imported from a handful of places. Berlin has created a raw material fund, but it is still small. Efforts to recycle rare earths or develop batteries that need fewer exotic components are still in their infancy.
Tax reforms and other incentives to encourage private-equity and institutional investors to fund scale-up businesses—as Sweden and France have done—could help boost the innovation that Germany has lacked. By channeling more savings into the market, the coming pension reform could help here too.
Berlin has warmed to proposals by Brussels to clamp down on state-subsidized Chinese imports. Yet with many companies still highly reliant on Chinese inputs, officials say Germany isn’t quite ready to withstand potential retaliation.
“There are costs and risks for sure but they depend on how the other side reacts. China also has something to lose,” said Schumacher. “Yes, you can improve your resilience, but the longer it takes, the more industrial know-how and value creation you might lose.”