A graceful swan of the last decade, Germany has become in a few years the ugly duckling it was in the 90s and early 2000s. Its resurrection was initiated by Gerhard Schröder’s reforms in 2003. Its regression, for its part, is explained by its exaggerated reduction in public spending over the last 10 years, and by the country’s excessive dependence on foreign countries.
Too many sources of dependency
In the second quarter, the German economy shrank by 0.1 percent compared to the first three months of the year. The decline in the influential IFO indicator at the end of August indicates that no improvement is in sight. Germany has been in a period of stagnation for four years. The reasons for this are diverse. “Germany has outsourced its security to the United States, its export needs to China and its energy needs to Russia,” Constanze Stelzenmüller of the Brookings Institute said in a speech. With the Russian invasion of Ukraine, these sources of dependence have been highlighted. Since the invasion, energy independence has become one of Europe’s top priorities. Yet the German government continues to procrastinate on its energy reform. This indecision is blocking any investment in German companies.
Now that China is exporting cars to Europe itself, Germany is bitterly regretting its dependence on the country. The first victim of this situation is Volkswagen. It is clear that the manufacturer is struggling to keep its head above water, since it is considering nothing less than closing factories in Germany, despite its promise of job security until 2029 in the face of its powerful works council. The symbiosis of yesteryear, in which Germany – and Europe – exported their technology in exchange for a large market outlet, is now nothing more than a memory.
In the meantime, however, German car manufacturers are continuing to invest in China. By opening major factories in their own country, they hope to still be able to sell their cars in Germany. A strategy that is not without risks. When it comes to producing electric cars competitively, German brands are still catching up. Under such circumstances, it is not easy for them to compete with the “top of the class” when it comes to electric cars. Added to this are the growing political tensions between China and Europe.
In recent years, German exports have increasingly turned to the United States, partly because of weak growth in China. But this approach exposes Germany to the risk of import tariffs, which presidential candidate Donald Trump is threatening. Not to mention that when that time comes, Germany will have to devote a larger share of its budget to defense. Does this mean that the country will then invest even less in its own economy?
An exaggerated reduction in public spending
If Germany invests so little in its own economy, it has only itself to blame. After the global financial crisis of 2007-2008, the principle of “schwarze Null”, or zero budget deficit, was enshrined in the German constitution. It limited the permissible threshold for the budget deficit to 0.35% of GDP from 2016. However, such a restriction also limits the possibility of stimulating management in the event of a crisis. A problem cleverly circumvented during the Covid crisis, but which is now leading to a doubling of budget cuts. Even more serious, over the past ten years, Germany has invested far too little in its infrastructure, in education and in other essential sectors. The considerable delays on the railways and the poor quality of internet connections cruelly illustrated this during the last European football championships.
On the other hand, the drastic increase in interest rates has hit the German housing market and construction sector in a disproportionate way. A mix of higher mortgage rates (it should be noted that the average mortgage term in Germany, at 10 to 15 years, is much shorter than in Belgium) and a considerable drop in purchasing power has significantly slowed down building permit applications and construction activity. Furthermore, the real consumption of the “Otto Normal” (the average German) remains well below what it was before 2019, just before Covid. The German consumer is more vulnerable to inflation than any other European.
Note that these latter problems are cyclical, and that a rise in real income as inflation falls and wage increases, combined with lower interest rates, will already provide considerable relief. Addressing Germany’s excessive spending restraint and sources of dependency, as well as its structural problems, requires other catalysts. Germany – like the European Union – always needs a crisis to change its policy course. A return of Donald Trump to the White House would give it a wake-up call. The pressure to increase defense spending even more rapidly, combined with the need to strengthen domestic consumption and investment at home, makes the policy of the schwarze Null untenable. Germany may even approve a new European common investment vehicle, similar to the European Union’s NextGeneration fund. A reform of Germany, Europe’s ugly duckling, would thus drag the entire European Union down with it. And everyone would benefit.
The opinions expressed in this blog are those of the authors and do not necessarily represent the position of BNP Paribas Fortis.
Koen De Leus Chief Economist Koen De Leus (Bonheiden, 1969) holds a master’s degree in business sciences from the Economische Hogeschool Sint-Aloysius (EHSAL). Since September 2016, he has been Chief Economist at BNP Paribas Fortis. He is also a visiting professor at the EHSAL Management School, particularly in the field of behavioral finance. In 2017, Koen published his book “The Economy of Winners: Challenges and Opportunities of the Digital Revolution”, and in 2012, “The Golden Rules of the Stock Market”. Together with Paul Huybrechts, he wrote “In the Land of the Old” in 2006, a book on the social and economic challenge of an aging population. Read more
