The faltering German economy

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At Davos last year, German Chancellor Olaf Scholz spoke of a “new German speed” that would set a benchmark for economic reform. A year on, Europe’s largest economy is starting to look more like a slow-moving car crash than an accelerating juggernaut. In 2023 it contracted by 0.3 per cent, making it the world’s worst-performing major economy. This has been accompanied by policy setbacks, nationwide strikes, and a steep decline in the ruling coalition’s popularity. 

The economic slump — which many analysts expect to continue this year — is a “wake-up call”, according to Finance Minister Christian Lindner. Last week he sought to rebut concerns at this year’s Davos gathering that the country was becoming the “sick man of Europe” once again. His diagnosis: Germany is just a “tired man” in need of “a strong cup of coffee” — by which he meant structural reforms. But whether it is sick, tired or simply in transition, the German people need to be convinced soon that the economy is heading in the right direction.

Popular anger is rising. The three parties in Scholz’s coalition — the Social Democrats (SPD), Greens, and Free Democrats (FDP) — have seen their combined share of the vote fall from over 50 per cent at the end of 2021, to less than a third today. More troubling for Germany, and Europe, is the growing popularity of the far-right Alternative for Germany (AfD). It is on course to win three regional elections in September. While anti-immigration rhetoric has bolstered its support, discontent with the governing coalition has been another significant factor. 

Scholz’s plan to draw on a €60bn climate transformation fund to expedite Germany’s industrial modernisation collapsed in November when its constitutional court deemed it illegal. The government had to freeze the funds and plug the resulting €17bn hole in its budget with austerity measures. This included scrapping a diesel subsidy for agricultural vehicles which set off angry protests by farmers earlier this month. Tractors stormed cities and blocked off several autobahn junctions. The disruption to millions of commuters has been exacerbated by a train drivers’ strike.

The unrest adds to a sense that the German economy is not working. Households and businesses have been hit hard by high energy costs, and are low on confidence. Industrial production is falling. The auto industry is struggling to compete amid a global trend towards electric vehicles. Meanwhile, skills shortages are high and the economy remains too reliant on trade with China. Bickering and policy mishaps have added to doubts over the coalition’s ability to guide the country forward. An ambitious but poorly handled green policy that urged homeowners to replace gas boilers with heat pumps had to be amended after a public outcry. Some also question the efficacy of giant subsidies for semiconductor factories.

The coalition cannot be blamed for all Germany’s ills. The entire eurozone has been weighed down by high interest rates and inflation — which have pushed up unions’ wage demands. The constitutionally enshrined debt brake, a rigid limit on budget deficits, is partly to blame for a long period of under-investment in railways, bridges and schools. Farmers have recently been staging similar protests in France and other EU countries too. At the same time, the government has overseen an impressive shift away from Russian natural gas and has pushed through reforms to slash red tape, encourage skilled immigration, and speed up the rollout of renewable energy.

An SPD focused on social justice, a Green party dedicated to fighting climate change, and the fiscally hawkish FDP were always going to be awkward bedfellows. But creaking infrastructure, high energy costs and weak digitisation need to be addressed much faster to help modernise and diversify the economy. Softening the debt brake to allow borrowing to fund public investment would be a start. The hodgepodge coalition must get its act together to arrest the decline in the German economy — and in its own popularity. The rise of the far right ought to focus the minds.

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