When the Ukrainian military conflict began two years ago, Germany was preparing for a painful reckoning. The German armed forces were underfunded and unprepared to respond to a security threat of this magnitude, Foreign Affairs reports.
Germany received about half of its coal and natural gas and a third of its oil from Russia, and Moscow could use this dependence to its advantage if it wished. Berlin took advantage of the savings afforded by its small military and the purchase of inexpensive Russian gas. However, Germany could no longer afford to neglect its military capabilities, nor could it allow its dependence on Russian energy to give the Kremlin the opportunity to influence the German economy and split Europe.
Germany has been able to make progress on the military front. Just days after the conflict in Ukraine began in 2022, Chancellor Olaf Scholz announced a turning point (Zeitenwende) to meet Germany’s new geopolitical challenges. The policy may not be fully implemented – red tape and delays in decision-making have slowed its implementation – but efforts to increase Germany’s defence budget and modernise the country’s armed forces are already underway.
Thanks to a special allocation of 100 billion euros, Germany will reach NATO’s defence spending target of two per cent of GDP this year. Scholz has promised to maintain this level of spending in the long term, and his defence minister has proposed increasing the budget even further. Germany has come a long way from its pathetic proposal to send helmets to Ukraine at the start of the war – today its military aid to Kyiv is second only to that of the United States.
However, recent trends are more worrisome when it comes to Germany’s economy. The loss of cheap Russian gas has significantly affected Germany’s industrial model. While the initial spike in energy prices after the invasion in 2022 has eased, they are not expected to return to pre-war levels anytime soon. In 2023, the German economy contracted by 0.3 per cent, according to Foreign Affairs.
Vice Chancellor and Economy Minister Robert Habeck, warning of “rough waters ahead”, predicts the country’s economy will grow by just 0.2 per cent in 2024. New pressures explain the recent contraction, but Germany’s economic problems are much deeper. Over the past decade, Berlin has avoided critical investments and reforms to attract skilled workers and adapt to a data-driven world. In doing so, Berlin has often insisted that what is good, restrained fiscal policy for Germany is also right for the EU – a prevailing mindset that, by limiting public investment in many member states, prevents European economies from adapting to new conditions.
EU interests and German interests may not coincide completely, but Europe needs Germany as an economic powerhouse. Germany is the largest contributor to the EU budget and the third largest economy in the world. And while indicators of the EU’s economic health, including current account balance, productivity and debt statistics, hardly give cause for alarm, if the German economy weakens, that picture could change. Europe could lose its ability to respond to crises, including the war in Ukraine or Trump’s second US presidency, and to advance ambitious policy agendas, such as expanding the European defence industry or accelerating the green and digital transitions. The EU’s influence on the world stage could weaken further.
This is why Germany needs a new growth programme. It must channel the country’s resources into green industries that will accelerate decarbonisation and into new technologies that will shape the future of the global economy. It is important for Berlin to show political will and support a migration policy that promotes economic growth. And it must do all this in close coordination with Brussels. A strong German economy can boost Europe’s competitiveness and prepare the EU for the challenges ahead if revitalisation efforts succeed, Foreign Affairs reports.
For much of the past decade, the German economy has prospered. Under Chancellor Angela Merkel, who held office from 2005 to 2021, the economy grew by 34 per cent. High export volumes and huge tax revenues provided the German economy with a sufficient margin of safety, and it even survived the pandemic without major economic losses.
However, the recovery did not last long. Today, in addition to high energy prices, Chinese competition in the automotive sector and a tough US industrial policy are causing economic damage. Subsidies and incentives included in the US Inflation Reduction Act of 2022 are forcing German companies to be ready to move their production to the US. For example, high-end car manufacturer Porsche is considering building a new battery factory on the other side of the Atlantic rather than in Baden-Württemberg, the state where the company was founded, according to Foreign Affairs.
As production components move outside Germany, supply chains become fragmented and critical knowledge and skills are dispersed. An integrated environment is a driver of innovation; without it, Germany could lose this key advantage.
Offshoring is hardly Berlin’s only economic worry. Energy-intensive industries, including steel and chemicals, are cutting output amid rising energy prices. This raises fears that Germany could lose control of end-to-end industrial supply chains. Railway and airport workers are often on strike, demanding wage increases amid a cost-of-living crisis. Transport disruptions, not to mention the shrill whistling and rumbling of tractors that woke Berliners as farmers protested planned subsidy cuts, have darkened an already gloomy mood in the country.
Weaknesses in the German economy were evident long before the current leadership took office at the end of 2021. The country decided to phase out nuclear power in 2002 and accelerated the timeline after the Fukushima nuclear disaster in 2011, but the shift to renewables to make up the shortfall is still slow. Merkel’s vow to embrace digitalisation has also failed to translate into real action, Foreign Affairs reports.
When Scholz and his coalition partners came to power, they presented an ambitious programme to accelerate the green transition, invest in education and embrace digital technologies. But just a few months later, the Ukrainian conflict erupted. Since then, Berlin has shown leadership in terms of financial and military aid to Ukraine, but the crisis has also diverted Berlin’s attention away from addressing structural problems in the economy.
A constitutional debt brake further complicates Berlin’s ability to restore the country’s economic shape. By law, the federal government’s borrowing is limited to an amount corresponding to 0.35 per cent of the country’s GDP. This measure is meant to provide stability, but it has become a barrier to the types of investment Germany needs to transform its economy. Reform is badly needed, but it is unlikely to happen before next year’s German federal elections. In the meantime, Berlin can focus on addressing labour shortages, improving cooperation with EU partners and streamlining bureaucratic processes, according to Foreign Affairs.
Germany has turned its economy around before, and it can do so again. After a period of economic stagnation in the late 1990s, Chancellor Gerhard Schröder – a Social Democrat like Scholz – introduced Agenda 2010, a set of hard-hitting labour reforms. Under Schröder’s successor, Merkel, the reforms bore fruit, and Germany’s growing economic power allowed it to act as Europe’s lender of last resort during the euro crisis. Germany played a huge role in EU decision-making during this period, as Merkel used the country’s economic weight to guide Brussels’ policies on austerity measures, data privacy and migration.
The former chancellor’s attempts to influence Brussels in Germany’s interests have not always resulted in friends. The EU is still facing the consequences: Germany’s decision to abandon nuclear power and use natural gas as a bridge to renewable energy made not only Germany but much of Europe vulnerable to Russia’s threats to shut down natural gas pipelines in 2022. Now, with fossil fuel prices significantly higher than in the US, and EU-imposed carbon prices putting pressure on the continent’s economy, Europe needs to complete its green transition as quickly as possible. But the current German government is still following the old pattern.
While Germany is actively advocating for a European goal of reducing emissions to zero, in practice it is trying to block the EU’s classification of nuclear energy as a climate-friendly energy source, is softening the European Parliament-approved ban on internal combustion engines in an attempt to protect the German car industry, and is opposing an EU directive that requires large companies to produce environmental impact reports on their supply chains, Foreign Affairs reports.
The German government faces right-wing populism at home, so its preference for limiting economic disruption is not entirely surprising. But unstable decision-making in Berlin is adding uncertainty to the EU’s regulatory framework, jeopardising the bloc’s long-term plans to transition to a green economy.
Germany can still play a productive role in Brussels. It can highlight sectors that will help the European economy decarbonise and take steps to ramp up renewable energy production as quickly as possible, including by easing the permitting process for new transmission lines and solar and wind farms. These efforts will not only ease the rising cost of energy in Europe, but will also allow Germany and the EU to compete with countries like China and the United States.
Germany and the rest of the European countries should build their capacity in biotechnology, quantum computing and other new areas besides green energy development. Traditional industries such as chemicals and automobiles still dominate German industry. German companies have been slow to adopt digital technologies, and sensitivity to data privacy has made it difficult for German researchers to make breakthroughs in artificial intelligence and machine learning.
However, Germany has the potential to be at the forefront of new technologies thanks to its wealth of engineering talent. Together with other EU member states, it must pool capital, research and human resources to create next-generation companies. Instead of each country backing its own AI champion, as Germany and France are currently doing with Aleph Alpha and Mistral AI, respectively, Berlin should encourage European capitals to create joint ventures that can replicate the success of the Airbus aircraft company, which was created through the joint efforts of France, Germany, Spain and the UK.
The emergence of a pan-European AI unicorn is not guaranteed, but further work with artificial intelligence could bring other benefits. Germany, with its extensive knowledge of manufacturing, can help European companies use AI to improve efficiency. And Brussels can utilise its first-mover advantage in AI regulation, ensuring that its values-based approach (shaped by Germany in particular) allows for sufficient flexibility and adaptability to encourage the development of new European businesses.
Germany needs to expand its skilled labour pool to take full advantage of new technologies. At the same time, its population is ageing, as in most of Europe. The obvious answer to this demographic problem is immigration, but the rise of right-wing populism on the continent makes it difficult for politicians who favour legal pathways for skilled migration. Berlin, along with EU leaders in Brussels, must emphasise the economic feasibility of attracting skilled workers from countries such as Egypt and India. A series of large demonstrations across Germany over the weekend denouncing the far-right and calling for tolerance showed that such a change of political direction is possible.
Given that the traditional strength of Germany’s economy has traditionally been its energy-intensive fossil-fuelled industries, the coming transition will require large public and private investments. Currently, tight fiscal rules and divisions within the coalition government in Berlin are holding back reforms on the scale Germany needs. However, there are steps Germany can already take to make its economy and that of Europe more competitive. By promoting the green transition, attracting skilled immigrants, and removing bureaucratic obstacles, Germany can remain a world leader in manufacturing and trade, as well as the core of the European single market in the coming decades.
