After almost two decades of economic prosperity, Germany is once again being labeled the "sick man of Europe". Sticky inflation and three consecutive quarters of stagnation or falling output have led to a bleak outlook for Europe’s largest economy. The International Monetary Fund (IMF) now expects Germany to be the only advanced economy to contract this year, forecasting a shrinkage of 0.3% compared to an average growth of 0.9% among the 20 countries that use the Euro, including Germany itself. This downturn marks a disappointing turn of events for a nation that, in the decade after the 2008-9 financial crisis, boasted an average growth of 2% per year, a consistent budget surplus, and a booming export sector.

The root of Germany’s current economic woes is not a single major ailment, but rather a collection of individual problems, according to Stefan Kooths, research director at the Kiehl Institute for the World Economy. These issues range from temporary setbacks such as a weak Chinese economy reducing demand for German exports, to more structural problems like a rapidly aging population and a high corporate tax rate. This combination of factors has led some observers to revive the "sick man of Europe" label for Germany, a moniker it first earned during a period of economic stagnation and high unemployment in the late 1990s and early 2000s.

Germany’s Economic Woes: A Closer Look at Europe’s "Sick Man"

Germany, Europe’s largest economy, is facing a series of economic challenges that have resurrected an unwelcome moniker: the “sick man of Europe.” The International Monetary Fund (IMF) predicts Germany to be the only advanced economy to contract this year, with a forecasted decrease of 0.3%, in contrast to an average rise of 0.9% for the other 19 eurozone countries.

Economic Downturn and Inflation

Germany’s economy has been stagnating or shrinking for three consecutive quarters, fueled by sticky inflation and falling output. Consumer prices rose by 6.2% in July compared to the same month in 2022, significantly higher than the 5.3% average across the euro area. According to Thomas Obst, senior economist at the Cologne Institute for Economic Research, this inflation is eroding Germans’ purchasing power and causing pessimism among households.

Falling private and public spending were the main drivers of the recession that Germany logged last winter. Additionally, the European Central Bank’s decision to raise its main interest rate to a historic high of 3.75% has negatively impacted Germany’s residential building sector, with more than 40% of construction companies reporting a lack of orders, a significant increase from 10.8% a year earlier.

Impact on Industry and Exports

Germany’s industrial sector, home to renowned manufacturers such as Volkswagen and Siemens, has also been affected, with output contracting 1.7% year-over-year in June. German exports to China, its fourth-largest export market, have been sluggish due to China’s slowing growth and record youth unemployment. Carsten Brzeski, global head of macroeconomic research at ING, points out that China has become a competitor and doesn’t require as many German-produced goods as it once did.

Deeper Structural Problems

Besides the impact of the pandemic and the war in Ukraine, Germany’s economic woes are rooted in deeper, self-inflicted problems. Brzeski argues that Germany has made no significant economic reforms over the last 10 years and has lagged behind in digitalization, infrastructure, and international competitiveness. The high cost of natural gas has also hit Germany’s energy-intensive manufacturers hard. With the country having completely shut down its nuclear power production, it remains vulnerable to supply shocks in natural gas.

Signs of Hope

Despite these challenges, there are still bright spots. Holger Schmieding, the economist who first labeled Germany the “sick man of Europe” in 1998, believes the current pessimism is overdone. He points out that Germany enjoys record levels of employment and strong public finances that make adjusting to economic shocks easier. Germany’s government is also taking steps towards immigration law reforms and speeding up the planning and approval processes for infrastructure projects.

One of Germany’s strengths lies in its adaptability, as demonstrated last year when it approved and built an LNG terminal in a matter of months. Schmieding credits Germany’s large number of small and medium-sized businesses, the Mittelstand, for their ability to react nimbly to a shifting competitive landscape.

Takeaways

Germany’s economic situation is undoubtedly challenging, with multiple factors contributing to its current state. While its inflation and recession issues are significant, it’s essential to remember that Germany has weathered financial storms before. The country’s adaptability, demonstrated by its quick responses to energy supply issues, and the steps its government is taking towards necessary reforms, are promising signs. Germany’s small and medium-sized businesses also continue to be a source of resilience. Only time will tell if these factors will be enough for Germany to once again shed the "sick man of Europe" label.