Germany is a Europe's sick economic giant

Chemical giant BASF has been a pillar of German business for more than 150 years, underpinning the country’s industrial rise with a steady stream of innovation that helped make “Made in Germany” the envy of the world. But its latest moonshot — a $10 billion investment in a state-of-the-art complex the company claims will be the gold standard for sustainable production — isn’t going up in Germany. Instead, it’s being erected 9,000 kilometers away in China, writes POLITICO at a long read on economic problems that hit Germany now.

Even as it chases the future in Asia, BASF, founded on the banks of the Rhine in 1865 as the Badische Anilin- & Sodafabrik, is scaling back in Germany. In February, the company announced the shutdown of a fertilizer plant in its hometown of Ludwigshafen and other facilities, which led to about 2,600 job cuts. 

Such malaise now pervades the whole of the German economy, which slipped into a recession in the first quarter amid a flurry of surveys showing that both companies and consumers are deeply skeptical about the future.

That concern is well founded. Nearly 20 years ago, Germany overcame its reputation as the “sick man of Europe” with a package of ambitious labor market reforms that unshackled its industrial potential and ushered in a sustained period of prosperity, driven in particular by strong demand for its machinery and cars from China. While Germany frustrated many partners by exporting vastly more than it was buying, its economy flourished.

Confronted by a toxic cocktail of high energy costs, worker shortages and reams of red tape, many of Germany’s biggest companies — from giants like Volkswagen and Siemens to a host of lesser-known, smaller ones — are experiencing a rude awakening and scrambling for greener pastures in North America and Asia.

Unemployment rose year-on-year by about 200,000 in June 2023, a month when companies normally add jobs. Though the overall unemployment rate remains low at 5.7 percent and the number of job vacancies high at nearly 800,000, German officials are bracing for more bad news.

New orders at the country’s engineering companies, long a bellwether for the health of Germany Inc., have been dropping like a stone, falling 10 percent in May alone, the eighth consecutive decline. Similar weakness is apparent across the German economy, from construction to chemicals.

“One sometimes hears about ‘creeping deindustrialization — well, it’s not just creeping anymore,” said Hans-Jürgen Völz, chief economist at BVMW, an association that lobbies for Germany’s Mittelstand, the thousands of small- and medium-sized firms that form the backbone of the country’s economy.

To understand the long-term effects of deindustrialization, one needn’t look further than America’s Rust Belt or the U.K.’s Midlands, once thriving industrial corridors that fell victim to policy missteps and global competitive pressures and never fully recovered. Only with Germany, the consequences would play out on a continental scale.

A problem is that Germany’s most important industrial segments — from chemicals to autos to machinery — are rooted in 19th-century technologies. While the country has thrived for decades by optimizing those wares, many of them are either becoming obsolete (the internal combustion engine) or simply too expensive to produce in Germany. Innovation begets economic growth and as Germany’s traditional industry declines, the question is what big new thing will replace it. So far, there’s nothing in sight.

Germany ranks only eighth in the Global Innovation Index, an annual ranking compiled by the U.N.’s World Intellectual Property Organization. In Europe, it’s not even in the top three.

The erosion of Germany’s industrial core will have a substantial impact on the rest of the European Union. Germany is not just Europe’s largest player; it also functions like the hub of a wheel, linking the region’s diverse economies as the largest trading partner and investor for many of them.

Over the past three decades, German industry has turned Central Europe into its factory floor. Porsche makes its top-selling Cayenne SUV in Slovakia, Audi has been churning out engines in Hungary since the early 1990s, and premium appliance-maker Miele makes washing machines in Poland. Thousands of small- and medium-sized German firms, the so-called Mittelstand that forms the backbone of the country’s economy, are active in the region, producing mainly for the European market.

While they won’t disappear overnight, a sustained decline in Germany would inevitably pull the rest of the region down with it.

The formula that made Germany Europe’s industrial powerhouse — a highly skilled workforce and innovative companies powered by cheap energy — has come undone. As a generation of baby boomers retires in the coming years, Germany is speeding toward a demographic cliff that will leave its companies without the engineers, scientists and other highly skilled workers they need to stay competitive in the global market.

Within the next 15 years, about 30 percent of Germany’s workforce will reach retirement age. Young Germans yearn for ‘safe’ jobs. Many young people would rather work for the state than start a business.

Efforts to compensate for the growing worker shortfall through migration have so far failed. (Though Germany continues to take in hundreds of thousands of asylum seekers every year, most lack the skills companies need.) German lawmakers passed a new immigration law that lifts many of the bureaucratic barriers foreign skilled workers have faced to settle in the country. Whether it will work is another question?

Compounding those demographic challenges are skyrocketing energy costs in the wake of Russia’s war on Ukraine, and Germany’s own efforts to combat climate change. By halting deliveries of natural gas to Germany, the Kremlin effectively removed the linchpin of the country’s business model, which relied on easy access to cheap energy. Though wholesale gas prices have recently stabilized, they’re still roughly triple where they were before the crisis. That has left companies like BASF, whose main German operation alone consumed as much natural gas in 2021 as all of Switzerland, with no choice but to look for alternatives.

The country even after nearly a quarter century of subsidizing the expansion of renewable energy, still doesn’t have nearly enough wind turbines and solar panels to sate demand — leaving Germans paying three times the international average for electricity.

The car industry has buoyed Germany’s fortunes for more than a century and the country’s economic future rests in large measure on the ability of the sector — which accounts for nearly a quarter of its output — to maintain its hold on the luxury segment in a world of electric vehicles.

Long a source of national pride, the car industry has become Germany’s Achilles’ heel for reasons that have more to do with hubris than the country’s structural deficiencies. For years, companies like Mercedes, BMW and Volkswagen refused to let go of the combustion engine, dismissing Tesla and other early innovators as flashes in the pan.

That strategic blunder opened the door not just to Elon Musk, but for China, which began investing substantial sums in electric vehicle development 15 years ago as the Germans pooh-poohed the idea, to build a substantial lead.

A recent study by insurer Allianz projected that if current trends hold with Chinese manufacturers increasing their market share in both China and Europe, European carmakers and suppliers could see their profits fall by tens of billions of euros by 2030, with German companies bearing the brunt.

For decades, the Chinese viewed German industry and engineering as a model. All of a sudden, it’s the Germans who are looking to China.

Funding offered by the U.S.’s Inflation Reduction Act has proved a particularly attractive lure. Volkswagen unveiled plans in March to build a $2 billion factory in South Carolina, where it wants to revive the Scout brand, a popular American 4×4 in the ’60s and ’70s.

A big flash point will be social welfare. Germany operates one of the most generous welfare states, with social spending accounting for 27 percent of the economy last year (compared with 23 percent in the U.S.). With Berlin under pressure to spend vastly more on defense, the belt-tightening — and the public backlash — has already begun. In an economic decline, it will only get worse.

A top priority for German industry — the modernization of Germany’s creaking infrastructure — will be more difficult to finance. Germany’s roads, bridges, shipping lanes and other critical infrastructure are in sore need of repair.

A recent survey of 128 German auto suppliers found that not a single one planned to increase their investment in their home market. More than a quarter were planning to shift operations abroad.

At some point, Germans will wake up to the dangers they face.

The question is whether they will before it’s too late to do anything about it?

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