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What’s the matter with Germany? I mean the question literally, not as a dismissive piece of rhetoric. It is well known that the country is in a deep industrial malaise: in one recent month, the level of industrial production fell to its lowest level in 20 years. The plight was poignantly portrayed in an FT Big Read last week, in which my colleagues asked: “Can anything halt the decline of German industry?”
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The answer matters far beyond Germany’s borders, given the country’s importance in the European and even global economy. But to be confident about solutions, you need to fully understand the problem you are trying to solve. And I’m not at all sure that even the expert debate is sufficiently clear about the root causes. I know I am not. The reason is, in a nutshell, a mismatch between the unique magnitude of Germany’s travails and the generality of the explanations used as premises for the debate. Below, I set out what puzzles me.
Look at this chart: it shows manufacturing output, adjusted for inflation, in the 20 largest EU economies, as well as Norway and Switzerland. The numbers are normalised to 100 in 2015.
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Anything stand out? Yes, that line at the bottom is Germany. But what is most interesting is how virtually no other European country has seen industry contract in the same way. There is no European industrial crisis, only a German one.
Take whatever comparator you like, and this point holds. French industry had a worse pandemic and slower recovery than Germany, sure, but it has held its own in a way that its competitors across the Rhine have not. Switzerland’s industry has many similarities with that of Germany but has faced more currency appreciation — yet it, too, has kept growing. Even countries tied deeply into the German manufacturing supply chain — look at Poland, Hungary and the Czech Republic — seem to float unshackled by their own industrial anchor. Only Slovakia, whose small economy gives an outsize role to Germany’s extended car industry, has been dragged down with it.
This uniquely bad performance confounds the standard explanations for Germany’s industrial woes. It is commonplace to lay the blame at the door of deteriorating exports in a world that is turning away from foreign trade. But why should this not affect other countries’ industry just as much? The typical answer is that Germany is more export-dependent than most countries. Compared with other economies of a similar size, it is true that Germany has a higher export-to-GDP share. But most European economies are smaller — and, therefore, more open — than Germany’s. As a result, Germany’s export-to-GDP ratio is quite a bit lower than that for the EU in the aggregate, as the European Commission’s chart below shows.
You can’t blame openness if more open economies are doing better. Could it be the wrong kind of openness — that Germany is more dependent on markets that have been particularly badly affected by the trade wars? In fact, its export structure is not all that different from the rest of Europe either. Here is Germany’s and the aggregate EU’s export structure for goods this year, according to the German statistics bureau and the commission:
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About 55 per cent of German exports go to the rest of the EU, mostly euro countries. Of the 45 per cent that go outside the EU, about 10 per cent go to the US, a bit more than 5 per cent each to the UK and to China. That’s not all too different from the overall EU profile: EU countries on the whole send about 60 per cent of their goods exports to one another, about 40 per cent to non-EU countries. The non-EU portion is also not too different — about 10 per cent of total goods exports go to the US, about 5 per cent to the UK and a little less to China.
The upshot is that it’s hard to blame Germany’s outsize industrial decline on a particularly unfortunate export dependence. Indeed, look at how export volumes have evolved in Germany and the EU as a whole:
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The change in export volumes (adjusted for price changes) looks virtually the same for Germany as for the larger group since 2019. It’s only in the years just before the pandemic that Germany’s export volumes underperformed the rest of the EU. Those of us who have been at this game for some time remember the worries about industrial recession well before the pandemic. Look again at the manufacturing chart above — Germany started underperforming the rest of the EU around 2017 onwards. But if outsize export problems could explain outsize industrial decline back then, this explanation no longer serves today.
Another frequent scapegoat is the price of energy. There is no doubt that Germany was hard hit by Russian President Vladimir Putin’s decision to turn off the taps on gas supplies to Europe in 2022 (and not to fill up Germany’s reservoirs in the autumn of 2021). But everyone in Europe suffered from the resulting energy crisis. Did Germany suffer a greater blow?
It doesn’t seem so. German corporate energy prices are middle of the range — they used to be just slightly lower than the European average and are now just slightly higher. By itself, that is not enough to account for such a unique underperformance. A similar point could be made about interest rates. While more expensive credit could certainly put a damper on industrial dynamism, interest rate rises have also afflicted all of Europe more or less similarly — at least in the entire Eurozone.
So that is the puzzle. Germany’s industrial decline is exceptional, but the purported reasons for it are not. We can’t be satisfied with explanations that boil down to export and energy woes. What do Free Lunch readers think? Share your thoughts on how you make sense of this puzzle — or whether I am missing something obvious — to freelunch@ft.com. I look forward to your messages. For now, here are some speculative solutions from me.
One possibility is that domestic demand is a bigger part of the story than it is usually made out to be. For example, real private consumption is barely higher than before the pandemic, and total final domestic demand has grown less than in the rest of Europe. Perhaps German industry’s real challenge is not weakening export markets but its struggle to compete in its home market — against Chinese-made electric vehicles, for example.
Or it could be that German industry is, after all, more vulnerable to Europe’s common problems, but in different ways than I looked at above. Much of the industrial decline has been in energy-intensive production. One recent study finds that energy-intensive industry represents a similar share of manufacturing in Germany as in the rest of Europe, but the degree of energy intensity in those subsectors is higher.
As for trade troubles, German industry may be more vulnerable to import disruptions: the OECD does indeed find that foreign value added content makes up a larger share of German export values than elsewhere in Europe (but less than the OECD average).
And finally, it could be as simple as German industry being a bit more tied to the past and unwilling to adapt to changing technology and demand, and that, as a result, it is weathering the current transformation worse.
If these suggestions are correct, then there are silver linings, as they mean that the problems can be addressed with the right domestic and European policies — some of which are already in the works.
If flagging domestic demand is a big part of the problem, then we should expect strong effects from the stimulus now under way. Last week, Germany’s official independent council of economic experts expressed concern that Berlin’s Damascene conversion on public borrowing — the government relaxed restrictions on funding infrastructure and defence on coming into office early this year — would not have the desired growth effects because it would simply free up funds for unrelated social spending.
But while the experts have a point, don’t forget that fiscal stimulus is more powerful the weaker domestic demand is. So if domestic demand really is depressed, almost any kind of deficit spending should boost growth noticeably. The resulting faster demand growth should make the necessary restructuring away from uncompetitive industries into growth sectors easier. In addition, it may vindicate the optimistic growth expectations the government submitted to the commission to justify its fiscal spree (Bruegel explains the details here).
The other silver lining is that an emerging new consensus in European policymaking should do Germany a lot of good by boosting European demand for domestic manufacturing production. One case in point is the Centre for European Reform’s excellent blueprint for a sensible “buy European” policy package for electric vehicles. Another example is the growing push for more common and more co-ordinated spending on common European public goods (such as grids and defence production).
A shame, then, that German leaders too often let domestic troubles distract them from — and even oppose — an ambitious pan-European agenda, when that is just what would be of most help.
Other readables
● Coalitions of the willing are the solution to Europe’s indecisiveness.
● Sarah O’Connor is characteristically excellent on the curious phenomenon of 1990s nostalgia.
● The surreal 45-day trek at the heart of Nato’s defence capability.
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