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What’s the matter with Germany, I asked last week, and many of you clearly wonder the same, as I have rarely received as many reactions — many thanks. Below, I address some of the points you have made and how you make sense of Germany’s particular underperformance puzzle.
Before getting to your reactions, let me reiterate the puzzle I described last week, as well as make clear what it is not. The observation that made me scratch my head was a recent divergence from the rest of Europe in terms of manufacturing without a similar divergence in exports. Since about 2021, German manufacturing volumes have fallen much more dramatically than in the rest of Europe (where, on the whole, they have edged up), but export volumes have fallen more or less in step. That was not true in the three to four years leading up to the pandemic, when German manufacturing was also underperforming, but exports were too, so it is easy to attribute that phase of decline.
The chart below shows this comparison for the period 2017-19 and 2022-25.
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This does not exactly disprove that exports have caused the more recent decline in Germany — which I take to be the conventional narrative. But if they did, that just shifts the puzzle as to why a similar fall in exports did not hit manufacturing in the rest of Europe.
One tentative explanation I have been given is that export struggles translate into production declines with a lag — especially in Germany where companies keep on redundant workers for a long time. But if it’s the late-2010s export challenge that explains the post-2021 industry underperformance, then what explains the late-2010s industry underperformance? German exports were doing very well in the early 2010s.
So we can be puzzled by a Germany vs Europe manufacturing divergence since the pandemic, even if we accept that weak exports pose challenges at both levels, and that before the pandemic, Germany’s manufacturing underperformance could be blamed on export shortfalls. (A recent Bundesbank report makes a good case that Germany has suffered from being specialised in products and trade relationships whose export prospects have developed worse than average.) So it’s not that underperforming exports are not an important factor. But an important part of the story is something they can’t explain.
From reading the many responses you sent, I find that the most illuminating reactions to the puzzle fall into three categories.
The first is that there may be no divergence on the measures that matter. Several expert economists have pointed out to me that while production volumes have dropped severely, the value added in manufacturing has not. Indeed, this Kiel Institute study reports that gross value added in manufacturing has been stable since the pandemic. As the authors point out:
This could indicate that manufacturing firms have significantly increased their production of services, which are included in gross value added but not in industrial production.
Daniel Gros, of Bocconi University, sent me a version of the chart below. It shows German manufacturing’s (nominal) value added as a share of the entire Eurozone’s, with little sign of recent underperformance.
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Falling volumes with stable value added suggest a restructuring of production, from lower- to higher-value added goods (and possibly industry-related services). That may not be a bad thing, on which more below.
This suggestion of restructuring relates to the second and third categories of reaction readers contributed, which both centre on how the sectoral breakdown of German industry makes it ill-fitted for today’s economic changes, either from a demand or a supply perspective.
The case in point is motor vehicle manufacturing, which looms larger in production and exports in Germany than in many other countries. Now, given that overall exports did not much underperform the rest of Europe, any particular German problem relating to car exports must have been made up for in better-than-EU-average performance in other exports. But domestic car demand is another matter. And, indeed, the chart of new car registrations below suggests that car purchases have dropped off everywhere — but more in Germany than elsewhere.
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Could the German government’s will-it-won’t-it vacillations on the EU target to require the phasing out of new internal combustion engine vehicles by 2035 possibly have encouraged people to wait and see before deciding what new car to buy? And of the cars that have been getting bought, an increasing share (even in Germany) is accounted for by the battery-powered vehicles where Chinese import competition is strong.
In short, many readers seemed to endorse my speculation last week that some of German manufacturing’s recent deeper than average decline is due not to unforgiving export markets but to a domestic market in the doldrums. And whose fault is a weak domestic market? As Erik Nielsen writes to me: “To argue that Germany’s roughly [10 per cent of GDP] decline in public debt (while others increased their debt) would have no impact on [domestic] demand seems a stretch to me.”
Finally, readers bring up demographic challenges, excessive labour costs and a generally conservative economic culture unwilling to make adjustments as needed as reasons why German manufacturing companies may themselves choose to expand (or maintain) production at other European sites rather than inside Germany. What is clear is that business invests a lower share of GDP in Germany than elsewhere in Europe, and that the shortfall has worsened since the pandemic, as the chart below shows.
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Energy costs could matter for this too. I highlighted last week that they have only gone from perhaps 5 per cent below to the same above the European average (that average has gone up a lot, however), but you readers have rightly argued that this could still make a meaningful difference to profit margins in squeezed companies with big energy needs.
The bigger supply-side point that readers have raised, which I touched but did not elaborate on last week, is that German industry is enmeshed in cross-border supply chains and can shift parts of those supply chains abroad depending on relative productivity and investment returns. That is compatible with final exports being more stable than industrial activity — it would simply reflect less of the work along the supply chain being done inside the country — and with the strong industrial performance of several countries strongly tied to German industry, such as Poland (but not Slovakia, as I mentioned last week).
Bringing all three strands together, I think a cautiously optimistic conclusion is possible. For they suggest that the problem isn’t as bad as all that — rather than a failure, what we observe may be a restructuring into more advanced activities and subsectors, as well as the direction of investment to places where that investment is most effective in raising productivity. It is, in short, Schumpeterianism in action. In addition, there is surely a problem — but a fairly easily solvable one — of inadequate domestic demand.
All of this may be poor consolation to those invested in legacy industries or working and living in the places that host them. What to do? Even if competition from China was the main challenge — both today’s and last week’s newsletter suggest it is not, or not the only one — protectionism is not going to get anyone very far.
In a recent opinion piece, economist Dani Rodrik writes:
The right way to counter Chinese imports in technologically sophisticated areas is to deploy modern industrial policies that directly encourage investment and innovation through the provision of public inputs, coordination, and subsidies where necessary. In effect, other countries should emulate China’s own industrial policies, though with appropriate adaptation to local economic, political, and institutional contexts.
But don’t expect this to create employment:
More aggressive policies may bring some manufacturing back, but few jobs will be created as a result. Automation in manufacturing can no longer be undone.
It follows that allowing much of the restructuring to happen — towards higher-tech parts of manufacturing and advanced services — is better than resisting it. Or in simpler terms, Germany has more to gain by embracing the future than salvaging the past.
Other readables
● Did globalisation kill neoliberalism? My podcast with Branko Milanović.
● Apropos of Schumpeter, French economist Philippe Aghion, whose work formalising Schumpeterian theories just won him the Economics Nobel Prize, has Lunch with the FT.
● How the EU got into a mess trying to regulate Big Tech.
● A writer of video games explains a fascinating aspect of how the gaming economy works.
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