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09 June 2023


Remember the sick-man-of-Europe competition? Over the decades, the award has passed backwards and forwards between the UK and Germany, though France, at times, deserved an honourable mention.

Brexit and the lack of a Brexit strategy in the UK notwithstanding, that trophy sits in Berlin right now. Germany has fallen into what economists call a technical recession after two consecutive quarters of falling economic growth. This is not the real definition of a recession. The US National Bureau of Economic Research defines it as "a significant decline in economic activity that is spread across the economy and lasts more than a few months". Here is where it gets weird. This downturn in gross domestic product certainly lasted for more than a few months. Domestic consumption is down. But the downturn is not spread evenly across the economy. Unemployment stands at 5.5 per cent, one of the lowest levels in living memory. The big employment story in Germany is one of staff shortages and wage rises. I know restaurants that closed because they could not hire staff. This is not what happens in a normal recession.

The closest parallel to what is happening in Germany right now is the UK in the 1970s - a period marked by stagflation - high inflation and low growth - combined with relatively low unemployment. According to the UK's Office for National Statistics, the UK's unemployment rate fluctuated between 3.7 and 5.6 per cent in that decade. The 1970s and early 1980s were marked by two severe recessions. The first, from 1973 until 1975, was triggered by the oil price shock. The second, from 1980 until 1981, by the Thatcher government's economic policies.

But the really big story of the 1970s and early 1980s in the UK was not a story of cycles, but structures. For me, the most convincing explanation of what happened at that time in many countries was the theory of structural slumps, a long super-cycle of decline, put forward by the US economics nobel laureate Edmund Phelps in a 1994 book. His analysis differs from the standard orthodox perspective which has the economy fluctuating around a fixed trend. But that is not what happened in the 1970s. A lot of shocks happened in that decade: the end of the Bretton-Woods system of semi-fixed exchange rate that provided global macroeconomic stability in the post-war period; sequential oil price shocks; and in the UK, a strong increase in strike action by the trade unions. All of that superseded the cycle. 

For modern Germany, the big structural shocks today are geopolitical and technological. The German economy is an analogue-age beast. Its main industries are fuel-driven cars, mechanical engineering and chemicals. The country has excellent scientists and engineers, but unfortunately over-specialised on pre-digital technologies, and not good at turning scientific innovation into commercial success. Germany, and other European countries, missed out on the digital revolution. The country's alienation with all things digital was best captured in a comment by Angela Merkel in 2013, when she called the internet "uncharted territory". I am wondering what she has to say about artificial intelligence.

Germany's overreliance on industrial production made it dependent on global supply chain links with China and Russia. It was part of a strategy of deep supply-chain integration across the entire Eurasian continent, with Germany as the hub of the network. The strategy collapsed with the pandemic and Russia's invasion of Ukraine.  

This is Germany's structural slump. The economic cycle will, of course, eventually turn up again. Recessions end. By 1978, UK economic growth was back at 4%. But those headline numbers did not tell us what really happened.

The UK got out of the structural slump through a complete economic reboot during the following decade. This is where I see the biggest difference with modern Germany. Olaf Scholz, the German chancellor, talked about a "change of era" in a now famous speech last year. The big idea of his government is the green transition. But they don't want to reduce their over-reliance on manufacturing industry - just make it greener. The supply chain vulnerabilities will remain.

The German car industry is still relatively profitable. But they will not remain so for much longer. The fuel-driven cars will be phased out by 2035. The big money in the next generation of electric cars is made in batteries and software - not areas in which the European and German car makers excel. 

The EU has, in theory, the capacity to match the US and China in research spending. Horizon Europe, the EU's science and research programme, is often cited as an EU policy success. I beg to differ. The reality is that Europe has been losing the scientific and technological edge it once had. 

The main reason is the EU governments are not nearly as focused on technology as the US and China. Whereas Joe Biden takes a personal interest in nuclear fusion, Europe's Luddite leaders prefer regulation. When you have no skin in the game, you tend to think of technologies as a threat. This is how the EU ended up with the world's most restrictive data protection regulation.

Getting out of a structural slump is hard. It would require a political reboot of a scale similar to what Germany itself went through after the second world war, and what the UK and the US did in the early 1980s. There are no signs of this happening yet. I am not saying that it won't happen at some point in the future, but right now there is not even political advocacy of change. 

The trophy of sick man of Europe is therefore safe in Berlin for the foreseeable future.


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