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26 March 2024

Why Germany declines


The Italian economy started to decline around 2000. In the UK, productivity growth declined after the global financial crisis, and never recovered. Russia's invasion of Ukraine is what has tipped the German economy over the edge. What is happening in Germany is not just your average joy ride up and down the economic cycle. The great age of Made in Germany, of German manufacturing and engineering excellence, is drawing to a close.

This is a story of industrial decline few people saw coming. It started long before Vladimir Putin invaded Ukraine. German industrial production has fallen by a cumulative 8 percent since 2015 whereas in the rest of the eurozone it has gone up by 6 percent. This is a huge shift, and there is more to come.

The canary in the coal mine is Thyssen-Krupp, the steel company. Its chief executive wanted to cut capacity by 40 percent because he does not believe the demand to pick in the long run. Steel sits at the beginning of engineering supply chains. If you cut the steel, the rest follows. Germany has entered what economists call a structural slump.

Having grown up in Germany, I can testify to the important role engineering and technology plays in German society. It used to be common to hear people on buses discuss hydraulic systems or other technical subjects. A majority of school leavers would be drawn to the technical crafts or science and engineering degrees, in some cases both in succession. Apart from the great footballers of the 1970s, the heroes at the time were the engineers at the car companies who developed the next generation of engines. Vorsprung durch Technik stood for this economic model. Ferdinand Porsche, the late patriarch of the Porsche family, was once asked which model he liked the best, he answered: the next one. That was the spirit. That was the time when Germany looked to the future.

I see digitalisation as the big intruding event, more so than geopolitics. Car companies used to make their big profits on diesel engines and the after-sales service. Electrical cars have more in common with electronic devices. The profit from electric cars comes from batteries and software. But China and the US own most of that supply chain.

Russia's invasion of Ukraine has definitely damaged energy-intensive production. You would expect that the fall in energy prices to have stopped the rot. But this is not happening. BASF, the chemical giant, concluded some time ago that its future lies outside Germany.  

Old-fashioned manufacturing still matters even in a digital world. Germany produces more ammunition for Ukraine than anyone else in Europe. Even electric cars have mechanical parts. The Germans know a thing or two about scaling up industrial production. Germany is also a rich country, which is starting its path of industrial decline from a high level. A well-trained workforce will ultimately adjust to a new world. There is a promising new generation of entrepreneurial start-ups, especially in the Munich area. But it will take some time until they hit prime time. Until then, maybe a decade, I expect the current malaise to persist.

The problem is that there is not much advocacy for diversification within the German government, or indeed anywhere in the German public debate. The debate is focused mostly on existing companies and sectors, not new ones. Germany does not have the infrastructure for a start-up economy, compared to the UK or the US. It is the old companies that do most of the investment. But many, like the German car makers, are living in the past.

Economic decline has many consequences, especially on politics. Since the start of the euro in 1999, Italy had 11 changes of prime minister. Since the global financial crisis, the UK had five - four since the Brexit referendum. Germany has had only two since 1998. Starting with next year's elections, I would expect that to change.

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