Scholz Is Failing to Engineer a Liftoff for the German Economy

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(Bloomberg) — Germany’s inability to generate meaningful growth is casting a shadow over the long-term prospects for the economy — and political hopes for the three ruling parties under Chancellor Olaf Scholz.

With business confidence last week plummeting and data on Tuesday likely to show that gross domestic product barely rose in the second quarter, a country long seen as Europe’s motor of expansion is increasingly looking like a deadweight. 

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Of the 10 quarterly GDP readings since Scholz took office, more than half showed either nearly no growth or a contraction. 

At the heart of Germany’s weakness is the manufacturing base that sustained export-led growth for much of this century. 

Momentum was weakening even before the Covid-19 pandemic, as Donald Trump’s first presidency and tensions with China soured the global trading environment in which German exporters had thrived. The end of cheap gas imports from Russia was a body blow that companies are still struggling to get past, especially in energy-intensive industries.

“There is still this hope that one day, the globalized world from which we profited so much will come back,” says senior economist Sandra Ebner from Union Investment. “This isn’t going to happen — and we are having an extremely hard time getting used to that.”

Germany’s car manufacturers, a central pillar of the economy’s past success, are also trying to make up for lost ground as they confront China’s head start in production of electric vehicles and in their home market, the phase out of combustion-fueled vehicles is going backwards.  

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“Only 12% of Germany’s newly registered vehicles are electric — last year it was more than 20%,” says Helena Wisbert, professor for automotive economics at Ostfalia university.

The latest financial results from the country’s industrial heavyweights paint a similar picture. BASF’s earnings declined after prices fell across its chemicals business and Mercedes-Benz Group trimmed a key margin forecast on the back of a subdued outlook and strong competition in China. Volkswagen — which already was forced to lower its outlook — will report earnings on Thursday.

The roots of the economy’s struggles go beyond cyclical volatility — half of an estimated 7% shortfall in industrial activity is structural, according to research by Bloomberg Economics. 

Despite such troubles, some observers had suggested that the worst would be over by now. Last October, Berenberg economist Holger Schmieding said that the German industrial slump might be close to its nadir. But as the second quarter dawned, industry was still languishing. 

In April, the Ifo institute said the economy was stabilizing, but a worldwide economic pickup somehow wasn’t helping German manufacturers — an outcome it described then as “puzzling.” In truth, production was falling again then and sank even further in May to reach the lowest level in four years and Ifo chief Clemens Fuest last week told Bloomberg Television that the overall outlook for Germany is “rather bleak.”  

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“I blame the technological stalemate,” says Martin Gornig, economist at the German Institute for Economic Research. “We can no longer invest in the old, fossil-fuel technology and we don’t yet know in which new technology to invest. If we can overcome this, Germany will certainly be able to become the European leader again.”

Easing non-energy inflation and continued wage growth might offer some support for sentiment, as could the budget plan for 2025 that Scholz’s fractious government managed to agree on last month after tough negotiations. 

But none of that seems to be feeding through to the consumer yet, with Thursday’s closely-watched business sentiment index of the Ifo institute showing a decline in services, which tends to track domestic consumption.

The repeated delays of Germany’s economic recovery are an ominous sign for the troubled chancellor, who last week affirmed that he plans to run for a second term next year. 

Earlier this month, the administration adopted a growth plan designed to put the country back on track. The package includes steps to strengthen private and public investment and speed expansion of renewable energies, additional tax write-offs for companies and incentives for people to work longer. The government will also extend tax relief on electricity costs for manufacturers and accelerate efforts to cut red tape.

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But it is unlikely that voters will feel the effects before a general election due in September 2025. And with the chancellor’s Social Democrats trailing in the polls, Germany’s economy malaise looks likely to become part of his legacy.

It’s also fueling support for extremists in Germany’s less developed eastern states. This September will see three state elections in the east and the far-right AfD and far-left BSW are both set to make gains with anti-immigration and pro-Russia platforms.

What Bloomberg Economics Says…

“Bleaker sentiment across sectors suggests the German economy is struggling to gain momentum. Worryingly, business morale has not only dropped in the industrial sector, where a turnaround appears increasingly distant. It has also fallen in the services sector, albeit from a higher level. We still think that growth might be slightly higher in the last two quarters of the year than it was in the first two. But the downside risks to our near-term forecast are notably increasing.”

—Martin Ademmer, economist. For full note, click here

Apart from the adverse geopolitical climate, Germany is struggling with a shrinking workforce, bureaucracy and an uncertainty over the political direction for decarbonizing the economy.

The self-imposed restrictions on government borrowing due to the so-called debt brake means there’s little leeway for public spending to address the country’s long-term economic problems. 

“There has been too little investment in many areas,” states Sabrina Reeh, equity fund manager at DWS. “Moving past this and investing more in infrastructure and digitalization can have a very supportive effect.”

—With assistance from Elisabeth Behrmann and Barbara Sladkowska.

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