Germany's Economic Crisis: Problems and Prospects

In 2023, Germany faced a serious economic downturn, becoming the world's worst performing major economy, in stark contrast to its previous successes. The main causes of the crisis include high energy costs, slow digitalization, political instability and demographic problems such as an aging population and labor shortages. This has caused not only an economic downturn but also social problems, including a housing crisis. The economic crisis has also contributed to the growing support for alternative political movements such as the right-wing Alternative for Germany and Sarah Wagenknecht's left-wing coalition.

From 2005 to 2019, Germany experienced rapid economic growth, known as the “labor market miracle”: employment increased by more than 15%. This growth was partly fueled by cheap imports of Russian natural gas. However, after Russia's invasion of Ukraine, Germany's dependence on Russian energy became a major concern. In March 2022, the U.S. imposed a ban on Russian oil supplies, and German officials warned that cutting off Russian gas could lead to serious energy shortages. German Chancellor Olaf Scholz initially resisted calls to stop importing Russian energy, but the EU has pledged to reduce its dependence on Russia. By September 2022, Germany's economy minister criticized high energy prices, accusing suppliers from the U.S. and other countries of profiting from the conflict.

Crisis

Germany's economy entered recession in 2023, contracting 0.3% across all quarters, making it the worst performer among the world's major economies that year. The economy was also expected to grow slower than all OECD member countries except the UK in 2024. The main reason for this decline was the impact of Western sanctions on Russia following its invasion of Ukraine, which resulted in Germany losing access to cheap Russian natural gas. This led to energy shortages and price increases, which affected various sectors of the economy. Inflation reached 8.0% in 2022 and 7.0% in 2023, while household consumption fell by 0.8%. Economists warned that Germany faced a high risk of a continued recession in 2024, with no short-term recovery in sight.

By 2024, Germany's economy will be in recession for the second year in a row, with a projected GDP contraction of 0.2%, compared with an earlier forecast of 1.3% growth. Economy Minister Robert Habeck emphasized that Germany has experienced slow growth since 2018 due to both domestic problems and external global challenges, especially its position between China and the United States. The country is expected to have the slowest growth among the G7 countries in 2024, indicating the need for a major reassessment of its economic strategy.

Lack of government funding

On November 15, 2023, Germany's federal budget crisis for fiscal year 2024 began when a constitutional court ruled unconstitutional a €60 billion climate fund needed to implement the climate and energy plans of the “Traffic Light” coalition. The fund was created by redistributing the emergency debt left over from the COVID-19 relief measures. The crisis deepened because of disagreements over circumventing the “debt brake” (Schuldenbremse), a fiscal rule that limits budget deficits and public debt. Although the debt brake had been circumvented several times before, including during the refugee crisis, COVID-19, and the war in Ukraine, it remained a staple of fiscal policy.

After intense negotiations, Chancellor Scholz's coalition reached a compromise in December 2023 that kept the debt brake in place for 2024 but required cuts to the climate and transformation fund, reducing it by €45 billion over the next three years. While this avoided an immediate political crisis, the austerity measures were imposed at a time of economic downturn, raising concerns about Germany's climate goals. Politico journalist Matthew Karnitschnig called the situation “the most German crisis in history.”

BASF, Germany's largest chemical company, faced an additional 3.2 billion euro in energy costs in 2022 due to sanctions on Russian gas. This financial strain forced the company to cut 2,600 jobs and close several plants, as well as move production abroad due to bureaucratic obstacles, over-regulation and the high cost of production in Germany.

Germany's economy continued to show signs of malaise in 2024. The ifo institute reported a decline in business sentiment, more than half of companies in the housing sector reported a lack of orders, and the number of defaults in the sector rose by more than 20% in 2023. By September 2024, the ifo business climate index had fallen for four consecutive months, signaling growing dissatisfaction with business conditions, especially in manufacturing and services. Economists predicted a further decline in the economy: weak investment, consumer reluctance to spend and inflationary uncertainty contributed to stagnation.

Germany's industrial sector, which was ranked as the most troubled market in Europe by the Weil European Distress Index, was also hit hard. High interest rates, labor shortages and excessive regulation have worsened the situation, leading to plant closures and project delays. The country's heavy reliance on exports and tight labor market have added to economic pressures, while rising inflation and mortgage costs have depressed consumer spending. Germany's Purchasing Managers' Index (PMI) showed a continued contraction in manufacturing, indicating that an economic recovery is not imminent.

Conclusions

Germany's economy has been hit hard by the ongoing energy crisis caused by sanctions on Russian gas, resulting in rising costs and deficits affecting various sectors. The country's performance in 2023 was the worst among the world's largest economies, with inflation and low consumer spending contributing to the downturn. Structural problems such as outdated regulation, labor shortages and over-reliance on exports hampered the economic recovery and left Germany struggling to adapt to new global economic realities. A political crisis triggered by a constitutional court ruling against a key climate fund has exacerbated instability, and cuts to vital funding in 2024 will further complicate Germany's economic outlook. Overall, the outlook for 2024 remains bleak, with stagnation and the possibility of recession continuing to weigh on the economy.