Scholz Is Failing to Engineer a Liftoff for the German Economy

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

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

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Of the 10 quarterly GDP readings since Schultz took office, more than half have shown either virtually no growth or contraction.

The core of Germany’s weakness lies in the manufacturing base that has supported export-led growth for most of this century.

Momentum was faltering 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 blow that companies are still struggling to overcome, especially in energy-intensive industries.

“There is still hope that the globalized world that we have benefited from so much will one day return,” says economist Sandra Ebner of Union Investment. “But that is not going to happen – and we are having a very hard time getting used to it.”

German carmakers, once a mainstay of the economy, are trying to make up ground lost to China’s advance in electric vehicle production and in its home market, where the phase-out of combustion-fuel vehicles is slowing.

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“Only 12 percent of newly registered vehicles in Germany are electric – last year it was more than 20 percent,” says Helena Weisbert, professor of automotive economics at the University of Ostphalia.

The latest financial results from the country’s major industrial companies paint a similar picture. BASF’s profits fell after prices fell across its chemicals businesses, and Mercedes-Benz Group cut its core margin forecasts on the back of a weak outlook and strong competition in China. Volkswagen, which has already been forced to cut its forecast, is due to report earnings on Thursday.

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

Despite these problems, some observers have suggested that the worst may be over. In October, Holger Schmieding, an economist at Berenberg, said that the German industrial recession may be nearing its bottom. But by the second quarter of the year, the industry was still weak.

In April, the Ifo institute said the economy was stabilizing, but the global economic recovery hadn’t helped German manufacturers in any way—a finding the institute described at the time as “puzzling.” In fact, output was falling again at the time, and fell further in May to a four-year low, and last week Ifo President Clemens Fuest told Bloomberg TV that the overall outlook for Germany was “rather bleak.”

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“I blame technological inertia,” says Martin Görnig, an economist at the German Institute for Economic Research. “We can no longer invest in old fossil fuel technology, and we don’t know yet what new technology to invest in. If we can overcome this, Germany will definitely be able to return to European leadership again.”

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

But none of this appears to be trickling down to consumers yet, with the closely watched Ifo business confidence index on Thursday showing a decline in services, which tend to track domestic consumption.

The repeated delays in Germany’s economic recovery are a bad sign for the embattled chancellor, who confirmed last week that he plans to run for a second term next year.

Earlier this month, the administration adopted a growth plan aimed at getting the country back on track. The package includes steps to boost private and public investment, accelerate the expansion of renewable energy, and provide additional tax breaks for businesses and incentives for people to work longer. The government will also expand tax breaks on electricity costs for manufacturers and accelerate efforts to cut bureaucracy.

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But voters are unlikely to feel the effects until a general election in September 2025. With the chancellor’s Social Democrats trailing in the polls, Germany’s economic malaise is likely to become part of his legacy.

The policy also fuels support for extremists in Germany’s less developed eastern states. Three eastern states will hold state elections in September, and the far-right Alternative for Germany and the far-left BSW are expected to make gains with their anti-immigration and pro-Russian platforms.

What does the Bloomberg Economics report say?

“The darker sentiment across sectors suggests that the German economy is struggling to gain momentum. Worryingly, business sentiment has not only declined in the industrial sector, where a turnaround seems increasingly distant. It has also declined in the services sector, albeit from a higher level. We still believe that growth could be slightly higher in the last two quarters of the year than in the first two. But the downside risks to our near-term forecast are increasing significantly.”

—Martin Adhemer, Economist. To read the full memo, click here

Beyond the adverse geopolitical climate, Germany is suffering from a shrinking workforce, bureaucracy and uncertainty about the political direction towards decarbonizing the economy.

Self-imposed restrictions on government borrowing due to the so-called debt brake mean there is little scope for public spending to address the country’s long-term economic problems.

“Investment in many areas has been very low,” says Sabrina Reh, equity fund manager at DWS. “Moving beyond that and investing more in infrastructure and digitalization could have a very supportive effect.”

—With assistance from Elizabeth Berman and Barbara Sladkowska.

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