GERMANY: An Introduction

Europe’s biggest economy and a strong international player

Located centrally in Europe, Germany is the fourth-largest country in the European Union but has the biggest population (83 million) and is by far the largest economy in Europe. The language German is native to almost 100 million people worldwide, being most widely spoken not only in Germany, but also in Austria, Switzerland, Liechtenstein, and the Italian province of South Tyrol.

Germany’s economy is the largest manufacturing economy in Europe. The automotive and commercial vehicle, electrical engineering, mechanical engineering and chemical industries are considered the most competitive sectors of German industry worldwide.

Another characteristic of Germany is that most companies belong to the "Mittelstand", small and medium-sized enterprises, which are very often family-owned.

Also owing to its geographic position with nine neighbouring countries, more than any other country in Europe, Germany is the world's top location for trade fairs. Around two thirds of the world's leading trade fairs take place in Germany, or used to take place before the COVID-19 pandemic.

Effects of the coronavirus crisis and fundamental challenges for the German economy

The COVID-19 pandemic continues to show not only Germany’s strengths but also its weaknesses. In general, the economy has withstood the situation quite well due to its strong manufacturing and exporting base (growing by about 2.7% in 2021). For 2022, the German Council of Economic Experts expects Germany's gross domestic product (GDP) to grow by 3.1%. However, there are several fundamental challenges for the German society and economy:

The production-oriented and export-strong German economy is affected to a pronounced degree by the current tension in global supply chains and in particular also by the shortage of microchips. The corresponding bottlenecks are likely to hamper German economic growth for some time to come. Nevertheless, it is questionable whether this alone will be enough to shift more industrial value creation back to the domestic market.

Challenges by the fight against global climate change

Global climate change will become an even more important issue in Germany. Although Germany has a relatively small direct influence on the further development of climate change due to its manageable share of global greenhouse gas emissions, the newly elected Federal Government consisting of Social Democrats, Greens and Free Democrats (Liberals), considers ambitious progress by Germany in climate protection to be imperative. One effect of this policy, in connection with the effects of the shutdown of nuclear power plants, which has already taken place, is a drastic increase in energy prices in particular electricity prices. Bottlenecks in the electricity supply cannot be ruled out either, especially in connection with the globally tense supply situation for natural gas and the (existing and possibly still escalating) Ukraine-Russia conflict.

According to the announcements of the newly elected Federal Government there should be a time-limited priority for renewable energies until climate neutrality is achieved. Furthermore, the aim is that the phase-out of coal-fired power generation will be completed by 2030, and to enable renewable energy measures, all existing obstacles and hurdles are supposed to be dismantled, planning and approval procedures greatly accelerated and the necessary land made available. In reality, however, it may be prudent to expect a further increase in regulatory intervention by the state. It is already being discussed whether the climate change crisis not only justifies but also requires the same comprehensive state intervention as the coronavirus pandemic. Overall, further development is therefore likely to be subject to considerable planning uncertainty in this respect as well.

Inflationary tendencies 

The partly politically desired increase in the cost of CO2-intensive activities is likely to further intensify inflationary tendencies and possibly trigger social financial mitigation measures by the federal government. The expected consequence is further deficit spending, which will further narrow the scope for inflation-fighting measures. Against this background, it seems likely that German policy will continue to move away from a liberal, pro-business line towards more interventionist policies.

The exact consequences for the global and thus also the German economy are not yet foreseeable. The question already arises whether the increased inflation can be contained or whether it may even lead to an inflationary spiral, which can also put pressure on the economic situation of companies that are not in a position to pass on the corresponding price increases to the market.

Another price driver in Germany is the real estate sector with a shortage of housing (especially in the conurbations), which has led to strong increases in rents and property prices and is expected to continue. There is hardly any improvement in sight here, especially since construction costs are rising disproportionately due to demand, labour shortages, stricter building regulations and, in some cases, shortages of raw materials.

Digitalisation 

The new federal government has taken up the cause of increased and accelerated digitalisation. The pandemic has made the corresponding omissions in Germany painfully visible. This is now felt not only by in business circles, but also by large parts of the population. In this respect, improvements and impulses are certainly to be expected. However, it remains to be seen whether the ambition will slacken when the pandemic is over and how these challenges can be reconciled with data protection, which is traditionally very strong in Germany.

Another challenge that is closely related to digitalisation is the further development of the German education system. The developments in the COVID-19 pandemic have shown that the German education system, which is still characterised by state forms of provision and only very few private elements, has substantial deficits. The comparatively rigid structures, augmented by federal peculiarities, hardly meet modern demands for flexibility and quality. Here, too, it is to be expected (and necessary) that a digitalisation push will set in that will promote equal opportunities and educational standards.

All in all, 2022 will be a year that will begin to show the extent to which the new government, consisting of a 3-party coalition (a constellation that is new and unfamiliar to Germans), will effectively and pragmatically begin the necessary modernisation of Europe's biggest economy in a context of many external challenges or whether it will exhaust itself in formulaic compromises and symbolic measures.