Why has the German economy gone from Europe's engine to its anchor?

Business Mayor

18-05-2025

The short explanation for Germany's current economic malaise is that it outsourced its security requirements to the US, its exports to China and its energy security to Russia, and now finds itself at the centre of a perfect storm.
That's perhaps an oversimplification. In his book Kaput: The End of the German Miracle, Wolfgang Munchau claims the country's recent reversal has been brewing for decades and stems from several faulty assumptions about the global economy, corporate complacency and a chronic underinvestment in digital.
In Munchau's view, crisis-stricken Volkswagen – which is laying off staff to cut costs having lost its way in the switch to electric motoring and whose corporate image remains tarnished by the 2015 dieselgate scandal – is emblematic.
But the security, exports, energy explanation for Germany's stuttering economic performance (the economy hasn't grown in nearly three years) remains a reasonable starting point.
Germany was uniquely exposed to the higher cost of gas on global markets triggered by Russia's invasion of Ukraine in 2022 because of its overreliance on Russian energy.
[ Kaput. The End of the German Miracle: Acerbic chronicle of a country's fall from grace ]
This stems back to former German chancellor Gerhard Schröder, who drove the Nord Stream 2 pipeline project, effectively deepening Germany's dependence on Russian gas.
After exiting office, he controversially became chairman of Russian state-owned energy giant Rosneft. The New York Times recently ran an article about Schröder under the headline, 'The former chancellor who became Putin's man in Germany'.
His successor Angela Merkel, in response to the Fukushima nuclear accident in Japan, further cemented Germany's reliance on Russian energy by phasing out the country's nuclear energy industry. The last nuclear power plants went offline in 2023.
Both Schröder and Merkel, like many others in the West, made what now looks like a colossal error of judgment in believing greater trading ties would move Moscow in a more liberal direction.
The high cost of energy (combined with the lack of an alternative) has crippled Germany's energy-intensive manufacturing base, pushing the country into a recession from which it has yet to emerge.
At an earlier point in the globalisation process, Germany also bet the country's export future on China. Initially this paid off. Order books were filled twice over as German industry supplied cars, machine tools and engineering expertise to the fast-growing Chinese economy. Strong export demand from China cushioned the German economy during the financial crisis when the rest of Europe stagnated.
But now German car manufacturers find themselves outstripped by Chinese competitors such as BYD, while German companies complain about Chinese market access restrictions and policies that favour home-grown firms.
Germany is the main reason why the EU runs a large trade surplus (in goods) with the US (the source of so much ire in Washington) but conversely it has a large trade deficit (€59 billion in 2023) with China and now finds itself caught in the middle of a tense geopolitical standoff between the US and China.
The third leg of this increasingly faulty economic stool comes courtesy of the current White House incumbent and his attempt to rewire the postwar global order. Donald Trump's cosying up to Moscow, his laying the blame for Russia's invasion of Ukraine on Kyiv itself and his condemnation of federalist institutions like the EU (he claims the bloc was set up to screw the US) have challenged the liberal orthodoxy and the assumption that Washington will underwrite Europe's security. Read More Chilly's seeks younger audience in first VCCP campaign
Even if a future US administration rows back on this, the fact that a US president of any hue could arrive at this point has sent shock waves through European capitals.
Newly installed German chancellor Friedrich Merz said last week his government's top priority was to transform the nation's armed forces into Europe's strongest conventional army to help counter the rising threat from Russia.
[ Merz vows to build the strongest army in Europe and revitalise Germany's fortunes ]
'Our friends and partners also expect this from us, indeed, they practically demand it,' he said in his inaugural address to parliament in Berlin.
Merz pledged that his government 'will provide all the financial resources the Bundeswehr [Germany's armed forces] needs,' which he said was 'appropriate for Europe's most populous and economically strongest country.'
Even before taking office, he moved to ensure that Germany can reverse years of underinvestment, passing legislation to remove the so-called debt brake, allowing for additional defence spending and a €500 billion infrastructure package, powering through Germany's long-standing cultural aversion to deficit spending.
He vowed to revamp Germany's struggling economy by reforming the country's outmoded bureaucracy while incentivising investment and entrepreneurship.
Like Ireland, trade is a key element of the German economy and the current uncertainty surrounding Trump's on-off tariff policies weighs heavily on the outlook.
The flagging German economy also appears to be driving a historic shift in the political landscape. Last year the Alternative for Germany party became the first far-right party to win a state election in the country since 1949. The party went on to double its vote share in this year's general election.
Whether Germany's current downturn is indicative of a long-term trend is now a central question. Münchau believes it is. 'The German supercycle is ending; that of the US is still going strong,' he says.