Germany needs a new economic business model

During the onset of Russia’s full-scale invasion of Ukraine, Germany experienced its definitive boiling frog moment. Former chancellor Angela Merkel’s 16 years of incrementalism appeared to have successfully disguised the fragility of Germany’s economic calculus. Fuelling Germany’s energy-intensive industrial base with cheap Russian oil and gas simply does not add up anymore. Now that large industrial companies are leaving the country in droves, Berlin is scrambling to engineer a new economic miracle. So where will future economic growth come from?

Germany is a country in search of its national character. Revered by its European peers for its economic prowess, Germany takes a lot of pride in its engineering ingenuity and exporting superpower – but this can no longer be taken for granted.

Experiencing three consecutive quarters of negative GDP growth, Germany is predicted to be the world’s worst-performing major economy this year by the OECD and International Monetary Fund. Shrinking industrial order books, dwindling purchasing power and over-exposure to a weakened Chinese economy all drum up fears of Germany becoming the ‘sick man of Europe’ once again.

However, these concerns are dwarfed by structural headwinds. Germany’s demographic crunch is predicted to produce seven million missing workers by 2035, reducing its potential labour force in 2060 by 11.7%. Endangering intergenerational solidarity, this labour shortage places strain on its pay-as-you-go pension system, which is predicted to collapse by 2028. With one-third of its roads having major defects, Germany’s crumbling transport infrastructure requires €372bn ($403.7bn) by 2030 to be fully functional. Worse yet, the country’s suffocating bureaucracy has been accelerating a ten-year downward company creation trend and slowing its shift to digitalisation. Germany ranks below the EU average in digital public services, human capital and integration of digital technology.

Can Germany reinvent itself?

To rid itself of the kind of morally vacuous pragmatism that outsourced its economic growth to China, Germany must reinvent its economic business model to unlock growth, innovation and a green transition. No more self-satisfied economic hubris that rests on the success of its industrial past.

While calls for adjusting the constitutional debt-break rule to create more fiscal space for public investment may be viable in the short term, this would not sufficiently address the country’s structural deficiencies.

Instead, to counterbalance its creeping deindustrialisation and loss of automotive manufacturing edge, Germany must create a coherent plan to secure economic prosperity.

First, Germany must cement its place as the world’s green technology manufacturing hub. Producing more low-carbon technology (LCT) goods than any other G7 country as a share of GDP, Germany proves it can become a global player to power global decarbonisation efforts. Comprising electrolysers, wind turbines, heat pumps, batteries and electric vehicles, LCTs are already transforming Germany’s carbon-intensive economy. However, to avoid blowing its early technological lead like it did with the solar photovoltaic industry to China, Germany must act swiftly and decisively.

Here, aggressively reforming its subsidy system in conjunction with an expanding energy supply to lower electricity prices is a good start. This means introducing both uncapped subsidies for LCT production and time-limited research and development subsidies for nascent industries such as green hydrogen technologies. While there are concerns that this could distort competition in the EU Single Market, it is a risk worth taking. By containing the lure of heavily subsidised production locations such as the US and China, this represents a generational opportunity to de-risk strategic dependencies.

Second, Germany must become a leader in global technology talent recruitment. To meet its annual shortage of 400,000 skilled workers, Germany needs to become an attractive immigration country. A glacial immigration policy on the front end and weak economic incentives on the back-end make for a tough sell. On the front end, streamlining visa processes, recognising foreign professional qualifications, lowering salary thresholds and providing expedited pathways to residence permits are all sensible changes to attract skilled non-EU workers. While the updated Skilled Immigration Act addresses these points in varying degrees, it is more likely to transfer bureaucratic strain on its diplomatic missions.

On the back-end, Germany’s tax treatment of employee stock-ownership plans is structurally uncompetitive compared with the US, the UK and France. Ensuring individuals are financially incentivised is existentially important to attract and retain technology workers in strategic industries such as AI, deep tech and sustainable mobility. Accordingly, substantive reforms that liberalise employee options law, such as the forthcoming Future Financing Act are urgently needed. Transforming into an employee ownership-based economy can significantly boost the country’s long-term competitiveness.

Third, Germany must make dismantling bureaucracy a national priority. Originating from a legalistic administrative culture, the country’s virulent bureaucracy loves risk-averse formalistic processes and a lack of individual empowerment. This managerial bureaucracy is felt everywhere, whether it is the arcane procurement processes of the armed forces, onerous building permits in the construction industry or stultifying verification processes to secure social welfare benefits. All are impediments to building a nimble and efficient digital state that serves its people. The National Regulatory Control Council observes that the compliance costs for statutory requirements grew by 160% between 2021 and 2022 to €17.4bn.

A regulatory rethink

To slim its bloated administrative state, Germany needs to introduce a regulatory moratorium on new federal regulations and expand its ‘one in, one out’ principle to a strictly enforced ‘one in, two out’ rule. Implementing this moratorium will drastically ease the burden on Germany’s economic engine, the Mittelstand. The downstream impact of the ‘one in, two out’ rule, which aims to eliminate two bureaucratic burdens for every new one, will help scrutinise punitive legislation for businesses by lowering compliance costs.

The moral imperative for this pro-technology agenda is indisputably urgent. Against the backdrop of a factious three-way coalition in Berlin marked by constant bickering, the right-wing extremist AFD party is polling nationally at a record 20%.

More than ever, Germany needs principle-based leadership that pivots from peacetime virtue signalling to wartime Hobbesian realism. It needs bold leadership that privileges unity through economic prosperity over political point-scoring and fearmongering. With a new federal election cycle looming, there is no time to lose.