Why some are calling the German economy ‘the sick man of Europe’ | CNN Business

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It’s been nearly two decades since Germany shrugged off its “sick man of Europe” label with a series of labor market reforms that ushered in years of economic outperformance.

Unfortunately for Berlin, the phrase is making a comeback.

Sticky inflation and three straight quarters of falling or stagnating output have put Europe’s biggest economy in the doldrums.

So much so the International Monetary Fund expects the country to be the only advanced economy to shrink this year — with a forecast contraction of 0.3% compared with an average rise of 0.9% for the 20 countries, including Germany, that use the euro currency.

A prolonged recession would be a disappointing outcome for an economy that, in the decade following the 2008-9 financial crisis, grew by an average of 2% a year, boasted a budget surplus for most of that period and saw its exports boom.

Germany suffers “from a bundle of individual problems,” rather than one major ailment, according to Stefan Kooths, research director at the Kiehl Institute for the World Economy.

Some of those are temporary, he said, such as a weak Chinese economy lowering demand for the country’s exports, while others, like a rapidly aging population and a high corporate tax rate, are structural.

The situation has prompted some observers to label Germany the “sick man of Europe” once again, 25 years after it earned that title during the late 1990s and early 2000s — a period that was marked by lackluster economic growth and high unemployment.

That label isn’t “totally wrong” this time around, Kooths said, “but it is a different sickness.”

So, what’s the diagnosis?

‘Pessimism’ at home and abroad

Inflation in Germany is running hotter than in most of its European neighbors. Consumer prices rose 6.2% in July compared with the same month in 2022, well above the 5.3% rate averaged across the euro area.

“Sticky” inflation is eroding Germans’ purchasing power, fueling “pessimism among households,” according to Thomas Obst, senior economist at the Cologne Institute for Economic Research.

Falling private and public spending were the main drivers of the recession — defined as two consecutive quarters of declining output — that the country logged last winter, Obst told CNN.

The European Central Bank has hiked its main interest rate to a historic high of 3.75% to help curb rising prices. But a higher cost of borrowing has hit Germany’s residential building sector hard: More than 40% of construction companies responding to a survey by the ifo Institute last month reported a lack of orders, up from 10.8% a year earlier.

“Higher interest rates and the drastic rise in construction costs are choking off new business,” said Klaus Wohlrabe, head of surveys at ifo.

The broader industrial sector, which includes Germany’s famed manufacturers such as Volkswagen and Siemens, has also taken a knock. Industrial output contracted 1.7% year-over-year in June, official estimates show.

German business activity, spanning both services and manufacturing, dropped in August at the fastest pace since May 2020, when the country only just began gradually lifting stringent pandemic restrictions, according to data from S&P Global released Wednesday.

“[German] industrial order books have emptied over the last 12 months,” Carsten Brzeski, global head of macroeconomic research at ING, told CNN.

“German exports to China are very sluggish, much [lower] than pre-pandemic,” he added.

China is Germany’s fourth-biggest export market but it is facing a cocktail of economic problems — including slowing growth and record youth unemployment — that have crimped demand for German goods.

China was Germany’s second-biggest export market as recently as in 2021. The shift is also the result of more fundamental changes in China’s economy, Brzeski said.

“China has become a competitor and simply doesn’t need as many German-produced goods as it did in the past.”

The pandemic, which snarled supply chains, and the war in Ukraine are to blame for much of Germany’s current predicament, argues Brzeski, but many of its problems run deeper, and are self-inflicted.

“Germany has simply not done any economic reforms over the last 10 years,” he said. “[It] has fallen behind [in] all international rankings when it comes to digitalization, infrastructure, international competitiveness, and now it is waking up to this reality.”

One problem — the cost of natural gas — has been particularly acute for its energy-guzzling manufacturers.

European gas prices soared to all-time highs last summer. Although they have fallen steeply in recent months, they are ticking up again as the possibility of strike action at liquefied natural gas (LNG) plants in Australia has raised fears of a global supply crunch.

“Energy price shocks resulting from the outbreak of war in Ukraine hit a highly industrialized country like Germany particularly hard,” said Obst at the Cologne Institute for Economic Research. “The danger of de-industrialization is not just an academic debate.”

Despite emerging from last year’s energy crisis better than many had expected, Germany is still vulnerable to supply shocks in natural gas, economists tell CNN. That’s partly because it has completely shut down its nuclear power production, giving it fewer energy alternatives compared with neighbors like France.

That “makes the problem of variability in the energy supply more biting than in other countries that are also decarbonizing,” said Kooths at the Kiehl Institute. “Germany is in a very singular position.”

Holger Schmieding, the economist who first called Germany the “sick man of Europe” in 1998, thinks the “current wave of pessimism” over its economy is overdone.

The country is in a much stronger position than back then, Schmieding, now chief economist at Berenberg, a bank, wrote in a research note last week. Today, he said, Germany enjoys record levels of employment and strong public finances that make “it much easier to adjust to [economic] shocks.”

The government is also taking the necessary steps toward reforming its immigration laws to help plug labor shortages, and speed up planning and approvals processes for infrastructure projects, he wrote.

Already, Germany has shown it can move quickly: Last year, it approved and built an LNG terminal in a matter of months to help it break its dependence on Russian energy.

That adaptability is what sets Germany apart from many other economies, argues Schmieding, and can be attributed to its large number of small and medium-sized businesses — its Mittelstand — which are able to react “nimbly to a shifting competitive landscape.”

“Germany is the undisputed global champion of ‘hidden champions’,” he said.