Far from the path to prosperity

 In 2023 and 2024 significant declines were recorded in the manufacturing and construction industries. The construction sector is suffering from high financing and construction costs as well as weak investment activity overall. The high construction costs reflect the material and energy problems associated with the pandemic and the war in the Ukraine, as well as high regulatory costs. Several partly mutually reinforcing causes can be named for the manufacturing crisis:

Weak global economy: The geopolitical conflicts are having a negative impact on international investment activity. The high inflation rates resulting from the energy price shocks caused by the war have weakened consumption worldwide. This global slump is dampening foreign demand for German industrial goods and exports. In the major industrial sectors in Germany, foreign sales account for around two thirds of business.

Weak domestic demand: In addition to weak external demand, there is an investment crisis in Germany. The construction recession has led to a significant drop in demand for industrial intermediate goods and construction-specific capital goods. In addition, the rise in financing costs is dampening general investment activity and thus an important part of the German industrial spectrum.

Uncertainties: The geopolitical upheavals are not only having a direct impact on global investment activity. Rather, the political uncertainties are also creating a business environment characterized by economic imponderables. In addition, uncertainties in the context of climate policy and, above all, the unclear economic policy course in Germany are causing caution and restraint among companies and consumers. The end of the coalition government in Germany in November 2024 and the uncertain outcome of the planned election in early 2025 are contributing to economic policy uncertainty.

Loss of competitiveness: Last but not least, the competitive position of internationally oriented companies has deteriorated, which in turn is curbing demand for industrial goods via the foreign trade channel and the propensity to invest domestically. As a result of the multiple cost shocks caused by the sharp rise in energy prices, higher raw material prices and production costs due to global logistics problems and higher labor costs, German industry has lost price competitiveness. Added to this is the appreciation of the effective exchange rate of the Euro against a number of international competitors.

The services sector, which accounts for around 70% of total economic activity in Germany, has so far provided an economic counterbalance. Growth was recorded across the entire spectrum of the service economy - in business services, consumer-related services as well as in the public and social sectors. The positive income trend as a result of wage increases and normalizing inflation rates as well as expansive government activity are currently benefiting this part of the German economy. Nevertheless, this is at best sufficient to compensate for the declines in manufacturing and the construction industry.

The arguments cited for the current manufacturing crisis cannot only be used to understand the poor cyclical situation. They partly overlap with long-term structural shocks. From a structural point of view, geopolitical changes and adjustment burdens have been causing an economic reorientation. This relates to the medium to long-term significance of previously familiar sales markets, the reliability of international supply chains and logistics systems, the supply of raw materials and energy and, last but not least, the international transfer of knowledge. The restrictions experienced as a result of the pandemic are being exacerbated by new tensions and uncertainties due to the changing geopolitical climate. It remains to be seen what long-term adjustment burdens the new US administration will impose on the global economy and Germany. Added to this there are the direct adaptation burdens for companies due to climate change and the political transformation goals. The acute deterioration in competitiveness must also be seen in a long-term context. The quality of a business location is influenced by a variety of conditions - such as the availability of skilled workers, energy supply, the various infrastructures - and not least by the fundamental economic policy orientation.

In terms of depth the current situation resulting from the pandemic and geopolitical upheavals has already exceeded the level of all the previous crises in Germany, in some cases considerably. As far as the duration and final impact on the economy as a whole is concerned, it remains to be seen how long the current crisis will last and thus how far the gap will widen. In order to evaluate an economic crisis, the necessary pace of recovery can be calculated. At a macroeconomic level, a growth rate of 1.7 to 2.1 percent per year was required in the previous crises in order to overcome the “underwater” periods. In terms of the acute crisis a permanent annual economic growth of 2.5% for the next six years is necessary. This appears to be a challenge that is almost impossible to achieve. The growth potential of the German economy is likely to be severely curbed by demographic trends in the coming years. Added to this are the adjustment burdens resulting from the geopolitically driven restructurings and by the decarbonization of the economy. There are serious doubts that the German economy will not return to the path of prosperity experienced in the last three decades.