How Germany became the new sick man of Europe

(Image credit: Future)

What’s going on in Germany?

The nation has a newish leader, elected on a wave of muted enthusiasm – or at least a sense that he couldn’t be as bad as the last lot – but who has quickly proved a disappointment in office. His government is looking weaker by the day, and he seems unable to tackle the deep-seated economic problems the country is facing. So yes, that’s Keir Starmer, of the British centre-left. It’s also Friedrich Merz, of the German centre-right. After just six months in power, Merz’s coalition is beset by infighting, policy deadlock and sliding poll ratings. His CDU/CSU bloc (the coalition’s biggest party) hasn’t slumped as dramatically as Labour. But its support has fallen to 25%, a historic low for the nation’s dominant party of government, and it’s now polling behind the far-right AfD. Six months in, fewer than one in five Germans wish to see Merz stand again next time. “There has never been such widespread dissatisfaction with a government in such a short period of time,” says Forsa pollster Manfred Gullner.

Why all the gloom?

Largely, it’s a growing realisation that the government will not be strong enough to tackle Germany’s fundamental economic and fiscal problems. Growth in GDP has been all but flat for three years and there was initial optimism that the Merz government might give it the kick-start it needs. In the spring, Merz (as chancellor-elect) used the outgoing Bundestag to negotiate and push through a historic package of fiscal reforms that partially untethered Germany from its self-imposed constitutional “debt brake”. The brake limits public borrowing to 0.35% of GDP in any given year, but it has now been lifted for infrastructure and defence spending (but not other areas). His government embraced a kind of Keynesianism, creating a €500 billion infrastructure and climate fund, and announced much higher defence spending. There were hopes that this bold stroke might stimulate growth and presage further reform. There are, however, big problems.

What problems is Friedrich Merz's government facing?

Political weakness. It looks increasingly likely that Merz, who turned 70 this month, may well have pushed through his most consequential reform before he even became chancellor. In that outgoing Bundestag, Germany’s centrist parties still had the two-thirds majority needed to amend the constitution. By contrast, Merz’s coalition has a very slim majority, making similarly radical constitutional change highly unlikely. Meanwhile, that coalition is already publicly fracturing on traditional left-right lines. For example, Merz (a fiscal hawk by instinct, despite his debt brake) warns that the country has been “living beyond its means” for years, and the finance ministry has warned of a €172 billion hole in its spending plans for the rest of the decade. Merz is trying to lay the ground for major reforms to pensions and the wider welfare state, which account for 31% of GDP, one of the highest levels in Europe. But Barbel Bas, his SPD (social democrat) labour and social affairs minister, publicly dismissed the chancellor’s recent big speech on the subject as “bullsh*t”. It doesn’t augur well.

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What are the other problems?

There are big question marks over whether the spending reforms already passed will drive robust growth. Defence spending is unlikely to do much in the long-term. Infrastructure spending has a greater multiplier effect, but the €500 billion package is not as big as it sounds: it’s spread out over 12 years, and the German press reports that some of the funding earmarked for infrastructure is in fact being diverted to cover day-to-day spending. There is scepticism about the state’s capacity to deploy money swiftly or direct it towards productivity-enhancing projects. Merz’s “autumn of reforms” has also disappointed, consisting of tinkering around the edges of welfare benefits.

What’s the bigger picture for the German economy?

That the economy has been stagnant for the whole of this decade. The country has been battered by geopolitical headwinds: Russia’s war in Ukraine and the energy-price spike, aggressive Chinese competition in traditional German manufacturing sectors – including cars, where China dominates in electric vehicles – and Donald Trump’s trade wars. All these have helped undermine the export-led model that underpinned Germany’s prosperity; manufacturing still accounts for one-fifth of the country’s gross value added. Industrial production is no higher than it was in 2005 and “many of Germany’s economic core strengths have turned into vulnerabilities”, says Marcus Berret of Munich-based consultants Roland Berger. Those include a “large industrial base that is hard to decarbonise, a high dependence on exports at a time when globalisation is under threat, and a mighty vehicle industry having to write off 140 years of internal combustion-engine expertise”. Meanwhile, Germany’s technology and digital sectors remain underwhelming. But the government, like its predecessors, shows few signs of dealing with these issues.

Could Friedrich Merz get a grip?

After shrinking for the past two years, most analysts expect growth to be a miserly 0.2% this year. Stronger growth is forecast in 2026, but projections have become more pessimistic. Last week, Merz’s own team of advisers downgraded their forecast for 2026 growth to below 1%. Businesses’ confidence has slumped and unemployment is rising (to almost three million, its highest rate in 14 years). A couple of years ago, The Economist ruffled feathers in Berlin by dubbing Germany the new “sick man of Europe”, arguing that for years Germany’s outperformance in old industries papered over its lack of investment in new ones. An obsession with fiscal prudence led to too little public investment and investment in digital technologies as a share of GDP is woefully low; less than half that in the US or France. Germany’s reliance on imported energy (70% of the total) and its ageing population make it ill-equipped for the future. Is Merz the man to turn all this round? On the evidence of his first six months, it seems very unlikely.

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Simon Wilson’s first career was in book publishing, as an economics editor at Routledge, and as a publisher of non-fiction at Random House, specialising in popular business and management books. While there, he published Customers.com, a bestselling classic of the early days of e-commerce, and The Money or Your Life: Reuniting Work and Joy, an inspirational book that helped inspire its publisher towards a post-corporate, portfolio life.

Since 2001, he has been a writer for MoneyWeek, a financial copywriter, and a long-time contributing editor at The Week. Simon also works as an actor and corporate trainer; current and past clients include investment banks, the Bank of England, the UK government, several Magic Circle law firms and all of the Big Four accountancy firms. He has a degree in languages (German and Spanish) and social and political sciences from the University of Cambridge.