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Germany’s economic model has run out of road

With rising raw material costs and a shrinking export market, Germany needs to break with its post-reunification status quo – or its workers will pay the price.

By James Meadway

Germany has moved into its first monthly trade deficit since reunification in 1991. Its export sales are being overwhelmed by sharp rises in the costs of imports – particularly oil and gas, following the invasion of Ukraine. With forecasts for further increases in domestic inflation, and a worsening of the deficit over the summer months, the German chancellor Olaf Scholz has warned of an extended crisis – one that “won’t pass in a few months”. He is right, but if anything that understates the severity of the economic challenge. Germany’s model of economic growth, pursued with some success for three decades, has now run out of road.

Germany’s growth model rested on three legs: cheap imports of energy and raw materials; suppression of manufacturing wages at home; high exports to the rest of the world. From reunification onwards, successive governments, irrespective of their political colours, have pursued the same objective: turning Germany into the world’s largest manufacturing exporter by value.

Two of those three legs have been kicked away. Cheap energy imports, already under pressure in 2021 as fuel prices began rising, juddered to a halt with Russia’s invasion of Ukraine and the sanctions imposed in response. Under Angela Merkel, Germany had grown to depend increasingly on Russia for its energy, with about half of its gas supplies, and a third of its oil, coming from Russia by early 2020. With the prices of both historically depressed, in real terms, during the 2010s, and supplies from Russia seemingly guaranteed, this gave every appearance of being a smart deal. Political difficulties, although worsening with growing Russian assertiveness, notably after the 2014 annexation of Crimea, could largely be smoothed over.

Those days are over, as Scholz and his Grüne (Green) coalition partners have been keen to stress. But even in the unlikely event that the Ukraine conflict is resolved soon, bringing gas and oil prices in Europe down, the “new normal” is likely to be significantly more expensive in the future – with higher prices for food, of which Germany is a huge importer, and for the growing range of hard-to-supply rare Earth minerals required for electric car production. Germany’s semiconductor industry cannot on its own meet domestic demand, and Europe’s share of worldwide semiconductor production has declined from 44 per cent in 1990 to around 10 per cent today. Global semiconductor shortages have, as a result, hit Germany’s automotive manufacturers severely over the past 18 months. Its government (like those of other EU members) is now scrambling to ramp up domestic investment in semiconductor manufacturing.

[See also: US diplomat Marie Yovanovitch: “The Trump years did great damage”]

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The second disturbance to Germany’s growth model is more subtle than that arising from war and invasion but equally important. Germany’s export success, especially following the 2008 financial crisis, has been based on selling high-value-added products, such as complex machine tools or high-end automobiles, to fast-growing markets in east Asia. By 2020, China was second only to the US as a market for Germany, having grown rapidly over the previous decade to account for 8 per cent of all German exports. Those exports sustained both a famously vast car manufacturing industry, but also Germany’s Mittelstand (the mid-size companies that power the German economy) of smaller manufacturing exports, concentrated in particular on the export of capital goods – machines to make other products with. China’s seemingly insatiable demand for machinery and equipment, as the economy powered through the 2008-09 recession and beyond, sustained growing German exports. Rising household prosperity in China also meant an expanding domestic consumer goods market, with China’s car market already the largest in the world by 2009, and German automobiles particularly favoured by its expanding and newly affluent middle class.

But even before Covid-19 hit, these export sales were under pressure. The Chinese government’s targeted investment in machine tools and other capital equipment, a core part of its “Made in China 2025” strategy, published in 2015, exposed German exporters to direct competition in their biggest overseas market. While Chinese manufacturing wages have risen strongly in recent years, they remain well below Germany’s and, with Chinese companies backed by heavy investment, subsidies and direct government support in the form of industrial policy, exporters have struggled against cheaper competitors selling increasingly sophisticated, comparable products. Germany’s solar industry, for example, was dramatically wiped out by Chinese competition a few years ago. Meanwhile, lockdowns in 2020 and beyond have also hammered demand for German products.

The only leg of the strategy still standing is the suppression of German wages and salaries. This has been a striking success for German capital since reunification. By investing in new factories in Slovakia, Poland and elsewhere from the early 1990s, German firms integrated the relatively low-wage economies of eastern Europe into their supply chains, directly reducing their costs but also applying downward pressure on wages in Germany.

By the early 2000s, this attack on workers’ living standards had been taken up by Gerhard Schröder’s government. The “Agenda 2010” programme was a series of major welfare reforms creating what amounted to a two-tier workforce inside Germany: a relatively protected (but shrinking) older section, able to enjoy the benefits and support of Germany’s justly famous social model, was set against a growing contingent of workers, typically younger, less educated and often immigrants, systematically excluded and pushed into low-paid, part-time and insecure work. Average real wages in Germany barely grew from the 1990s to the 2008 financial crisis, and even fell somewhat between 2004 and 2008. Inequality has risen sharply.

Since the crash, real wages in Germany have risen, but the eurozone crisis created the opportunity to maintain the same cost-cutting pressure on living standards. The economic institutions of the EU were essential for this. The trade and government deficits of southern European euro members such as Spain and Greece created a market inside the eurozone for German products while, outside the eurozone, the presence of these weaker economies in the single currency meant the euro was permanently devalued – making German exports, sold in euros after 1999, cheaper and so more competitive internationally.

German workers’ share of national income has declined as profits have risen. But so, too, has investment spending by German firms, down from over 25 per cent of GDP in the 1980s to around 20 per cent in the 2010s. This was an economy living on borrowed time: exploiting its international position rather than investing for the future. With two legs of the German growth model removed, the Scholz government is likely to lean heavily on its sole remaining prop – the suppression of wages and salaries. Real wages have fallen for the last two years, and German bosses are warning of worse to come. The alternative would be to abandon the export model and reflate the domestic economy – pushing up real wages as a primary objective, squeezing profits in the export-oriented sectors as needed, and driving up public investment to create jobs. But neither the current government nor its opposition appears willing to break with the post-reunification economic legacy. It will be German workers that are forced to pay the price.

[See also: Can Ukraine win the war?]

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