Europe’s Sick Man is Coughing Again

Sick Again

The term “Sick man of Europe” has been passed around like an award for over 100 years. One of its earliest recipients was the Ottoman empire, which during its final days was plagued by military, governmental, and economic problems. The term was applied to the UK after 1960, when decolonisation ended its imperial reign and deindustrialization and inflation ravaged the home islands. In the 90s it was awarded to Germany, as reunification turned out to be much more costly than expected. Although the country initially showed strong signs of growth, it slipped into a recession in 1993, and economic turmoil continued for the rest of the millennium although GDP growth picked up again. It found revival under the new policies of the Schröder and Merkel governments in the beginning of the 2000s and by the 2010s, Germany returned to the economic forefront of Europe, shaping the image of the fiscally prudent, export giant we know today.

However, just 3 years after the end of Angela Merkel’s reign, Germany has once again been dubbed as the “Sick Man”. On September 30, a Bloomberg article bluntly stated, “Germany has given up hope of achieving any growth at all in 2024”, highlighting growing pessimism around the German economy. With rising political disillusionment and the far-right Alternative für Deutschland gaining traction all over the country, the German economic miracle is unravelling.

The Economic Reforms of the 2000s

So where did things go wrong? According to Adam Tooze, historian and Director of the European Institute at Columbia University, the reason lies in the current German economic model conceived in the early 2000s under the Schröder and Merkel governments having reached its twilight.

The policies introduced by these governments were austerity measures aimed at revitalizing the economy after reunification. This included Welfare state reforms such as the Hartz IV unemployment benefit reform which led to stagnating wages and increasing inequality. At the same time, the obsession with balancing the budget slashed public investments. When both government and population tighten their belt, demand for goods within an economy falls. This freed up goods for export, which became highly price-competitive due to wage stagnation, a depreciating Euro, and cheap energy from Russian gas. This model initially revived the economy, conserved a strong government balance sheet, and significantly reduced unemployment—albeit through low-paying jobs.

How the Model Is Now failing

Although Germans take pride in their exports, trade surpluses (or deficits) are not inherently beneficial. For Germany, they affected the economy positively before exposing a big weakness in 2020. Export surpluses rely on the willingness of countries to absorb German goods as every trade surplus needs its corresponding deficit in another country. After the Covid shutdown, international trade and supply chain disruptions persisted, even after reopening. Meanwhile, Germany struggled more than economies with strong domestic demand, such as the US. Concurrently, China, fuelled by Beijing’s active industrial policy, slowly began replacing German imports with its own products domestically and started taking over Germany’s market share in international markets.

The second weakness of the model is its insistence on maintaining a balanced budget. It has served Germany well but has led to a severe lack of public investments. In the middle of September 2024, the Carola bridge in Dresden collapsed, severing one of the city’s main transit routes. Such an event is not particularly surprising, as there are around 15’000 bridges in need of renovation in Germany. And such problems extend to everything from housing or the military to the electric grid.

In short, Germany’s growth was not primarily driven by productivity increases or investments. Instead, it relied on getting more people to work for low wages, low energy costs and foreign demand for goods. All are ways of growth which are now either exhausted or falling away, leaving Germany stranded in economic limbo.

The Political Consequences

This model has been the source of amazing growth in the past, and helped Germany recover from its post reunification struggles. However, there are some major drawbacks as the figure below shows. Income inequality correlates strongly with the current account, a measure of Germany’s export surplus showing the effects of the new economic model. A study done by the Center for Economic Policy Reform further shows that wealth inequality has risen over the same period. The study argues that this is primarily because the bottom 50% of the population are falling behind due to them not holding assets and therefore not profiting from increased asset prices. The large inequalities lead to a share of the population feeling left behind and dissatisfied as stagnating wages and low public investments mean that there is almost no improvement in their living standards.

As Adam Tooze notes, austerity combined with immigration is a recipe for xenophobia. The AfD channels the general discontent by blaming immigrants and subsequently presenting itself as the solution by being the strictest party on the issue. He furthermore argues that the most worrying fact should not be the approximately 15% of the German electorate that can be considered far right, but the other 15% which are worried about immigration and are being driven into the hands of the far right due to the anger stoked by the AfD.

Cure for the Itch

A solution to these problems would be a large public and private investment initiative, but Germany handcuffed itself with the debt brake, making it impossible to run fiscal deficits to undertake large public investments. As the IMF notes, the debt brake has served Germany well, but reform and moderate easing should take place to address urgent issues. Germany has plenty of fiscal capacity and additional spending, especially on infrastructure, would not affect debt sustainability as investments have vast positive effects on the economy. Without such a reform, Germany would have to look towards other revenues such as increased taxes or budget cuts somewhere else, which are not popular with a population that has seen its quality of life stagnating or even deteriorating.

What could help politically is good left-wing opposition. However, the only left-wing opposition consists of Die Linke, which remains stuck in the past as parts of its roots are found in the SED, the former ruling party of eastern Germany. In January 2024, the party Bündnis Sahra Wagenknecht, split off from Die Linke forming around Sahra Wagenknecht who was up to that point the main face of Die Linke. The party is characterized by a blend of far left and far right policies. Meanwhile, the Greens and SPD—key players in the current traffic light coalition and the only big left of center parties, were the architects of the Schröder-era reforms and have shown time and time again that when push comes to shove, they will cave to the right.

Historically, Germany has adapted to economic challenges, and it once again needs to adjust its course. However, this requires a revaluation of the economic mantra established some 20 years ago. A shift that, so far, lacks the necessary political will.

Jonas Bruno