Germany: German economy contracts for second consecutive year amid manufacturing sector’s
The manufacturing sector faces an existential crisis
In 2024, the German economy registered a contraction for the second year in a row, with almost no real GDP growth since the Covid-19 pandemic (see graph below). This marks five years of economic stagnation for the country, the longest phase since the Second World War – and many looming threats are not making the outlook rosier for this year.
The crisis of the manufacturing sector, which represented about 19% of GDP in 2023 (to be compared with 10% in the USA), explains much of the slump. Total exports of goods, driving the industry, have declined over the last two years, reflecting the sharp decline in exports to China (see graph below), while exports to the USA, by far Germany’s main export destination, have stabilised. This trend is very clear for the automotive and machinery sectors. In this context, possible import tariffs on European imports imposed by the new Trump administration would represent a significant threat for the German economy.
Factors related to both the Chinese and German economies underpin the ongoing decline in exports to China. Indeed, the Chinese manufacturing sector is benefitting from a long-term industrial policy to develop national champions supported by subsidies and protectionist measures – stimulating competitiveness in various sectors, such as cars, specialty chemicals, machine tools, and progressively in many other more clean technology sectors as well. As a result, China now competes on the same products range as Germany, but with no need for producers to be profitable, contrarily to western manufacturers, for whom return feeds investment. But, this also reflects internal imbalances in China, as increasing production capacities cannot be absorbed by structurally low household consumption levels, which are still dragged down by the impact of the property sector crisis of the last two years. Mounting production surpluses from China are consequently exported, causing the market shares of German producers to decrease in third countries.
On the other end, the German industry sector is plagued by an increasing competitiveness gap, due to higher energy prices (see graph below), and a growing technological and productivity gap between Europe, the United States and China.
Sector-specific issues add to the challenges
While all energy-intensive industries are suffering from competitiveness issues, other sectors are facing great challenges as well. In addition to competitiveness issues vis-à-vis China, the abrupt termination of subsidies for electric vehicles implemented by the Scholz government in late 2023, to address budgetary constraints, adversely impacted electric vehicles sales at a time where the industry had just converted numerous domestic factories into battery-car production and had to adapt to more stringent environmental regulations.
The construction sector is another sector that faces many difficulties. Bankruptcies increased by 17% last year with respect to the previous year. Interest rates that remain high, slump in orders, higher costs and significant burdens from taxes and bureaucracy have all taken their toll. The residential sector was particularly hit. The outlook for 2025 is not better, as the confidence in the sector remains low (see graph below).
Another struggling sector is the livestock farming industry, which faces today significant export restrictions on meat due to an outbreak of foot-and-mouth disease (FMD) that led to containment measures. This is the first outbreak in nearly forty years. As Germany has lost its FMD-free status, veterinary certificates, required for exports to non-EU countries, cannot be issued and the exports of meat, dairy products, hides and other animal-based goods are now difficult.
On the other hand, Germany is still standing firm in the aviation sector, even though China also has the ambition to expand the production of its own narrow-body aircraft, what would impact German sales.
Germany’s “debt brake” constraints investments
Political uncertainty in the lead to and following the collapse of the government last November, amid persistent rifts on spending and economic reforms, was another factor weighing on investor confidence and leading to a decline in foreign investments. The formation of a government could take some time after the federal elections of 23 February. However, Germany’s likely next chancellor, Friedrich Merz, from the conservative CDU party, aims to concentrate on restoring the industrial competitiveness, should it place climate policies on hold. Underinvestment also resulted from the country’s “debt brake”, a constitutional provision introduced under former chancellor Angela Merkel in 2009, preventing regional governments from taking on any new debt and the federal state from borrowing more than 0.35% of GDP per year – bringing about the ageing of the infrastructures, notably in the railway and road networks. Depending on the result of the elections, a reform of the debt brake rule, which would necessitate a two-thirds majority in parliament, could be undertaken to allow some fiscal easing, especially as public debt progressively declined to reach 62% of GDP in 2024, the lowest ratio among large Eurozone economies.
Analyst: Florence Thiéry – f.thiery@credendo.com
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