Germany’s economy like that of Britain is currently facing stagnation, with growth expected to be minimal in 2025 due to high labour costs, trade tensions, and a reliance on exports.
Structural challenges in Germany, including an aging population and weak productivity, further complicate the recovery process. The country is going through a difficult phase right now. Real GDP growth is projected to accelerate to around 1% in 2026 and 1.5% in 2027. With growth being led by domestic demand, Germany’s current account balance is expected to decline gradually over time but remain positive. Inflation is expected to stay near the ECB’s target of 2%.
Headwinds include rapid population aging, as the working-age population is projected to decline more sharply than in any other G7 economy over the next five years. Productivity growth is also likely to remain modest, absent further reforms both domestically and at the EU level to improve economic efficiency and foster innovation. Germany has fiscal space for such easing, given its relatively low debt level. Debt is projected to rise to around 68% of GDP by 2027, still the lowest among G7 economies. However, due to a fiscal rule embedded in its constitution, there is a limit on how much debt Germany can accumulate. This is known as the “debt brake” (Schuldenbremse), and this limits the debt to 0.35% of GDP.
While this rule is designed to ensure fiscal responsibility, borrowing less means the government has less money to invest in public goods and essential infrastructure. This can in turn lead to slower economic growth. Any further refinement of the debt brake should preserve sustainable public finances by eventually bringing all government spending within its constraints while safeguarding sufficiently high levels of public investment and flexibility to respond to shocks in a countercyclical manner.
One is surprised to observe that among the seven G7 nations, it was the only economy to shrink in 2023. For the first time in 30 years, major German car maker Volkswagen is thinking of factory closures and layoffs. Experts tell us this may just be the tip of the iceberg. Germany has one of the highest corporate tax rates compared to other Western countries like France, the USA, or the UK.
This makes it less attractive for businesses to expand or invest in Germany. Along with high taxes, another challenge is the complicated bureaucracy. In Germany, the paperwork can be so overwhelming that you might need to fill out a form just to apply for another form. For example, it takes about eight days to start a business in Germany, while it only takes four days in countries like France, the USA, or the UK. These could discourage entrepreneurs and investors and make it harder for businesses to operate in Germany.
The energy-price shock in mid-2022 and rapid monetary tightening that was required to contain inflation combined to deliver two years of negative growth during 2023-24. The economy began to recover in late 2024 as these shocks started to dissipate, but the pace of recovery has been constrained by new trade-related headwinds, resulting in real GDP rising by a projected 0.2% in 2025.
Weak growth in recent years also reflects lacklustre underlying productivity growth, in part due to long-stalled structural reforms, and increasing competition in export markets. A smart move will be to stabilize the labour force. Here, the authorities should make it easier for women and parents to work full-time, including by continuing and deepening efforts to expand access to reliable child and eldercare.
Moving away from the current joint taxation system while providing additional child allowances could further improve work incentives by reducing high marginal tax rates on second earners, who tend to be relatively responsive to tax incentives. For lower-income earners, the current tax and transfer system is complex and creates disincentives for increasing hours worked due to high effective marginal tax rates (sometimes more than 100%), arising from benefit withdrawal rates. Merging multiple benefits and creating more uniform withdrawal rates could increase labour supply while delivering fiscal savings. Ongoing efforts to facilitate the labour market includes the faster integration of immigrants.
Germany was once a world leader in exports, innovation, and patents. A true economic fairy tale. So, what happened? In 2023, Germany’s GDP shrank by 0.3%. It is expected to drop by another 0.2% last year. But why does this matter? Why do we need GDP to always grow? Because everyone wants a better standard of living. Even though Germany has a very low birth rate, its population like that of Malta, is still growing slightly due to immigration. If the economy doesn’t grow along with the population, as can be expected, the standard of living will decline. Obviously, higher GDP means more jobs, higher wages, and improved living standards for everyone. It is natural to ask why industrial production in Germany has been on the decline. This started in 2018, caused by two major reasons causing this trend. One key factor is the end of rapid economic growth in emerging countries, especially in China.
China was once a significant market for German goods. But the country is now capable of producing many of these products themselves. This has reduced global demand for German exports, especially in the automotive sector. This article cannot omit to discuss the car industry. It faces another significant challenge: the shift to electro mobility. German manufacturers like VW, BMW and Daimler have been slow to adapt to the growing demand for electric vehicles. One is aware that unlike traditional combustion engines, electric vehicles are less complicated to build and require fewer parts, so competitors like China sell better electric cars and cheaper. As can be explained in turn, this has led to a reduced demand for German expertise and components.
Another hindrance is energy. For many years, Germany relied heavily on importing energy at very low prices, especially from Russia. This cheap energy was an important factor behind the country’s strong economic performance. However, with the start of the war in Ukraine, this dynamic changed and Putin turned off the taps for Europe. Naturally, the prices shot up. Even though energy prices have reduced somewhat from the extreme highs, they are still significantly higher than they were before the Russian war. An exciting alternative is the production of green hydrogen.
In Brandenburg, the coal-dominated energy region of Lausitz is to become a hydrogen region. There are plans for a further 1,000 wind turbines to drive forward the production of green hydrogen. Hydrogen technology also seems very promising in terms of Co2-free inland navigation. Since 2015, the Berlin-based company H2Mobility has been building a Germany-wide filling station network for hydrogen particular of interest for bus operators and haulage companies. Most notably, more and states are building and installing hydrogen-ready pipelines to be connected to the nationwide supply household network. One augurs that the hydrogen revolution will ease the pains of Germany’s acute stagnation.
