October 13, 2022 - 10:10am

The International Monetary Fund has recently updated its world economic outlook, predicting a global growth rate of only 2.7% (compared to 6% in 2021). One of the worst performers is the Eurozone, which is expected to grow by only half a percentage point — and even that prediction could turn out to be too optimistic.

The problem is particularly acute in Germany, where borrowing costs are beginning to rise and the markets are noticing. The backbone of German innovation and a major source of future growth are its small to medium sized businesses. Almost 40% of total corporate turnover is generated by these enterprises, and they account for 55% of value added in the German economy. They also train the future industry workforce, and are responsible for 1.3 million of the 1.5 million training places in German companies. Keen innovators, smaller companies are often investing twice as much in research and development as their larger competitors. Unfortunately, the current crisis is hitting precisely this sector of the economy hardest, driving up insolvencies among Germany’s so called ‘Mittelstand’.

The tragedy is that the government in Berlin is doing next to nothing to reassure investors. Current proposals are not addressing necessary steps to maintain the country’s industrial base, but instead consist almost entirely of throwing money at the problem. The government wants to spend up to €200bn (almost 5% of GDP) to “shield” enterprises from energy shortages, but it is becoming increasingly clear that no money in the world can increase the supply of energy if, simply, there is not enough. The most important step would be to ramp up domestic energy production, but neither the Social Democrats nor the Greens have any realistic plans in this regard, with the exception of more wind and solar farms, which will not save Germany’s industry.

The problems in Germany go much deeper. As this paper shows, Germany is losing its competitive edge across the spectrum; from education where outcomes are stagnating to entrepreneurship where the number of startups is declining. German universities, once the envy of the world and the role model for America’s Ivy Leagues, have fallen well behind.

So, who will be the future investors in an economy that is losing its entrepreneurs? The answer for many Germans seems to be the state, in the hope that every problem can be papered over by massive government spending, entirely ignoring that more spending with less production will lead to ever more inflation. 

But this is not the 1870s or 1930s, where, despite the economic depression, German companies founded in the 19th century maintained their innovative edge. The problem is that the current recession and its driver, a serious lack of energy, is part of a massive wave of deindustrialisation across the continent. That will be difficult to unwind, making this recession unique. Unless a significant course correction takes place, it will be the final one before a descent into a world of permanent European stagflation and economic decline.