Germany's Economy, Once a Global Model, Faces Challenges Amid an Energy Crisis That Reveals Persistent Weaknesses

19 Sep, 2023

Germany's Economy, Once a Global Model, Faces Challenges Amid an Energy Crisis That Reveals Persistent Weaknesses

For much of the 21st century, Germany had been riding a wave of economic successes, dominating global markets with its high-quality luxury cars and industrial machinery. Its export prowess had fueled half of its economy, making jobs plentiful, while its government's finances remained stable as many European countries struggled with debt. Books were even penned about the lessons other nations could glean from the German economic model. However, those days of triumph have now given way to a stark reality. Germany currently finds itself as the worst-performing major developed economy in the world, with both the International Monetary Fund (IMF) and the European Union forecasting economic contraction for the year.

The root cause of this downturn can be traced back to Russia's invasion of Ukraine and the subsequent loss of Moscow's affordable natural gas supply. This energy shock has hit Germany's energy-intensive industries particularly hard, putting a strain on its historical status as Europe's manufacturing powerhouse. This sudden slump in Europe's largest economy has triggered a flurry of criticism, introspection, and debate regarding the path forward.

The risk of "deindustrialization" looms large, as soaring energy costs and government inaction on persistent issues threaten to drive new factories and high-paying jobs elsewhere, warns Christian Kullmann, CEO of major German chemical company Evonik Industries AG. From his 21st-floor office in Essen, Germany, Kullmann points to the remnants of the region's industrial legacy, emphasizing how it has now transformed into a symbol of the energy transition, marked by wind turbines and green spaces.

The loss of cheap Russian natural gas, a necessity for keeping industries operational, has severely disrupted Germany's economic model. To mitigate the crisis, the German government requested that Evonik keep its coal-fired power plant running a bit longer, albeit with a transition plan towards carbon neutrality by 2030.

One contentious solution proposed is a government-funded cap on industrial electricity prices to navigate the transition to renewable energy sources. However, this idea faces resistance from Chancellor Olaf Scholz's Social Democrats and the pro-business Free Democrats, who argue that it would perpetuate reliance on fossil fuels.

The price of gas, which has doubled since 2021, is inflicting pain on industries requiring continuous high-temperature processes, such as glass and metal production. Additionally, Germany's economic woes have been exacerbated by a slowdown in its key trading partner, China, after decades of robust economic growth.

These external shocks have laid bare longstanding issues in Germany's economic foundation, including lagging digital technology adoption in both government and business, slow approvals for renewable energy projects, and underinvestment in infrastructure like roads and high-speed internet. The decision to phase out nuclear power plants in 2011 is now being questioned due to concerns about electricity prices and shortages. Moreover, a severe shortage of skilled labor, with nearly 2 million job openings, poses a significant challenge.

Relying on Russia for natural gas via the Nord Stream pipelines is another regrettable oversight. Clean energy projects also face bureaucratic hurdles and local opposition, leading to sluggish progress. Massive clean energy subsidies offered by the U.S. government have left Germany envious and concerned about falling behind in the global race for future technologies.

Companies like Evonik and Drewsen Spezialpapiere are taking matters into their own hands, investing in renewable energy sources like wind turbines to reduce dependency on natural gas. Specialty glass manufacturer Schott AG has experimented with emissions-free hydrogen as an alternative, but scaling this up presents logistical challenges.

Chancellor Scholz has called for a speedy energy transition, akin to the rapid establishment of natural gas terminals to replace lost Russian supplies. However, internal disagreements within the coalition government over energy price caps and bans on new gas furnaces have left business leaders frustrated. They see recent government proposals, including tax breaks and efforts to reduce bureaucracy, as insufficient remedies.

Germany had grown complacent during a "golden decade" of economic growth from 2010 to 2020, driven by labor cost reductions and increased competitiveness. However, this complacency led to misguided decisions regarding energy policies, such as exiting nuclear energy and relying heavily on Russian natural gas.

Holger Schmieding, chief economist at Berenberg Bank, suggests that ending the uncertainty over energy prices through a price cap could be a crucial immediate step to aid not only large corporations but also smaller businesses. Regardless of the chosen policies, speedy government action is essential to provide businesses with the certainty they need for planning and investment decisions. Germany's economic resilience provides room for maneuver, but the pressure to enact necessary changes is mounting.