Germany’s long slog out of stagnation

Greetings. US “liberation day” has come and gone, as have all the pre-announcement takes. Frankly, there was little useful that could be said before we saw what tariffs Washington would unleash. So while waiting, I have been thinking about Europe and in particular the Germany economy, the subject of today’s piece. For Donald Trump’s tariffs, read my colleague Alexandra Scaggs on the, ahem, “original” method cooked up in Washington to set so-called reciprocal tariffs, and Ed Luce for the diplomatic fallout from Trump’s “beautiful trade war”.

But: Germany. We are keen followers of the German economy here at Free Lunch. Looking over our past writing, we may even be accused of being cheerleaders — hey, it’s all relative — for a country more often used to getting flak from readers of the FT and similar anglophone publications. Four years ago, I expressed great hopes for the three-party coalition agreement (a hope the country’s constitutional court put an end to by outlawing the fiscal tricks that had reconciled the three parties’ priorities). Last month, I enthused about incoming chancellor Friedrich Merz’s bold reform proposal for the constitutional “debt brake”. And my colleague Tej Parikh’s bullish piece on Germany’s underrated economic strengths was namechecked in Merz’s debate with rival Olaf Scholz in the recent election campaign.

On a visit to Berlin a few weeks ago, some of the people I spoke to encouraged me to temper my enthusiasm. So I decided to seek the advice of Ulrike Malmendier, a professor at University of California, Berkeley and a member of the German Council of Economic Experts, the independent body that comes as close as anything to being the country’s economic priesthood. I have just interviewed her for the FT’s Economics Show podcast, which I’m a co-host for while Soumaya Keynes is on leave. Our conversation is now online — please listen (or read the transcript here) and consider subscribing to the podcast, and send your comments and reactions to me at [email protected].

My overall takeaway was that Malmendier is both more optimistic and more pessimistic than the standard fare in the English-speaking press. She is impatient with those who blame the last government’s policy, and doesn’t think that Germany’s economy needs a root and branch overhaul.

I’m not one of the people who think that fundamentally we have to change our business model of exchange with many different countries, being strongholds on export markets and so on…

What, then, has been holding the German economy back (and for longer than you may think — in my interview I highlight that talk of a manufacturing recession started already around 2018)? The answer is a list of structural factors — and that’s what I put down as a more pessimistic take, because improving those is much harder and requires deeper policy change than just loosening borrowing limits and splashing some more money at the economy.

At the top of Malmendier’s list is the lack of labour, in both quantity and quality. There aren’t enough workers —

we don’t have enough working population in Germany, and that’s something that was so forecastable 10, 20 years ago. And it just hasn’t been addressed. We need more foreign-born workforce. We need to become attractive to workers from abroad.

— and Germany needs to do better in how it educates its young:

a lot of this frankly is actually in primary education, giving people a good starting point in math and writing and so on, I think, can do wonders. Once you go higher up, and for sure when you go to the college level, I think Germany is actually doing a great job, particularly in the engineering realm.

Other structural challenges include high energy prices and an unpreparedness to use knowledge tools such as artificial intelligence software. (You can find more on all of these headwinds in an article co-authored by Malmendier from February.) There is also a European-scale problem, which is that start-ups struggle to find the big-league finance needed to scale up in earnest:

We’re in a world where we need to allow new technologies, whether in the life sciences, artificial intelligence, you know climate technology. We need those to take over an increasing role, allow them not only to consist of cool start-ups, but actually to scale and grow in Germany, rather than going abroad whenever they are being successful and wanting to scale.

[Once start-ups show promise, they] don’t just need €500,000, they don’t need just a million. They might need 20, 50, maybe 100 million. Somehow, we don’t have the venture capital funding depth to support these companies. And what happens is that, at best, foreign investors come in. US investors, they harbour then socialise these people to come over to the US, try out the much bigger market that’s available to them there . . . Germany has [grown] I think 0.1 per cent over the last five years. US has grown 12 per cent. They come in on top of that and cherry-pick those companies which are going in the future-oriented direction in Germany and in Europe and bring them over after all the public co-funding. So that system has to change.

That point about the lower funding amounts that EU start-ups manage to attract is, by the way, also highlighted in a recent FT opinion article by entrepreneur Brent Hoberman. He points the finger at how complicated and different national rules, from employment standards to the need for notaries, clip the wings of EU company founders. The solution he and many other founders favour (which I have also endorsed — and which Brussels has promised to pursue) is a “28th regime” of simple rules that companies could opt into and gain the immediate right to operate in all the countries of the EU.

Malmendier, too, criticises the large differences in business rules between EU countries.

How can we get funding across countries? How can we allow cross-border investments and how can we make the European capital markets become one capital market? Well, we have Esma, we have a European supervisory body, but then we have all the national regulatory bodies who have their special look at things and they have special decision-making powers. So that’s maybe a good example for a case where I would think giving that up to the European level and having a common decision-making body just to reduce the bureaucracy would make enormous difference and really help the funding availability.

With diagnoses such as these, it should not be too surprising that Malmendier is less excited than I am (and lots of others are, by all accounts) about the economic benefits to expect from Berlin’s newfound embrace of deficit spending. She’s not complaining — “I think that some changes were necessary” — but her emphasis is on how the money is spent.

I’m really unhappy with people or opinion leaders who try to attribute this failure to maybe what the outgoing government did. I’m sure there’s stuff to criticise, but that’s not the issue…

I’m not convinced that the strict limit of the debt brake in and of itself is the main culprit. If you look back over the last decade, it was actually quite rarely the case that we totally hit against that debt ceiling. For in my mind, what the main issue has been is that the money we had available was not spent enough on really future-oriented, long-term investment…

I would put big infrastructure investments as part of that, defence spending, which of course we end up talking much more about than we thought recently, but also education. [That’s] why in November we came out and said we need something like an infrastructure fund. We need something like a minimum spending per pupil on education and minimum spending on defence.

I choose to be hopeful. Berlin’s choice of an infrastructure fund for €500bn over 10 years shows a new willingness to invest in what is needed. Defence spending, too, promises beneficial spillover effects. An important recent report by Ethan Ilzetzki for the Kiel Institute showed that research and development spending built into defence expenditures can have a large permanent effect on broad economic productivity. And stories of how US military procurement gave rise to everything from the microwave to the internet are legion.

The greatest obstacle may, in fact, not be economic but cultural. Malmendier confirmed my impression that a large part of German society is not prepared or eager for the sort of change that it would take to bring Germany’s economic mojo back.

In the passages that most moved me, Malmendier talked about her research into how what people experience in their formative years shape their attitudes and behaviour for the rest of their lives — including their economic lives. So Germans east of the iron curtain who lived through the collapse of the German Democratic Republic:

I am actually quite influenced by my own research on how our lifetime experiences have long-lasting effects on how we look at the world and what we do in the world…

The fact that you grew up in a country, the GDR, and you know, maybe not everything was perfect, maybe some things were actually outright terrible under the regime, but you had a certain role, you had a certain job, hopefully you felt useful in that job, and suddenly you’re told, oh that’s all worth nothing. That is something that stays with you for the rest of your life and can induce a very negative outlook.

We finished the interview on how today’s young, too, will be marked by a dangerous and volatile world, hardly designed to treat them well. It’s up to all of us to improve their predicament, or suffer lasting consequences. And above all — and this is where Malmendier’s analysis matches Tej’s and my takes — Germans have to find it in themselves to choose more creative destruction.

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