Can Germany Engineer Faster Growth at Last?

Editors’ Note: MarketMinder Europe is politically agnostic. We prefer no party nor any politician and assess developments for their potential economic and market implications only.

2017. That was the year of Queen Elizabeth II’s Sapphire Jubilee, England’s historic ICC Women’s World Cup victory and Man City’s third Premier League title.

It is also the last time German gross domestic product (GDP) outgrew eurozone GDP in a calendar year.^[i]

Yes, Germany, once the region’s strong man, has become its metaphorical sick man, to borrow Tsar Nicholas’s infamous phrase, continually growing more meekly than the bloc as a whole. German stocks seemingly haven’t minded, but politicians have, and now it seems they are (again!) trying to do something about it.^[ii] Last week, the government announced a suite of economic reforms. We doubt they shift the fundamental backdrop for stocks much or spur a return to a German-led eurozone economy, but perhaps they will spark some investor cheer.

A year ago, Germany’s coalition government took power with an agenda including economic reforms. The goal: boost competitiveness to reinvigorate its economy, which stagnated amidst high energy costs and other troubles in its once-mighty auto industry.^[iii] But for months, the coalition couldn’t agree on what should go in that reform package, leading to a sizable public backlash against Chancellor Friedrich Merz and his centre-right Christian Democratic Union. Last week, they finally broke the deadlock, and Merz announced a shiny new reform package he claimed would modernise Germany’s economy and break the weak-growth trend.^[iv]

Sorry to be pessimistic, but we have our doubts. Whilst there are some provisions we think are beneficial, none look likely to move the needle, and the whole thing strikes us as a mixed bag. On the beneficial side, the plans would free up labour markets a bit and tighten the sick leave system to address chronic absenteeism. Tech and a big swath of heavy industry may also get exemptions from Germany’s rigid labour code so they can be more nimble and better compete globally. Other red tape cuts include ending the statutory requirement for companies to contribute to government statistics and easing permitting and licencing. Instead of waiting for approval for months (or years) on end, applicants will have an automatic green light if they don’t get a reply in four months. Lastly, the retirement age will rise from age 67 to 70.^[v]

These tweaks all seem largely fine to us from a macroeconomic perspective, but they are generally small potatoes. To us, they look mostly like a symbolic move to show the government is aware of some long-running headwinds and wants to make it easier for new businesses to form and grow. We doubt they magically jolt Germany’s auto and chemical industries back to life. They also pair with some tax changes that risk roiling sentiment by funding low-income tax cuts with higher taxes on peoples making over €250,000 and axing some tax breaks, which could ensnare the same small business owners and entrepreneurs the other reforms seek to encourage.

And perhaps most importantly, they don’t appear to address some of the big, long-running issues, like energy. Germany’s high energy costs stem from the country’s decision to abandon nuclear power after 2011’s Fukushima disaster. Replacing Germany’s mighty nuclear plants with wind and solar proved overly optimistic, and officials filled the shortfall with gas. That worked fine when Russian gas flowed freely and cheaply but has left Germany at the mercy of international supply and pricing since 2022. Cheap gas once made life easy for automakers and chemical companies, which use it as a feedstock. Now, German electricity is far more expensive than still-nuclear French, by margins of about 28% to 320% since the war in Iran broke out.^[vi] This makes it exceedingly difficult for Germany to compete with cheap, subsidised Chinese machinery and auto imports. Which we reckon is why the reform package also formalises Germany’s support of proposed EU barriers against subsidised imports.^[vii] 

So maybe these changes boost investor sentiment a bit if they pass, which isn’t guaranteed. Public backlash could be an issue, particularly over job protections and the retirement age. But if Merz can break political gridlock and enact these, a small sentiment tailwind is about all we would see as likely in terms of market relevance, not terribly dissimilar to Germany’s removal of the debt brake so many commentators we follow claimed was huge a couple years ago. Our research finds reforms like those floated last week, even when they are fruitful, tend to be structural economic drivers more than cyclical.

Yet similar to Japan, we don’t think the stock market relevance is about whether German policy changes deliver immediate fast economic growth. We think it is probably more about whether reform-minded governments have the persistence to continue pursuing tough but needed change. If they do, and the changes don’t create a long list of losers to pair with the winners, then we find it can give businesses and investors the confidence to take more risk—a nice tailwind. Perhaps Germany is now at the early stages of a longer-term comeback, but only time will tell.