Can Germany Engineer Faster Growth at Last?

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2017. That was the year of the US’s coast-to-coast solar eclipse, the Houston Astros’ first World Series win and the New England Patriots’ historic Super Bowl comeback win, perhaps rivaled by Argentina’s recovery against Egypt today.^[i]

It is also the last time German GDP outgrew eurozone GDP in a calendar year.

Yes, Germany, once the region’s strong man, has become its metaphorical “sick man,” continually growing more meekly than the bloc as a whole. German stocks haven’t minded, but politicians have, and now it seems they are (again!) trying to do something about it. Last week, the government announced a suite of economic reforms. We doubt they shift the fundamental backdrop 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 sideways economy, which stagnated amid high energy costs and other troubles in its once-mighty auto industry. 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 center-right Christian Democratic Union. Last week, they finally broke the deadlock, and Merz announced a shiny new reform package he claimed would modernize Germany’s economy and break the weak-growth trend.

Sorry to be pessimistic, but we kinda have our doubts. While there are some beneficial provisions, none look likely to move the needle, and the whole thing is a mixed bag. On the beneficial side, the plans would free up labor 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 labor 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 licensing. Instead of waiting for approval for months (or years) on end, applicants will have an automatic green light if they don’t get a replay in four months. Lastly, the retirement age will rise from age 67 to 70.

These tweaks all seem largely fine from a macroeconomic perspective, but they are generally small beans. 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 folks 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 address some of the big long-running issues, like energy. Germany’s high energy costs are self-inflicted, stemming 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 natural 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 natural gas once made life easy for automakers and chemical companies, which use gas 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.^[ii] This makes it exceedingly difficult for Germany to compete with cheap, subsidized Chinese machinery and auto imports. Which is why the reform package also formalizes Germany’s support of proposed EU barriers against subsidized imports. 

So maybe these changes boost 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 gridlock and enact these, a small sentiment tailwind is about all we would expect in terms of market relevance, not terribly dissimilar to Germany’s removal of the debt brake so many pundits saw as huge a couple years ago. Reforms like those floated last week, even when they are fruitful, tend to be structural economic drivers more than cyclical.

Yet similar to Japan, it isn’t about whether German policy changes deliver immediate fast growth. 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 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.