By Nicholas Larsen, International Banker
Germany was never expected to be the weakest link in Europe’s recovery. While countries such as Spain, Greece and Portugal have outperformed on the upside, the eurozone’s largest economy has struggled to generate consistent, meaningful growth. Successive forecasts have been revised downwards; industrial activity remains under pressure; and policymakers are increasingly realising that the country’s economic difficulties reflect key structural limitations beyond mere cyclical weaknesses. As such, Germany finds itself confronting the stark reality that its economic model is no longer delivering the prosperity it once did.
Indeed, throughout much of the 21st century, Germany greatly benefitted from a growth model centred on export-led manufacturing, driven largely by access to cheap natural gas imported from Russia, which helped maintain its dominant, globally cost-competitive position. It also prospered from expanding global trade flows and deepening international economic integration, with China emerging as a major export destination for German manufacturers.
This combination allowed Germany to thrive despite emerging underlying weaknesses, including slowing productivity growth, public investment lagging behind that of many peer economies, delays in infrastructure modernisation, slow progress in digitalisation and the creeping demographic pressures of an ageing population. As long as exports continued to perform strongly, however, these issues attracted limited attention.
Resoundingly, this is no longer the case. The removal of access to Russian energy following the February 2022 outbreak of war in Ukraine and China’s evolution from a major customer of German exports into a formidable competitor across several advanced manufacturing sectors have removed two cornerstones of Germany’s industrial primacy. Rising geopolitical tensions, increasing protectionism and weaker global trade growth have only further undermined the environment that had previously supported Germany’s export-oriented model.
“After a decade of strong export-led growth, the COVID-19 pandemic, Russia’s war of aggression against Ukraine and rising trade tensions have hit the German economy and emphasised the need to accelerate structural reforms,” the Organisation for Economic Co-operation and Development (OECD) reported in April. “Productivity growth had slowed down even before the pandemic due to weak public and private investment, declining business dynamism and rising skilled labour shortages exacerbated by rapid population ageing.”
Germany experienced two consecutive years of economic contraction in 2023 and 2024, and last year’s gross domestic product (GDP) growth was a mere 0.2 percent.
Germany experienced two consecutive years of economic contraction in 2023 and 2024, and last year’s gross domestic product (GDP) growth was a mere 0.2 percent. What’s more, forecasts for 2026 remain subdued despite a substantial fiscal-stimulus programme and increased public-investment commitments. “Unfortunately, we’ve had to lower the growth forecast we gave in this year’s report,” Monika Schnitzer, chair of the German Council of Economic Experts, an independent advisory body to the federal government, stated in late May. “We now expect gross domestic product (GDP) to grow by just 0.5 percent this year and 0.8 percent next year.”
Germany’s multi-year stagnation has thus become difficult to dismiss as a temporary cyclical downturn, with many now arguing that its problems run much deeper. Indeed, a growing consensus among analysts acknowledges the structural weaknesses that have been building for years. Rising energy prices stemming from the Persian Gulf conflict, geopolitical uncertainty and trade tensions have undoubtedly weighed on activity in 2026, but they have struck an economy that was already struggling with a loss of industrial competitiveness as Chinese firms moved aggressively up the value chain and now compete directly with German producers in sectors such as electric vehicles, industrial machinery and advanced manufacturing equipment.
The automotive industry provides perhaps the clearest illustration. While German carmakers remain global leaders, they now face mounting competitive pressures from Chinese electric-vehicle (EV) manufacturers. They are also struggling to adapt to the global industry’s rapid ongoing electrification trend, again spearheaded by China. As a result, an economy that once relied heavily on export growth is increasingly forced to seek alternative sources of expansion.
Over longer time horizons, moreover, it is demographics that constitute arguably the German economy’s toughest challenge. Simply put, Germany’s population is ageing rapidly—around 23 percent of Germany’s population was aged 65 or over in 2024, compared with just 15 percent in 1991. As the post-war Baby Boom generation retires, the number of working-age individuals is expected to decline significantly over the coming decades. At the same time, life expectancy continues to rise, placing additional pressures on pension systems, healthcare spending and public finances.
The economic implications for an ageing Germany are substantial. A shrinking workforce reduces the economy’s potential growth rate—unless productivity improves sufficiently to compensate. Labour shortages have already emerged across a range of sectors, limiting business expansion and increasing wage pressures.
Recognising these pressures, policymakers have increasingly turned their attention to labour-market reforms, with Chancellor Friedrich Merz backing proposals to raise the retirement age gradually towards 70 over the coming decades and to link pension eligibility more closely to rising life expectancy. While these reforms are politically contentious, they may ultimately prove unavoidable in the face of Germany’s steep silver demographic trajectory.
Stagnation is also closely linked to weak productivity growth.
Stagnation is also closely linked to weak productivity growth. Historically, productivity improvements have allowed advanced economies to maintain rising living standards even as demographic conditions deteriorated. In Germany, however, productivity growth has slowed significantly over the past decade, with bureaucracy and regulatory barriers often identified as major impediments to economic dynamism.
Planning and approval processes for infrastructure projects can take years. Business-formation rates have weakened. Venture capital (VC) markets remain less developed than those of comparable Western markets. Regulatory complexity continues to discourage entrepreneurship and investment. And administrative burdens and lengthy approval procedures frequently delay projects that might otherwise support growth.
Years of underinvestment are further compounding these economic woes. For many years, Germany maintained a strong commitment to fiscal discipline, prioritising balanced budgets and debt reduction, which, in turn, contributed to financial stability. Some argue, however, that it also resulted in insufficient investments in infrastructure, digitalisation and public services, with the consequences of this fiscal policy now increasingly apparent.
Businesses regularly cite inadequate transport infrastructure, lengthy planning procedures and slow administrative processes as obstacles to growth. Digital public services also remain underdeveloped compared with those of many peer economies, while infrastructure investment has frequently been cited as insufficient to modernise Europe’s largest economy. In particular, public investment as a share of GDP has consistently lagged levels seen in several faster-growing European economies.
“The public investment in relation to GDP in Germany over the past few decades has been around 2.5 percent of GDP. Roughly only half of what Poland has been investing,” Marcin Piątkowski, a Polish economist and professor at Kozminski University, recently explained to Euronews. “So, because of its fiscal fundamentalism, Germany has grossly underinvested in its future.”
Can fiscal stimulus deliver a badly needed recovery? The most significant shift in German economic policy has been the abandonment of strict fiscal orthodoxy, which constrained public borrowing and limited government spending. Following the federal election and growing concerns about competitiveness, policymakers opted for a dramatic change of direction. New borrowing authority has enabled substantial increases in defence spending and infrastructure investment, while a €500-billion infrastructure fund aims to support long-term modernisation efforts.
Analysts expect Germany’s less stringent fiscal policy to provide a meaningful boost to economic growth over the coming years. “While a massive energy price shock caused by the Middle East conflict is slowing down the economy, a highly expansionary fiscal policy is supporting growth,” Prof. Dr. Timo Wollmershäuser, deputy director and head of forecasts at the ifo Center for Macroeconomics and Surveys, recently observed. “The economy is currently being shaped by conflicting forces.”
Yet many economists caution that while public spending can support economic activity in the short term, it cannot alone reverse demographic decline, improve productivity or restore competitiveness. Without accompanying structural reforms, therefore, there is a risk that higher spending will simply generate additional inflationary pressures while leaving deeper weaknesses unresolved. As Piątkowski also contended, “A much bolder, even revolutionary approach, will be needed for Germany to prevent further deindustrialisation, mostly at the hands of China, and to identify new industries and sources of growth.”
It should also be observed that Germany’s economic challenges are not occurring in isolation. Accounting for roughly one-quarter of the eurozone’s output, the country plays a central role in guiding the regional economy. Weak German demand affects exporters across Europe, while slower German growth reduces momentum across the eurozone. Germany’s difficulties also complicate the European Central Bank’s (ECB’s) crucial task of implementing monetary policy. Weak growth would ordinarily support arguments for lower interest rates, yet persistent inflationary pressures linked to energy costs and fiscal expansion create competing policy considerations.
More broadly, Germany’s experience reflects several challenges confronting Europe as a whole: ageing populations, weak productivity growth, increasing global competition and the need to finance large-scale investments in defence, energy and technological transformation. For this reason, German stagnation is increasingly viewed as a barometer of Europe’s ability to adapt to a changing global economic environment.