Is the German economy "kaput"?

Wolfgang Münchau is one of the most prominent journalistic voices in European financial and economic circles in his role as chief European columnist for the Financial Times. Late last year he published his book on the German economy, aptly titled Kaput - The End of the German Miracle, which has spread rapidly in translation across the continent.

Münchau describes today's German economy as a prisoner of the post-war model. The price for the successful economic restart of the war-ravaged country was the emergence of a corporatist system. In it, a tacit alliance has operated for decades between large domestic industry, the financial system, represented mainly by politically controlled public regional banks, and politics.

The result of this alliance is a neo-mercantilist practical policy, the aim of which has for many years been to maintain its position as the world's export champion, and in which German industrial products have had their path carefully trodden by banks and politicians. Later, the expansion of German producers into China and the now notorious energy strategy of tying itself to Russian gas were added to the mix.

Falling behind in new industries

But what was enough in the 1970s or 1980s is no longer enough today. Germany has missed out on the digital revolution: it has no competitive advantage in software, hardware, telecoms or artificial intelligence and is often embarrassingly behind the world leaders.

Innovation is expected from old industrial giants and the start-up culture is stunted. After all, Germany has as of the current year as many "unicorns" (which are startups valued at over one billion dollars) as Israel, which is ten times smaller. Compared to the US, it has even twenty times fewer.

Added to this is the growth of China, where Chinese manufacturers have started to replace German investors at home in the first phase and are gradually challenging them on the international market as well. Covid, the energy crisis, the war in Ukraine and the tariff wars have only served to trip up the staggering economy.

Parallels with China

The title of the book expresses Münchau's pessimism. The author's blueprint for improvement has plenty of points, but is not comprehensive enough. Germany should shed its obsession with exports, invest more in digital technology, and attract an educated workforce.

Economic policy should not be defensive, and instead of constantly supporting and protecting declining old industry, it must focus on creating the conditions for new firms to grow. Examples are Denmark, with its flexible labour market, and the Netherlands, with a much more diversified economy. These things are easy to write down, but harder to translate into concrete policy.

The book has one strong message - reform of the German debt brake. This is a very common recommendation that other authors also make to Germany. But would easing the debt brake really put the brakes on the economy?

We can find a historical parallel in the German story with today's China. China's automotive sector is growing rapidly thanks to the cooperation of the banks and the local Communist Party. The Party has decided that China will be an automotive superpower, just as it had previously decided to be a construction or steel superpower.

It has done so at the cost of a huge amount of sunk capital, the long-term return on which is far from certain. Today, Chinese builders and steelmakers are struggling with low demand in the same way that German car manufacturers are. Unlike Germany, however, China does not run a huge welfare state, so it has a long-term advantage in the money-pouring competition.

Opening the gates of the debt brake does not automatically mean that higher deficits and debt will lead to the right investments that will increase the country's productivity. It may also be the case that the additional resources will be used to do exactly what Münchau criticises - more or less covertly subsidise outdated business models and postpone reforms. France or Italy have left the fiscal gates wide open, and have not got powerful and globally competitive economies in return.

Germany is no Kaputt. It still has large private and public capital, it has know-how in several unique areas, it is able to attract talent, and its fiscal situation is solid by European standards. The best first step is therefore to shake off economic pessimism.