Why Germany’s economy is much stronger than you think

Indeed, if you listen to the news, one thing is certain. We begin with breaking news here in Germany, where the governing coalition has collapsed and Chancellor Olaf Scholz has called for a confidence vote in mid-January. Volkswagen has issued a warning that has people wondering whether it has reached the end of the road as an industrial powerhouse. Germany's economy is going down the drain. And yet, here you are about to listen to an economist on YouTube telling you, "Don't worry about Germany's economy going down the drain."

And yet, here you are, about to listen to an economist on YouTube telling you, "Don't worry about Germany's economy; it's going to be just fine and may arguably even have a very bright future ahead of it for five reasons." Starting with reason number one: Germany's industry is exceptionally resilient. To see why, just zoom out a bit. You will notice that Germany has been Europe's industrial base for well over a hundred years. Germany's industry has survived two wars, the splitting of the entire country, and the stagnation of the early 2000s when Germany was labeled the "sick man of Europe." Yes, it will survive this minor downturn as well.

Why? Well, besides the fact that its infrastructure and knowledge are firmly established, the German industry stands out due to its high level of diversification. In fact, the Harvard Complexity Lab has consistently ranked Germany among the top five most complex economies in the world—just below Japan but well above the U.S. and even China. This diversity means that if there is a crisis in one industry or with a particularly large firm, there are many other areas of German industry that may cushion the blow.

Today, this issue is more relevant than ever, as the main problem German firms have been facing in the last couple of years is a massive skills shortage. A skills shortage— that sounds pretty serious. However, let's take a step back and think about that for a moment. There are not enough skilled individuals in Germany to produce what German firms are capable of producing. Alternatively, one could argue that there are simply too many highly competitive, outstanding firms in Germany for its existing workforce.

That is a problem that many countries would love to have. It means that news, which would be horrible in most countries—like companies wanting to close factories and move them elsewhere—is actually good news for Germany. It is the skills shortage solving itself. The skills shortage is pressuring German wages to go up. This causes some less productive firms, like Miele and Volkswagen, to move factories elsewhere.

And while this is terrible for those people losing jobs that they may have loved, it means that on the scale of the economy, a number of skilled workers have just become available to help the thousands of other great German firms that cannot grow without them. Sadly, German society does not yet seem to fully understand that this is how the economy is supposed to operate, as the news that Volkswagen may keep factories open in Germany in exchange for a 10% pay cut was celebrated as somewhat good news. It is really not. Artificially suppressing wages like that keeps ordinary Germans poorer than they need to be and starves smaller German companies of the workers that they so desperately need.

Allowing the skills shortage to solve itself may even address Germany's other big problem: its lack of innovation. Indeed, the German press has been alarmed by how new startups halved between 2003 and 2019, and then dropped by another 6% since 2019. But is it any wonder that young, talented Germans are not starting new companies if the skills shortage in the country is so severe that they have their pick of amazingly well-paid jobs straight out of university? The fact that some of Germany's most well-known companies are in trouble today may actually be good news, as it will help companies and startups struggling with the skills shortage to get ahead. However, with Trump back in the Oval Office, deglobalization is likely to continue.

Germany's firms famously profited handsomely from globalization in the past by selling machines and advanced goods to China. So now, with both China and the U.S. increasingly hostile to German exports, could it be that Germany's industry is facing a significant decline? After all, not necessarily, because the second reason to be optimistic about Germany is that it is well positioned to profit from fragmentation. Yes, that's right, I said fragmentation, not deglobalization. You see, there are hopeful signs that deglobalization will mostly take the shape of decoupling between blocks of countries.

But within these blocks, countries will continue to trade quite intensely with each other. Even so, the fact that rising globalization is over will surely still be bad news for Germany's companies, right? No. You see, another way to look at this is that German companies had essentially already completed globalization, during which they profited from selling their technology to China. However, in doing so, they created their own biggest global competitors.

But now, with Trump back in the White House, China's position as the factory of the world looks increasingly fragile. Therefore, other countries like Vietnam, Hungary, and India have an opportunity to become the next factory of the world. However, to do so, they will need the latest German machines. That is, of course, if it weren't for Germany's terrible government that previously only angered Trump, stifled German innovation with too much red tape, and foolishly neglected to invest in German infrastructure when it could borrow at a 0% interest rate. Yet, here again, Germany will likely be fine because, reason number three, Germany's democracy is working as it should.

That is, if a government fails to solve the problems that the public wants them to address in a functioning democracy, they should be voted out. Indeed, this is exactly why, while the collapse of the Schulz government may look like a sign of weakness, I see it as a sign of strength. His squabbling government was not able to fix Germany's problems, so its popularity plummeted, which led to more squabbling in the coalition, ultimately resulting in its collapse. They are messy, and things could go wrong.

But one thing is clear: the German public is fed up with Germany's crumbling infrastructure, inefficient government, cost of living crisis, and red tape. There is immense pressure on the next government to actually fix these problems or risk falling out of favor, allowing Germans to try again. That being said, there is also one glaring weakness that Germany's politicians have been too slow to address: the country's dramatic demographic decline, a problem that analysts like Peter Zeihan have claimed could be akin to a death sentence for the German economy. Luckily, I’m here to tell you that Germany will be just fine because the country's demographic decline is actually quite manageable.

Sure, as you can see here, Germany is facing a significant decline in its working-age population and a corresponding rise in its elderly population. Moreover, Germany's population decline is more drastic than in countries like France and the United States. However, it is far less dramatic than it would be in a country like China, where the working-age population is projected to fall below the number of elderly by 2075. Additionally, China's working-age population is expected to decrease faster than that of Germany, and the UN is also far more confident in this projection. This confidence is reflected in the fact that the shaded area, which represents the confidence interval, is much smaller for the China projection than for Germany.

Why is that the case? Well, the reason is simply that in the past, Germany has seen some significant migration waves that have caused its population to increase, even though it had been predicted to decline due to low fertility. This could very well happen again. Sure, there's very little political appetite for that right now, but maybe in 20 years, when labor shortages are much more extreme, it could be that Germany again welcomes immigrants from the east or even the south with open arms.

And even if that does not come to pass, this chart of Japan's GDP per person in terms of purchasing power shows that an advanced, democratic, and well-diversified economy can age gracefully—growing more slowly, sure, but growing nonetheless. Unlike Japan, Germany's government enters its demographic decline phase with exceptionally low debt, meaning that the country has an exceptional amount of financial room to support its rapidly aging population. Of course, you may say that even when corrected for this demographic decline, Germany is currently performing much worse than countries that are already aging faster, such as Italy. This brings us to my final argument: Germany's current problem is only temporary.

As you can see here, Germany is unique among Western economies in that manufacturing still accounts for a large share of its GDP. This means that the German economy is exceptionally exposed to changes in people's preferences for either goods or services, preferences that are usually pretty stable. Except for, of course, during the pandemic when the world could not spend as much on services anymore and started ordering significantly more goods, causing a global manufacturing boom. Not coincidentally, Germany's economy performed exceptionally well during the pandemic.

But now, with the pandemic well behind us, the global manufacturing sector is in recession. This also affects the United States. However, the German economy is feeling the impact much more intensely because it is still exceptionally dependent on manufacturing. Therefore, while Germany performed better than others in the aftermath of the pandemic, it is now doing worse. Luckily, the upside is that when global manufacturing inevitably recovers, Germany will likely recover as well.

So, even though the news about Germany seems pretty bad right now, and some of these problems, like demographics, will likely lead to lower Japan-style growth in the future, I think that Germany will be just fine. First, its industry is very well diversified. Second, it is well-positioned to actually profit from fragmentation. Third, it will get a new, potentially much more competent government soon. Fourth, it is relatively well positioned to deal with an aging population.

Manufacturing will recover from the COVID aftermath soon. Although, just to be crystal clear, what I've done here is essentially present you with an opinion—hopefully one with convincing arguments. However, any economic opinion about the future should be taken with a large grain of salt, given that it depends largely on the decisions of politicians, who are unpredictable. For example, if China invades Taiwan or Trump has a fallout with Germany, many of my optimistic arguments could become significantly weaker. But, of course, there are also many things that can happen that could strengthen my arguments. In any case, I always recommend comparing opinions from economists like me with those of multiple credible sources, such as, for example, today's sponsor, The Economist. For the skeptical case about Germany's economy, I heartily recommend this article about how Volkswagen's problems could be indicative of a broader trend of de-industrialization in Germany, followed by this article about how many of its current issues are actually a consequence of Angela Merkel's policies. Finally, to better understand Germany's current political crisis, I recommend this article to read up on the fall of Germany's fractious coalition.

Such extensive coverage of economics as well as politics is exactly why I'm excited to share that Money and Macro viewers can now, until December 3rd, get 50% off an annual subscription to The Economist, which gives you full access to their daily in-depth global reporting for an entire year. What I especially love about The Economist is that they stand for independent journalism for independent thinkers. After all, while they have taken a much more pessimistic stance on Germany, they were still happy to sponsor this video making the optimistic case instead. Whether you prefer the print edition or their app's digital weekly edition, you'll always get a well-balanced perspective on global affairs, no matter where you are.

So, don't miss out on a 50% discount! Click the link in the description or the top comment, or head over to economist.com/moneymacro to claim your exclusive 50% discount today. By using my link, you also support my channel. Also, you've heard it. Don't worry, my dear German friend.