Who will be the locomotive of the European economy?

At the beginning of 2025, the German economy continued to be mired in multiple contradictions. Although the inflation rate in February remained at 2.3%, a significant decline from the peak in 2024, this level is still higher than the ECB’s 2% target, and the stickiness of core inflation highlights that price pressures on the consumer side have not completely subsided. At the same time, the historic loss of 19.2 billion euros announced by the Deutsche Bundesbank in 2024 exposed the double blow of the depreciation of bond assets held in the high-interest rate cycle and the withdrawal of quantitative easing policies, which not only weakened the resilience of the central bank’s balance sheet, but also implied that the room for monetary policy adjustment is limited. The two seemingly isolated sets of data actually outline the complex status of the German economy – struggling on the edge of stagflation: after two consecutive years of negative economic growth (-0.3% in 2023, -0.2% in 2024), the German government gave a target of 0.3% for economic growth in 2025, while the German central bank’s forecast was only 0.2%.

One of the major difficulties facing the German economy is structural challenges. In recent years, the deep structural defects of Germany’s export-oriented economic model have become more prominent: over-reliance on traditional manufacturing, lagging digitalization and green transformation, aging infrastructure and shortage of skilled workers. 2024 can be called a “lost year” for German foreign trade, and the continued sluggish global market demand has caused great suffering to German exporters. Preliminary data released by the German Federal Statistical Office in February showed that Germany’s exports in 2024 will be 1,559.7 billion euros, down one percentage point from 2023, especially the machinery and equipment and automobile industries have been hit the hardest. At the same time, factors such as the slow progress of digitalization and high taxes and energy costs have led to a sluggish willingness of enterprises to invest. Relevant statistics show that Germany’s fixed asset investment will fall by 2.8% in 2024, of which machinery and equipment investment will fall sharply by 5.5%, and industrial capacity will still be 10% lower than before the epidemic. In addition, the aging of German society has exacerbated the shortage of skilled workers, and the controversy over immigration policy has made the society more torn.

Another major dilemma is the lack of consumption motivation. In 2024, Germany’s private consumption will increase by only 0.3%. Market research firm GfK released a report saying that since mid-2024, German consumer confidence has stagnated and the consumption environment has continued to be sluggish. Due to high food and energy prices, corporate layoffs have increased consumer uncertainty, resulting in a high propensity to save, which has further suppressed consumption.

For well-known reasons, energy costs and supply issues are extremely troubling the development of the German economy. The sharp fluctuations in the European energy market have dealt a heavy blow to the German economy, which relies on energy-intensive industries, pushing up production costs on the one hand and reducing consumers’ disposable income on the other. According to data from the German Energy and Water Industry Association, the average household electricity price in Germany in 2024 was 40.92 euro cents per kilowatt-hour. Energy costs have become a sword hanging over the German economy. Whenever there are large fluctuations in the energy market, the German economy will shiver involuntarily.

Despite facing many difficulties, Germany, as the locomotive of the European economy, still has many advantages.

When it comes to the German economy, its strong manufacturing foundation and innovative research and development capabilities are the first to be mentioned. Germany has accumulated profound experience in high-end manufacturing technologies such as automobiles and chemicals, especially in the field of mechanical manufacturing. German mechanical equipment is known for its high precision and high reliability, and is widely used in global industrial production. At the same time, Germany’s vocational education system continuously supplies professional and technical talents to various industries such as manufacturing, making Germany highly competitive in the fields of scientific research and development, engineering technology, etc., and providing strong intellectual support for economic development. It has invested heavily in scientific research and has many top scientific research institutions and laboratories.

Faced with a weak situation for several years, Germany is working hard to promote its economic revitalization plan. According to reports, in the exploratory talks on the formation of a new federal government, the German Union Party and the Social Democratic Party have reached an agreement on relevant fiscal plans to support national defense and infrastructure. On March 4, Merz, chairman of the CDU and candidate for prime minister of the Union Party, said that the “debt brake” mechanism stipulated in the Basic Law would be relaxed to allow more defense spending, and defense spending exceeding 1% of GDP would not be restricted by the mechanism. The “debt brake” mechanism is a fiscal rule written into the German Basic Law in 2009, which aims to avoid excessive government borrowing and limit the government’s structural deficit rate to 0.35% of GDP. In addition, a special fund of 500 billion euros will be set up for infrastructure repair in the next 10 years; in addition, it will promote the reduction of family burdens, ensure the stability of pensions, and establish a fair tax system.

The new German government is bound to face arduous tasks, and the series of economic measures it has taken will play a key role in the direction of the German economy. If fiscal policy is properly adjusted, it can find a stable balance between stimulating the economy and controlling debt, industrial policy can effectively promote the upgrading of traditional industries and the development of emerging industries, labor market reforms are smoothly implemented, and the trade environment is improved, then the German economy is expected to achieve a gradual recovery and return to the growth track.

The German economy faces many thorny problems in 2025, such as the suppression of consumption by inflation, the chain reaction caused by central bank losses, the decline of industrial competitiveness, structural contradictions in the labor market, and insufficient investment. These problems are intertwined and bring huge challenges to economic recovery and growth. However, if the new government can effectively implement structural reforms and open up new growth poles through manufacturing transformation and cooperation, Germany may be able to gradually emerge from the trough after 2026.