Britain is not the sick man of Europe – that accolade goes to Germany

To survive in a modern, digital world, the German economy requires not a green transition but a full-scale revolution.

Photo by KENZO TRIBOUILLARD/AFP via Getty Images

Remember the “sick man of Europe” competition? Over the decades, the award has passed back and forth between the UK and Germany, though France, at times, has deserved an honourable mention.

Brexit notwithstanding, that trophy sits in Berlin right now. Germany has fallen into what economists call a technical recession after two consecutive quarters of falling economic growth. This is not the real definition of a recession. The US National Bureau of Economic Research defines it as “a significant decline in economic activity that is spread across the economy and lasts more than a few months”.

Here is where it gets weird. Germany’s fall in GDP has certainly lasted more than a few months; domestic consumption is down. But the downturn is not spread evenly across the economy. Unemployment stands at 5.5 per cent, among the lowest levels in living memory. The big employment story in Germany is one of staff shortages and wage rises. I know restaurants that have closed because they could not hire staff. This is not what happens in a normal recession.

The closest parallel to what is happening in Germany right now is the UK in the 1970s, a period marked by stagflation – high inflation and low growth – combined with relatively low unemployment. According to the UK’s Office for National Statistics, the UK unemployment rate fluctuated between 3.7 and 5.6 per cent in that decade. The 1970s and early 1980s were marked by two severe recessions in the UK. The first, from 1973 to 1975, was triggered by the oil price shock. The second, from 1980 to 1981, by the Thatcher government’s economic policies.

But the really big story of the 1970s and early 1980s in the UK was not a story of cycles, but structures. For me, the most convincing explanation of what happened at that time in many countries is a theory put forward by the US economics Nobel laureate Edmund Phelps in a 1994 book called Structural Slumps, which identified long super-cycles of decline. His analysis differs from the standard orthodox view, which has the economy fluctuating around a fixed trend. But that is not what happened in the 1970s. Many shocks happened in that decade: the end of the Bretton Woods system of semi-fixed exchange rates, which provided global macroeconomic stability in the postwar period; sequential oil price shocks; and, in the UK, an increase in trade union strike action. All of that superseded the classic cyclical pattern.

For Germany today, the big structural shocks are geopolitical and technological. The German economy is an analogue-age beast. Its main industries are fuel-driven cars, mechanical engineering and chemicals. The country has excellent scientists and engineers, but unfortunately it is over-specialised in pre-digital technologies, and not great at turning scientific innovation into commercial success. Germany’s alienation from all things digital was best captured in a comment by Angela Merkel in 2013, when she called the internet “uncharted territory”. I am wondering what she has to say now about artificial intelligence.

Germany’s over-reliance on industrial production made it dependent on global supply-chain links with China and Russia. It was part of a strategy of deep supply-chain integration across the entire Eurasian region, with Germany as the network’s hub. The strategy collapsed with the pandemic and Russia’s invasion of Ukraine.

This is Germany’s structural slump. The economic cycle will, of course, eventually start to improve. Recessions end. By 1978 UK economic growth was back at 4 per cent. But those headline numbers did not tell us what really happened.

The UK got out of the structural slump through a complete economic reboot during the following decade. This is where I see the biggest difference with modern Germany. Last February Olaf Scholz, the German chancellor, talked about a “change of era” in a now famous speech. The big idea of his government is the green transition. But it doesn’t want to reduce Germany’s over-reliance on manufacturing industry – just make it greener. The supply-chain vulnerabilities will remain.

The German car industry is still relatively profitable. But it will not remain so for much longer. Fuel-driven cars are to be phased out by 2035. The big money in the next generation of electric cars is in batteries and software – not areas in which the European and German car makers excel.

The EU has, in theory, the capacity to match the US and China in research spending. Horizon Europe, the EU’s science and research programme, is often cited as a policy success. I beg to differ. The reality is that Europe has been losing the scientific and technological edge it once had.

The main reason is that EU governments are not nearly as focused on technology as the US and China are. Whereas Joe Biden takes a personal interest in nuclear fusion, Europe’s Luddite leaders prefer regulation. When you have no stake in it, you tend to think of a new technology as a threat. This is how the EU ended up with the world’s most restrictive data protection regulation.

Getting out of a structural slump is hard. It would require a political reboot on a scale similar to what Germany itself went through after the Second World War, and the steps the UK and the US took in the early 1980s. There are no signs of this happening yet. I am not saying that it won’t happen in the future, but right now there is not even political advocacy for change.

The trophy for “sick man of Europe” is safe in Berlin for the foreseeable future.