Germany’s economic crossroads could lead it to thrive in the 're-industrial era'

Tectonic shifts in the geo-economic landscape – from a tariff-induced correction in US equity markets to the potential for a cessation of conflict in Ukraine – have prompted investors to rotate in full force to European stocks.

Added to that, the conclusion of elections in Germany and the potential for a dramatic shift in the country’s fiscal culture (and the spending packages which might unfold) have magnetized inflows from foreign investors and pushed the German DAX equity market to an all-time high.

Are market participants too sanguine? After all, until recently, cries of hopelessness have dominated the debate on the German economy, as the country wades through its longest period of stagnation since the Second World War.

In fact, set against the backdrop of a shifting geopolitical landscape and deep uncertainty in global markets, certain parts of the German economy actually hint at a promise of resilience and upside potential.

The innovation of German companies, the strength of its Mittelstand (or small to medium businesses), the industriousness of its workers and the dynamism of its services exports all rank as hidden gems beneath the surface of the otherwise doomsday discussion related to Germany’s present industrial crisis.

As Chancellor Friedrich Merz’s new government seeks to unleash a bumper fiscal package and potentially reform Germany’s dirigiste approach to public spending – effectively rendering the "Schwartz null" (or practice of fiscal rectitude) to the dustbin of history – so there is hope for additional cultural shifts to unfold within the German business landscape.

By adopting a "total fund management" approach, the German government and its people can positively respond and meet changing patterns of demand in the "re-industrial era."

That is, as countries and companies grapple with ever-rising energy demand – and simultaneously confront the economic costs of climate change – it is evident that we haven’t fully exited the "old economy" of resource-intensive activity and transitioned into a purely "new" era of services-led economic growth.

Some countries are trying to get ahead in securing resources from across the energy spectrum and, in doing so, ushering in the return of industrial policy and policies of climate protectionism. It is clear that we are not in a post-industrial era. Rather, this era can be characterized as the "re-industrial era" — and it is one in which Germany can play a leading role.

Historically, the German economic model of growth driven by highly skilled manufacturing and industrial production has been underpinned by stable access to natural resources – from coal mines in the Ruhr to Russian natural gas.

Since the Euro was introduced, Germany has arguably benefitted from a relatively weaker currency than the Deutschmark, thus making its exports more competitive, both in Europe and globally.

The temporal shocks resulting from the trade war during the first Trump administration, the pandemic and Russia’s invasion of Ukraine have all culminated into an industrial crisis within Germany.

Even as Scholz’s government sought to cement new resource ties with countries such as the United States, the United Arab Emirates and Saudi Arabia, the sharp rise in energy costs have pushed German companies to shift production offshore.

Looking beyond industry, German households face some of the highest electricity prices in the world: thus, the energy crisis also ate into an already diminished household purchasing power.

Changing structural forces have also raised questions as to whether Germany’s manufacturing prowess is fit for purpose. As economies such as the US, China and South Korea have led the fourth industrial revolution, Germany – in some ways – has failed to leap beyond the combustion engine.

With the exception of a few notable companies, one can argue that Germany hasn’t fully embraced the era of digitization. Even within the automotive sector, China has rapidly outpaced Germany in the production and export of battery electric vehicles.

In terms of labour supply, an argument can be made that Germany’s workers may currently lack the skills to meet changing patterns of demand. Although Germany’s programmes of vocational training have been immensely successful, there may be a mismatch of skills required for the industries of the future.

Externally, softer demand from a structurally slowing China – as well as trade tensions from the US – might also curtail Germany’s export powerhouse. Demand for German cars has been dented amidst the luxury slowdown within mainland China.

Added to that, trade tensions with Washington might divert German exports and capital flows away from the US. One can also argue that Germany is now in direct competition with China in some industrial sectors.

Thus, set against the backdrop of a supply of industry and workers which may not be fit for purpose in the digitized or fourth industrial revolution world – combined with a deteriorating (and challenging) external environment, the cries of despair for Germany’s economy have not been entirely unfounded.

However, with an eye on the future, it is important to note that Germany actually leads Europe in patent creation – and has trounced its regional peers in recent years.

Its research and development (R&D) spend is one of the highest in the world, indicating that the country as a whole is willing to invest in innovation to move forward. Moreover, although many tout Germany’s role as a manufacturing power, Germany vies with Ireland as Europe’s top services exporter for trade outside of the European Union (EU).

This is materially significant: in a world marked by record trade restrictions on goods, the trade in goods appeals to human emotion and is, therefore, preferred by Washington and its erstwhile trading partners in a tit-for-tat tariff escalation.

To date, the sharp rise in protectionism has not yet seeped into services – and thus, Germany’s services exports may also be rendered resilient amidst the present tariff maelstroms.

Moreover, as more and more manufacturing activity is geared towards services – such as the after-sales service of a major industrial product – Germany is well-positioned to be able to export such services in spite of geopolitical turmoil.

One clear arena where these two coincide is in the cleantech sector. While different countries pursue their own "green new deals" or iterations of the US Inflation Reduction Act, the rise in climate protectionism across different domestic agendas ironically beckons cross-border capital, manufacturing expertise, intellectual property and know-how.

By originating transformative ventures across the energy spectrum, Germany can produce not only its own champions but also dynamic services exports. Thus, far from being a broken model, Germany may indeed be powerful and resilient within the re-industrial era.

As Chancellor Merz’s government irons out the details of the proposed fiscal stimulus package, this dramatic shift in Germany’s practice of fiscal conservatism might also be matched by a shift in the mindset.

Breaking with the past of the Schwarze null does not have to imply a wasteful or profligate policy. Rather, the government and the business ecosystem should adopt a total fund management or a total portfolio approach.

By acting much in the same way as a sophisticated institutional investor, the government could seed investments that over the long term, can generate a positive return. As one wise executive put it, such fruitful government spending requires a shift in the mindset from expenses to investment.

Such asset classes could include housing: as house prices hover near a record high in Germany, investors may flock to join the government in the development of attainable housing, thus mitigating a social issue and creating an impact.

Investing in human capital, too, is likely to yield a multi-faceted return. Initiatives such as training programmes for future venture capital investors can be emboldened and expanded.

Supporting Germany’s strides within innovation in financial services presents another laudatory opportunity (although perhaps not too much innovation). Moreover, building a future-proof human capital base also involves agile organizational planning.

As executives within the Germany Mittelestand navigate succession challenges, the government and businesses could continue to look afield for examples of countries which get this right.

Taking this total fund management approach enables the government and its business ecosystem to invest for the future in which Germany can play a significant role.

Even amidst shifting tectonic plates in the geopolitical landscape, these certain unsung aspects of the German economy – coupled with a stewardship approach from the government – can render the country in a strong position – even when the heady fumes of fiscal stimulus eventually fade into contrails.