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Interest rates have risen rapidly in the euro zone, as they have across the rich world, to deal with the inflation unleashed by covid-19 and Russia’s war in Ukraine. Higher rates are starting to hurt German construction and business investment. Yet the country tends to be less sensitive to rate increases than most. Far more difficult are changes wrought by external factors. More than any other major European economy, Germany depends on China (see chart 1, meaning the Asian giant’s slower than expected recovery from zero covid is proving painful. Meanwhile, the gas-price shock of last year still reverberates—and gas futures signal that prices will remain roughly double their pre-pandemic level in the coming years. Energy-intensive industrial production has yet to recover from last year’s lows. And the country’s consumers are struggling: real wages have only just started to grow, having fallen to levels last seen in 2015.

Ministers are mulling how to respond. The Greens, part of a coalition government with the Social Democrats and fdp, a pro-business party, want to spend €30bn ($33bn, or 0.7% of gdp) on subsidising electricity for industrial use and funding green building and social housing. “The current weakness of the construction sector could indeed be used by the public sector to build more instead,” agrees Monika Schnitzer, head of the German Council of Economic Experts, an official body. The fdp, for its part, would like to cut taxes and create incentives for the private sector to invest, such as by allowing faster depreciation of investment goods. Both plans would lead to a wider fiscal deficit, and thus involve accounting trickery to get around the country’s strict deficit limits.

Whatever response politicians eventually agree upon, Germany’s problems seem likely to last for a while. The purchasing-managers’ manufacturing index is at its lowest since the early months of covid. Surveys such as the ifo index show that German business leaders are gloomy about the future. Expectations for the next six months continue to deteriorate. The imf reckons that the country’s economy will grow by only 8% between 2019 and 2028, about as fast as Britain, the other European struggler. Over the same period, France is forecast to grow by 10%, the Netherlands by 15% and America by 17% (see chart 2).

Germany’s transition to net-zero emissions is the next difficulty for the economy. The country has already undergone one uncomfortable transition: from being a pioneer of renewable energy to a climate laggard. This has left its annual carbon footprint, of 9 tonnes a person, around 50% higher than that of France, Italy or Spain (see chart 3). Although Germany is one of the most energy-efficient countries in Europe—meaning waste is low—it consumes enormous amounts of energy owing to its large industrial base (see chart 4). Making this energy greener will require awkward trade-offs.

The original plan, dreamed up in the glorious 2010s, was to replace nuclear energy with renewables and cheap Russian gas. Neither now looks possible. Russian gas will not flow to Germany any time soon. Meanwhile, Mrs Merkel often preferred to spend on pensions, rather than on renewables. nimbyish hostility to strengthening the grid, especially in the power-hungry south, has not helped.

It is not just Germany’s industrial base that will be less energetic in the future—its population will be, too. Germany is both an old country, and one old in a peculiar way (see chart 5). Its working-age population makes up 64% of the total population, just as in America. Yet Germany’s median age is 45, compared with 39 across the Atlantic. Since the country’s post-second-world-war baby boom was delayed by a combination of famine, destruction and displacement, there is now a great swell of workers on the verge of retirement.

As these boomers quit the workforce, jobs will become more difficult to fill. Already, firms are struggling. Even during last year’s energy crisis, Germany’s much-lauded Mittelstand—smallish firms that are often world leaders in their niche—cited a paucity of suitable workers as their most pressing concern. Without immigration or more women and elderly folk in the workforce, the labour market will lose 7m of its 45m workers by 2035, calculates Enzo Weber of the Institute of Employment Research, a think-tank. As he notes: “The raw figures are dramatic.”

Yet making it easier for parents to work full-time would clash with Germany’s traditional family model, and schools and nurseries are already short-staffed. Once, such problems would have been circumvented by attracting workers from eastern Europe, using the lure of higher Western wages. But many economies to the east are booming, and their labour markets are also tight. Two-thirds of Polish industrial firms, for example, cite labour shortages as a factor limiting their production, compared with less than one-quarter in the euro zone. In a sign of the times, Hubertus Heil, Germany’s labour minister, recently travelled to Brazil as part of a campaign to entice health and care workers to the country. A law introduced in 2020 to welcome more workers from outside the eu had to be updated this year, in order to further lower barriers to entry, after failing to attract sufficient numbers.

Overcoming these three challenges—geopolitics, climate change and demography—will require a nimble, digitally savvy and highly capable state. Unfortunately, Germany’s state is none of these things. The country’s success has for a long time masked the inadequacy of its institutions and administration, which is now being exposed. As Ms Schnitzer of the country’s official economic advisory council puts it: “The state is suffocating under its own rules and procedures.”

Even optimists are losing hope. “Artificial intelligence is often irrelevant for us, because there is no ai for a fax machine yet,” sighs Ann Cathrin Riedel, who runs next, an advocacy group that seeks to digitise public bureaucracies. She cites examples of municipalities that have to plan their school needs without knowing the number of children who will turn up because they do not have the required data. A law introduced in 2017 decreed that, by 2022, 575 services would be available in digital form. In the end, just 128 were. And many merely provided an online front-end. “Now you can digitally apply for housing benefits, but the administration prints out the page and puts it into the same folders as before,” notes Ms Riedel.

Sclerotic bureaucracy is a problem when companies must adapt to a fast-changing global economy and the entire capital stock serving fossil fuels needs to be replaced. At the moment, it takes more than 120 days for a German firm to receive an operating licence, compared with fewer than 40 in Italy and Greece. Construction permits take more than 50% longer than the oecd average. Clinical trials are so difficult that biotech firms set up research centres abroad. Almost 70% of Germans think the state is overwhelmed. Without enormous improvements, it will become a bottleneck as the economy tries to adjust.

The problem is not a lack of funds—it is the nature of the administration itself. Observers paint a picture of a government stuffed with lawyers and unable to steer policy or even monitor consultants properly. Germany’s federal structure has created a patchwork of digital fiefdoms that are fiercely guarded. Olaf Scholz, the country’s Social Democrat chancellor, has so far shown little interest in deep reform of the state, and seems keener on fiscal rules than bold change. The last time Germany was in such a mess was the late 1990s, when The Economist labelled the country the sick man of the euro. Back then, German politicians embarked on painful reforms, which ended up being assisted by favourable conditions in the global economy, not least a boom in emerging markets. There is no such boom in sight now. ■

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