Making Germany Grow Again

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Making Germany Grow Again

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Bibliographic details

• Authors: ULRIKE MALMENDIER, CLAUDIA SCHAFFRANKA
• Published: June 2, 2025

Overview

• Long-term, future-focused investment can rescue Europe’s largest economy from stagnation.
• The new government’s fiscal plan to fund infrastructure investment and increased defense spending is a start but must be complemented by opening the economy to future-oriented technologies, greater market integration in Europe, and stronger domestic capital markets.
• Opinions expressed are those of the authors and do not necessarily reflect IMF policy.

Diagnosis: recent performance and outlook

• Germany’s economy has been stagnant for the past five years, growing by just 0.1 percent since 2019.
• Over the same period, the US economy grew by 12 percent and the euro area as a whole grew by 4 percent.
• The German Council of Economic Experts expects growth to remain sluggish for the next two years, with potential output increasing by only 0.4 percent per year.
• Manufacturing has been in continuous decline since 2018.
• Output in energy-intensive industries has been declining almost continuously since the start of 2022.
• Demographics: in the next 10 years, 20 million workers are expected to retire while only 12.5 million enter the labor market.
• Labor market structure: about one in two women now work part-time.

Key drivers of stagnation

• Labor costs and competitiveness
  • Labor costs are the main driver of the decline in German price competitiveness, exceeding the effect of rising energy costs.
  • Sluggish productivity growth combined with rising wages has deteriorated unit labor costs relative to peers such as France and Spain.
  • A high degree of employment stability and policies such as “short-time work” have slowed structural change and reallocation to more productive sectors.
• Manufacturing and external environment
  • Even as foreign demand (especially from China) recovered after COVID, manufacturing and core industries did not benefit and exports failed to rise accordingly.
  • Rising trade fragmentation, the threat of US tariffs, and increasing competition from China compound the challenge.
• Energy costs and capacity for high-energy industries
  • Energy prices remain elevated historically, relative to the US, and relative to many neighboring European countries, reducing attractiveness for energy-intensive industries such as data centers.
  • International Energy Agency estimates point to a potential doubling of global electricity demand from data centers between 2022 and 2026, which Germany is not ready to provide at low cost.
• Legacy technologies and sectoral concentration
  • Germany’s leadership in automotive, mechanical engineering, and chemical sectors has led to focus on existing technologies, hindering diversification into high-tech sectors like IT and biotechnology.
  • Private R&D spending is relatively strong but concentrated in “mid-tech” sectors.
• Financial system and capital allocation
  • Under the traditional German financial system, too much capital is allocated by the banking sector and too little flows to innovative and higher-risk businesses.
  • Venture capital volume rose from an average of 0.02 percent of GDP in 2011–13 to almost 0.09 percent in 2021–23, but remains insufficient, especially for late-stage financing.
  • Fewer and smaller venture capital funds in Europe make it hard for start-ups to secure multiple large financing rounds; many larger European scale-ups move to the US for deeper capital markets and better exit options.

Policy recommendations and reforms

• European market integration
  • Actively push for greater European integration in goods, services, capital, and energy markets to enable firms to scale within a single market of almost 500 million consumers.
  • EU Commission should prioritize removing remaining nontrade barriers (complex procedures for permits and licenses, lack of tax harmonization) and coordinate harmonization of national regulation.
  • Coordinate a European build-out of national electricity systems to reduce system costs and increase the efficiency of energy trading; adopt a European perspective rather than focusing exclusively on domestic needs.
  • Lead efforts to improve and harmonize national insolvency regimes to make it easier to value assets across EU borders.
  • Strengthen and reform the European Securities and Markets Authority.
  • Increase venture capital funding at the European level by channeling resources to the European Investment Fund or the European Tech Champions Initiative.
  • Encourage German households to shift saving vehicles away from savings accounts toward broadly diversified stock market investment to enhance returns and encourage long-term investment.
• Strengthening domestic capital markets
  • Build deeper and more liquid capital markets to channel financial capital to productive and innovative companies, especially young and innovative firms and scale-ups.
• Labor force and participation
  • Increase domestic labor force by improving workforce participation and attracting foreign-born workers.
  • Supply high-quality and reliable childcare to increase hours worked by mothers.
  • Improve incentives for older people to continue working by restricting early retirement and linking the standard retirement age to longer life expectancy.
  • Speed up administrative immigration processes and extend the Western Balkans Regulation to additional countries to attract more skilled foreign workers.
• Fiscal strategy and public investment
  • Use any available fiscal space strategically, prioritizing future-oriented investments that strengthen long-term competitiveness rather than masking structural weaknesses.
  • The new financial package creates a special fund for infrastructure and exempts defense spending above 1 percent of GDP from the “debt brake.”
  • Address design flaws of the current debt brake: allow transition phases after crisis years to permit gradual reduction of the structural deficit and consider rules that account for the overall debt-to-GDP ratio.
  • Tackle political biases favoring short-term benefits over long-term gains; ensure the special fund truly finances additional infrastructure investment and avoid redefining defense spending in ways that encourage consumptive expenditure.
  • If Germany aims to reach the 2 percent NATO defense spending target in the long term, defense spending should come from the core budget.

Key statistics and exact figures cited

• Growth since 2019: 0.1 percent (Germany)
• Comparative growth since 2019: 12 percent (US); 4 percent (euro area)
• Expected potential output growth: 0.4 percent per year (next two years, German Council of Economic Experts)
• Demographic flows next 10 years: 20 million expected to retire; 12.5 million expected to enter the labor market
• Venture capital: average 0.02 percent of GDP in 2011–13; almost 0.09 percent in 2021–23
• Data center electricity demand: potential doubling between 2022 and 2026 (IEA estimate)
• Energy-intensive industry output decline: almost continuous decline since the start of 2022
• Manufacturing decline: continuous decline since 2018
• Defense spending exclusion threshold from debt brake: above 1 percent of GDP
• NATO defense spending target: 2 percent
• Female part-time work: about one in two women work part-time

Source: Making Germany Grow Again — ULRIKE MALMENDIER, CLAUDIA SCHAFFRANKA, June 2025.

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