MUNICH – A few months ago, Germany was bracing for a harsh winter. After Russia cut off Europe’s natural-gas supply and prices more than doubled, German officials warned of power outages and rolling blackouts. Some cities reportedly planned to convert sports facilities into “warming halls” for the poor and the elderly, and the media speculated about energy rationing. But those predictions did not materialize. In the face of a historic challenge, Germany proved to be more resilient than many had believed.

Yet Germany is still panicking. Instead of fretting about gas heaters, however, Germans are now haunted by the specter of deindustrialization. Not a single day goes by without some media outlet or research institute predicting that factory closures and the rise of China will lead to the country’s downfall. The state-owned bank Kreditanstalt für Wiederaufbau recently warned that Germany faces “an era of declining prosperity.” And Yasmin Fahimi, the head of the German Trade Union Confederation (DGB), warned that the energy crisis would lead to deindustrialization and massive layoffs.

Meanwhile, the Center for European Economic Research (ZEW) in Mannheim called Germany the “big loser” of today’s global economy, placing it 18th out of 21 industrial countries in its competitiveness ranking. Other experts have warned that rising energy costs will force manufacturers to move their operations to Eastern Europe and the United States in response to US protectionism.

What explains this gloomy mood? German business leaders first raised the threat of deindustrialization last April, when Germany was considering a boycott of Russian gas, which at the time accounted for over half of its natural-gas supply. Corporate executives, among them Markus Krebber, CEO of energy company RWE, warned that an embargo on Russian energy would lead to mass unemployment, poverty, and widespread social unrest.

These warnings contrasted with an earlier academic paper by prominent German economists who estimated that the Russian energy embargo would cause a mild to moderate recession. The authors argued that a large economy like Germany has many ways to adjust to this severe shock, such as finding alternative suppliers and switching to other energy sources. Moreover, they argued, the government could step in and soften the boycott’s economic fallout.

As it turned out, the apocalyptic scenarios never materialized, even after Russian President Vladimir Putin shut off the Nord Stream pipeline to Germany. Instead, the German government was indeed able to find alternatives to Russian energy, energy-saving measures reduced gas consumption by 30%, and the winter ended up being milder than expected. The country’s gas supplies have recovered, and prices fell from €350 ($377) per megawatt hour in the summer to €80 per megawatt hour. There were no blackouts, and the decline in gas consumption did not even depress industrial output, as German firms simply became more efficient.

Given its longstanding dependence on Russian gas, the war in Ukraine and subsequent surge in energy prices represented Germany’s biggest crisis since World War II. But the German economy has weathered the storm and is estimated to have grown by 1.9% last year – a far cry from the recession many had expected.

But the real threat is right around the corner. In a troubling sign, China recently overtook Germany as the world’s second-largest car exporter. China’s share of the global electric-vehicle market increased to 28% last year thanks to its dominance in battery manufacturing and the success of Chinese manufacturers like BYD Auto, Wuling, and GAC Motor, whereas the share of German companies like Volkswagen fell from 7% to 4%.

Similarly, China’s car exports to Europe surged from 133,465 in 2019 to 435,080 in 2021, owing to growing demand for Chinese-made EVs. Europe now imports more cars from China than it exports, as the net-zero transition and looming European phase-out of the internal combustion engine threaten to make the German auto industry obsolete.

In addition to car manufacturing, Chinese competition threatens the German machinery sector, a key segment of the Mittelstand – the small and medium-size manufacturers that form the country’s industrial backbone. Earlier this year, the German association of machinery and equipment manufacturers, VDMA, published a report showing that China’s machine-tools exports have surpassed Germany’s. While machinery exports from Germany grew by nearly 10% in 2021, machinery imports from China increased by 26%. Ironically, German firms operating in China had a crucial role in facilitating this transition, as they were forced into partnerships with local firms and thus accelerated technology transfer, effectively training their future competitors.

In 2022, Germany surprised the world by managing to shift away from Russian gas without falling into a severe recession. But restoring the country’s competitiveness is an even bigger challenge. Three decades ago, Germany went from being the sick man of Europe to being its economic engine. To compete in the increasingly cutthroat global economy of the twenty-first century, it must reinvent itself again.

Dalia Marin, Professor of International Economics at the School of Management of the Technical University of Munich, is a research fellow at the Centre for Economic Policy Research and a non-resident fellow at Bruegel.

Copyright: Project Syndicate, 2023.
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