The German economy is under considerable pressure to adapt, writes the Bundesbank in its September Monthly Report. The country is facing demographic change, the transition to a low-emission energy supply and dependency on China for the procurement of key intermediate goods. A sudden break with China would likely bring about far-reaching disruptions to supply chains and production in the short term, the authors explain. In 2022, there was no other country from which German firms sourced more of their imports, including numerous intermediate inputs. Amongst other things, China has global dominance over the production and refining of important raw materials such as rare earth elements, lithium and cobalt. The authors suggest a greater diversification of suppliers in international trade, potentially facilitated by regional free trade agreements. This could reduce dependency on China and prevent potential large-scale disruptions to supply chains.

So far, higher energy costs have led to few instances of production relocation 

The article describes how, as a result of the Russian war of aggression, declining gas supplies from Russia and heightened uncertainty about energy supply have driven massive increases in energy costs. Higher energy prices in Germany than before the start of the war in Ukraine can also be expected in the years to come. In addition, measures to limit climate change could contribute to a further increase in the prices of fossil fuels such as oil or gas. “Initially,” the experts write, German industry was able to effectively absorb the energy price shock thanks to being in good shape in terms of profitability and financing.” According to the Bundesbank’s analyses, losses in profitability for the manufacturing sectors are likely to have been manageable on average. Some sectors did see major disruptions, especially the particularly energy-intensive manufacturing sectors such as the chemical and paper industries and the manufacture of basic metals. In a Bundesbank survey, many enterprises reported that they responded to higher energy prices by making adjustments such as saving energy or raising sales prices. In addition, many enterprises have adapted or plan to adapt to increased energy costs by stepping up their investment in energy efficiency and their use of renewable energy. By contrast, relocation of production has been rare so far, even in the manufacturing sector. Broad-based deindustrialisation is not on the table,” says Marcus Jüppner, co-author of the report. Nevertheless, Bundesbank estimates suggest the surge in energy costs could lower Germany’s trend GDP growth. 

The path to a zero-emissions economy is one of the greatest social and economic challenges. “Reliable and consistent energy and climate policy is essential for sufficiently mobilising private investment to finance the green transition," the report states. This would provide enterprises with the required planning certainty and reduce the macroeconomic costs of the decarbonisation required. This conclusion is backed up by the Bundesbank’s simulations. If the energy transition is to succeed, Germany must invest massively in renewable energy, certainly at a pace many times greater than we have seen so far, said Jens Ulbrich, the Bundesbank’s chief economist. He advocated simpler approval procedures and faster legal processes. 

Demographic change will put pressure on labour supply

Mr Jüppner noted that demographic change was another major challenge for the German economy, adding that it will reduce the labour supply and intensify competition for skilled workers. From the second half of the 2020s onwards, the number of people of working age will decline. As baby boomers leave the working age bracket over the next 15 years,” the experts argue, even immigration is unlikely to offset this effect.”

The Federal Government’s plans to supplement the 2020 Skilled Immigration Act (Fachkräfteeinwanderungsgesetz) point in the right direction. This also includes the transposition of the EU Blue Card for highly qualified individuals into national law and the indefinite extension of the Western Balkans regulation. The plans also envisage immigrants outside the influx of skilled workers being quickly integrated into the labour market. In addition, there are other ways of increasing labour force participation or hours worked, whether through better childcare facilities or later retirement. These would require the government to adjust the institutional framework. 

Digitalisation offers growth opportunities

The authors also see a need for action in the area of digitalisation, which could significantly stimulate growth. Bundesbank analyses show that the digital sectors have been an important driver of aggregate productivity growth since the 1990s. Digitalisation received a boost during the pandemic. In order to harness the potential of digitalisation, it would be necessary, amongst other things, to have a more efficient digital infrastructure and better digital skills training, both in the workforce and in the education system.

German economy well positioned, but action needs to be taken

Despite these complex challenges, Bundesbank experts believe that the German economy is largely well positioned. German enterprises continue to make great use of the opportunities offered by international markets. Furthermore, they have weathered the energy crisis well. The authors found that the German economy also has a well-trained workforce, infrastructure that remains sound, consensus between management and labour and comparatively stable underlying conditions. However, the government must ensure that these clear challenges can be overcome by amending the institutional framework. The authors suggest numerous areas in which such changes could be made. Politicians are currently taking some steps in this direction. However, these would also have to be implemented and continued.