Germany’s Industrial Problems, Economic Identity, and Regulatory Reform
Arriving at the EU Summit in Copenhagen last week, German Chancellor Merz made an unusual statement to domestic media. Although he knew that security and Ukraine were the topics on the agenda, he emphasized that the most important thing was to talk about reforming business regulation and competitiveness. Of course, there were no—and could not have been—major agreements on this last week, but Merz’s statement, as we’ll see, carries double significance.
Where do Merz’s motives come from for shifting (domestic German) attention to regulatory reform and competitiveness, and for bringing the EU level into that story?
A Tough Domestic Landscape
There is a growing number of public outcries from German employers directed at the new government. Almost every day, some (mostly industrial) company announces layoffs. This may seem strange, as there is no classical recession. However, Germany has been in a creeping crisis for several years, without high unemployment. We predicted the possibility of this unusual state (a recession without unemployment) more than two years ago.
Industrial production in Germany has been stagnating or slightly declining since 2018. The problems in the industry are structural and cannot be explained solely by the pandemic shutdowns or the energy crisis that began after Russia’s attack on Ukraine in 2022. By the end of that year, Germany’s total real GDP began to stagnate, and the country has been struggling to return its real GDP to 2019 levels. Six lost years.
The causes are complex (e.g., Germany’s misguided energy strategy for over two decades), but they carry not only economic, but also identity-based and political consequences. Faith in the uniqueness of German engineering and industrial power has been seriously shaken. And that means that the modern German reputation and identity—built after World War II on economic success, productivity, and economic leadership due to the inability to build on historical or political narratives—has been seriously undermined. The consequences of this modern German failure are broader; they are linked to the long-term lag in productivity growth in the EU compared to the U.S.
Bankruptcies are occurring as a result of structural problems. Many bankruptcies have been delayed for companies that have long been uncompetitive but survived during the pandemic and immediately afterward thanks to state aid and the ability to pass structural cost pressures onto customers through higher prices. That is now coming to an end, especially in the automotive and other energy-intensive industries that have not used the past three years to swiftly adapt their technologies, organizations, markets, and production mixes.
U.S. tariffs and competition from Chinese electric vehicles only add salt to the wound. It’s no surprise then that the Federation of German Industries (BDI) issued a warning about an economic crisis, calling for tax relief and administrative reforms to ease doing business. Such demands are becoming more frequent and louder, not just because of the prolonged creeping crisis, but above all because Merz promised them during the campaign. Expectations of the new government are high.
The increasingly vocal messages from employers are correctly interpreted by the media as expressions of anger, linked to early disappointment or, more precisely, a confrontation with reality. The president of the Association of Machine and Equipment Manufacturers (VDMA), Bertram Kawlath, told Chancellor Merz that the mood in their industry is not only tense but furious, because the delays in reforms are very costly. Geraldine Dany-Knedlik from the German Institute for Economic Research states that the German economy will remain on shaky ground, and momentum will not be sustainable due to structural weaknesses. The president of the Confederation of Skilled Trades, Jörg Dittrich, believes the economy is in intensive care and demands immediate treatment by reducing the costs of bureaucracy and the social system.
The Confederation of German Employers’ Associations (BDA) criticizes delays in health insurance reform and calls for swift action to reduce contributions. German employers are also calling for corporate tax reform to encourage investment, greater labor market flexibility to make hiring and firing easier, and reduced electricity taxes. At the same time, they criticize sustainability reporting and the EU’s planned ban on the sale of internal combustion engine vehicles from 2035 (which particularly worries the European auto industry).
Chancellor Merz responds with promises of an “autumn of reforms”: he mentions reducing long-term unemployment benefits, reactivating pensioners in the labor force, and reforming the pension system—a reform Germany has postponed for decades. Merz has also promised reforms aimed at massive infrastructure modernization, increasing labor market and skills flexibility, business deregulation (e.g., changes to the Supply Chain Due Diligence Act), reducing taxes and energy costs, and more. During the campaign, there was also talk of reducing VAT and grid fees for electricity distribution for businesses.
The SPD, as the junior partner in the grand coalition, opposes some of these reforms. They are caught between their role in government and the left-wing opposition, which emphasizes the importance of social and environmental protection. It remains to be seen whether they are aware that—if they block or water down Merz’s reforms too much, and Germany fails to escape from the creeping crisis—they may be paving the way not for their own return, but for the rise of the AfD to power.
The Ifo Institute Identifies the Current Economic Situation as a Crisis
Although, following stagnation in the first half of 2025, real GDP is expected to grow by 0.2% for the whole year, and by 1.3% and 1.6% in 2026 and 2027 respectively, the Ifo Institute identifies the current economic situation as a crisis. However, the expected recovery depends on a new financial framework for infrastructure and defense—meaning, on fiscal expansion. This is another factor that explains the deep transformation of Germany’s economic identity. For decades, Germany was unmatched in its commitment to conservative fiscal principles and fiscal responsibility. Now, Germany is implicitly acknowledging that the economy alone, without fiscal stimulus, cannot resolve the current situation.
Energy: Both a Brake and an Engine
Energy and the country’s flawed energy policy are among the most discussed topics, but energy prices are not the only factor in this story—though they are a major driver. Mario Draghi’s report on EU competitiveness, published in September last year, which returned productivity and competitiveness to the forefront of European policy, begins with the observation that the EU economy pays, on average, two to three times more for energy than the economies of the U.S. and China.
Another key factor behind this lag is weak innovation—especially in new technologies and digitalization. Draghi points out that, among the top 50 companies in new technologies, only four are based in the EU. This is linked to Europe’s (primarily Germany’s) lag in developing the semiconductor and artificial intelligence industries. The Dutch and French are ahead of the Germans in this sector—at least judging by the acquisition of the French AI company Mistral by the Dutch company ASML, a global leader in chip manufacturing technologies.
Therefore, it’s an oversimplification to attribute the problems in the industrial sector (not only in Germany) solely to relatively high energy prices. If that were the case, Finland and Sweden—where electricity (and energy in general) is absolutely and relatively the cheapest—would be industrial powerhouses. But they’re not. The real question is: Where along its historical path did Germany lose its innovative edge?
Even though productivity and competitiveness are broader topics than energy economics alone, energy prices—beyond their objective contribution to unsustainable production costs—carry special significance. They reflect the political paradoxes of our time—populism, which knows no political color or borders. Because of this, employers in many countries see themselves as victims of populism. One argument supporting this view is Germany’s shutdown of nuclear power plants (in contrast, the French were far wiser and more resistant to green populism), and the implicit subsidization of lower energy prices for households at the expense of higher prices for businesses.
No one objects to political decisions to assist households, if such support is targeted and funded from the state budget. But in practice, this is rarely the case: subsidies are extended to all households, and the sources of those subsidies are unclear. Still, Germany is not an extreme case when it comes to electricity pricing policy, since households and businesses pay similar prices.
Energy policy everywhere is a victim of populism and political careerism, even though it has enormous potential to become a space for major innovations aimed at increasing energy availability and reducing its relative long-term cost.
The Crisis of Germany’s Economic Identity
Therefore, the “anger” of German employers can be interpreted as a mixture of dissatisfaction with their own weaknesses (which are still not fully recognized) and public policies (whose shortcomings are better acknowledged), culminating in what we have called the crisis of Germany’s economic identity. Italy, France, and Spain do not face this problem because they are used to being seen as economically weak countries.
Adding to this is a latent fear stemming from an aging population and a limited political capacity to accept immigrant workers, contributing to a growing sense of urgency—even panic—in Germany: we’ve lost too much time, and we don’t have any more to spare.
How Important Is the EU Level?
Merz, who took over the coalition government in March, has jumped on the global wave of renewed interest in deregulation and competitiveness. This explains his communication with an anxious domestic public, as we highlighted at the beginning of this article. But it also explains part of his messaging at the EU level, especially toward the European Commission: focus more on simplifying EU regulations.
Let’s recall: Draghi’s report brought the simplification of regulations and competitiveness back to the center of political attention. The new Commission has adopted this idea and centered its work around the EU Competitiveness Compass (adopted in January). All of this happened after the topic became globally relevant again—following the announcement and subsequent failure of the Musk-Trump DOGE deregulation project in the U.S., and the success of Sturzenegger-Milei’s deregulation project in Argentina. In Germany’s neighborhood, Tusk’s government in Poland also raised the temperature with its reform agenda.
However, let’s be frank—this is hardly revolutionary. The topics of productivity, cost competitiveness, and regulatory simplification have been central to global economic discussions from the fall of the Berlin Wall until the 2008 crisis. After that came years of neglect, during which Brussels became associated with green policies and regulation. Now, with the return of deregulation to the spotlight, Brussels is again in focus, but this time perceived as a symbol of bureaucracy and administrative burden. For example, the Federation of German Industries (BDI) expects a tougher stance in Brussels to defend German interests by opposing costly regulations passed at the EU level.
And that’s not entirely unfounded. There are indeed areas (e.g. the green agenda) where the Commission has driven the expansion and rising cost of regulations. However, only superficial observers buy into the idea that Brussels (the Commission) is the main source of costly rules and red tape. The Commission does what the Council enables it to do through voting, and von der Leyen, who sometimes overreaches with her ambition, can easily be reined in by national leaders like Merz.
It’s important not to lose sight of the fact that key cost factors such as energy policy, taxation, and budget structures are overwhelmingly under the jurisdiction of member states—around 90%, compared to just 10% at the EU level. After all, the EU Commission’s budget is about 1% of EU GDP, while public spending by national governments in percentage of GDP reaches nearly 50% in individual countries.
National leaders sometimes find it convenient to redirect public anger about costs and stagnation toward Brussels, using it as a kind of shield. Merz’s statement from the beginning of this article could also be interpreted that way. Still, as we pointed out, it was also a message to his fellow party member and compatriot, Ursula von der Leyen, to stay within her mandate and focus all her energy on what matters to Germany right now.
Final Thought
Ultimately, the focus of efforts to revive the economy and boost competitiveness and productivity—not just in Germany—should not be Brussels, but rather the actions of national governments. Merz knows this well.
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