Germany has led headlines since the pandemic.

Recession. Stagnation. Weak Recovery.

Today the threat arising from geopolitical turmoil threatens to hurt Germany even more. But can a more resilient government, led by Friedrich Merz, return Germany to its former dominance?

Macroeconomic State of Affairs

Germany grew 0.3% from the months in the 2nd quarter of 2026.1 Whilst this number seems small, it follows growth of 0.4% for the previous quarter, building a strong foundation for recovery. This recent growth arose from strengthened export demand, which is somewhat reassuring considering the effect Chinese firms have had on German exports in recent years - in particular in the automotive industry. Moreover this may have restored global market confidence which could help to reduce the long term chronic underinvestment Germany suffers from.

The economy showed strong resilience in August, limiting inflation to 2.9% amid a soar in energy prices arising from the Iran war.2 However, long term energy costs have been consistently high post-pandemic due to numerous geopolitical events including the Ukraine war and the Iran war. The issue has been further exacerbated due to the closure of all nuclear power plants in Germany in 2023. This is likely to have affected business profitability and put off investors leading to downwards pressure on GDP.3

Despite the recent increase in exports, Germany remains a shadow of its former self. With a fall in exports in 2023 and 2024, Germany has yet to offset the permanent damage done by increased global competition.4 In particular, due to flat domestic demand, German manufacturers are forced to sell abroad where tariffs and increased competition from countries like China negatively affect exports – a core strength of the pre-pandemic economy, and a key driver of Germany’s last ‘Wirtschaftswunder’ (economic miracle).5

The labour market, on the other hand, is showing extraordinary resilience despite unfavourable macroeconomic conditions, with the current unemployment rate sitting at around 4.2% – much lower than other G7 countries.6 In addition, the participation rate lies at 80%, which represents continued improvement.7

Finally, Germany’s national debt paints a pretty picture. Germany’s debt-to-GDP ratio is 63%, the lowest of the G7.8 This, in theory, should give Germany significant fiscal headroom, cheaper borrowing costs and market confidence, which could allow them to support current recovery via fiscal means. However, in practice, this is not the case due to strict EU budget rules, for example the Maastricht treaty requiring member countries to keep national debt below 60% (though this can be exceeded in the short-medium term). 9

Long Term issues

Despite Germany’s recent improvements and its reputation as an engineering and automotive superpower, Germany’s digital lag hampers its growth. Many German factories lack up to date infrastructure reducing international competitiveness.10 The key issue lies in Germany’s overlooking of recent industrialisation and attitude towards digitalisation. Successive governments in the 80s and 90s prioritised analogue technologies: to give an example, in 1982 Helmut Kohl (the Chancellor of Germany at the time) overturned the previous plan to build a nationwide high-speed, fibre-optic network and instead aggressively deployed coaxial copper TV cables as it was cheaper upfront and easier to distribute. Overall, this allowed countries like the US to get ahead who had prioritised digital venture-backed sectors.11

In an attempt to achieve economic success (via trade surplus), Germany provided subsidies as a form of import protectionism for local industry.12 However, this merely shifted capital to sectors of the economy which were becoming less successful and less productive rather than supporting the growth of new industries which may have had a greater comparative advantage. Due to abundant high skilled labour, strong investment into R&D, and an efficient supply network, German car manufacturing was very successful worldwide through the late 20th and early 21st century. However, in the long run, the potential over prioritisation of this industry may have resulted in other industries – like the aforementioned digital venture-backed sectors – being neglected. Thus, Germany may have missed opportunities to diversify into dominant sectors which had potential to improve overall German productivity, especially considering the decline of the German car market.

The current situation is bleakly similar, with German firms falling behind in AI, LLMs, IOT and quantum computing – looking at them not as transformative technology and innovation, but rather a source of gradual productivity gains.13 This technological lag may finally force Germany to switch from mitigation to adaptation via innovation, despite the risks and their historical reluctance to go against traditional industries.

Furthermore, Germany’s potential is also affected by stiff regulation. Bureaucracy loses Germany an estimated 3% of GDP per year, with firms forced to hire workers for the sole purpose of compliance with these regulations – tying up skilled labour that could be deployed more productively elsewhere.14 Further issues lie in the complexity and amount of legislation which can overwhelm many firms, in particular SMEs.15 This may be another factor affecting investment, as foreign investors might be less likely to invest in places with more red-tape.

Current Affairs

Aside from Germany’s self-inflicted setbacks, geopolitical forces have also been shaping the economy. Rising protectionism from Germany’s largest trading partners may disrupt Germany’s exporting industries, for instance its highly US-dependent automotive and pharmaceutical industries.16 Meanwhile, flat domestic demand and other competing exporters like China only exacerbate the situation. China was Germany’s biggest trading partner in 2025, however the gap between German exports to China and German imports from China is only widening, with Germany running a €40 billion trade deficit with China over the first half of 2025. 17

Of all macroeconomic blows, the recent twin global energy crises have hit Germany particularly hard. Since shifting all of its energy infrastructure away from Russia post 2022, Germany’s energy import dependence has fallen despite the closure of its nuclear power plants. The recent US-Iran war, however, threatens even further damage to critical energy-intensive sectors like chemicals and steel. Though, the recent G7 release of 100 million barrels of oil and the ability to increase coal production have dampened recent pressures. 18 Unfortunately, the full cost of these crises is indefinite, but it is safe enough to say that the longer the Iran-war lasts, the more severe we can expect the impacts to be on the German economy.

Government Responses

It’s clear that the German economy is suffering from numerous short and long term issues; so what can the government actually do?

In March 2025, Germany introduced a debt brake reform allowing half a trillion euros of investment in infrastructure and amended a number of rules, like uncapping defence spending. Such amendments should improve Germany’s global competitiveness. 19 A separate proposed income tax reform set for 2027 would provide relief for low and middle income earners whilst expanding the existing high earner rate to include a 47% band for incomes above 280,000 euros. 20 This could help to revive domestic demand in the short run by providing €10 billion per year in relief. However, the policy may not be fully funded by the increase in the higher tax band leading to a potentially significant cost to an already fiscally constrained government.

Another policy starting in 2027 is the Altersvorsorgereformgesetz (AVRG), which allows savers to save in longer term equities, ETFs and funds which could allow an influx of liquidity into German industry, possibly reinvigorating the finances of domestic firms.21 Moreover, the previous Riester system required mandatory 100% capital contribution guarantees whereas the AVRG allows savers to choose between 100%, 80% and 0% which could lead to larger returns for individuals willing to take on more risk. There are also mounting pressures to improve labour market flexibility by relaxing labour laws, for instance legalising zero-hours contracts. However, adjacent historical employee protection laws – like those protecting against unfair dismissal – would likely be eroded.22

The German Motor: Speeding up or slowing down?

In recent months the German economy has shown signs of resilience in growth terms along with the capacity to limit inflation and unemployment. However, a number of long term factors persist, dampening growth, reducing global competitiveness and squeezing consumers. A digitalisation lag stemming from decades of retrograde policy is holding back growth. Bureaucracy further affects international competitiveness by universally increasing administration costs. The global export battle has intensified as newer players like China have entered the game, taking a chunk out of Germany’s export market share. And EU fiscal limits preventing Germany from utilising government spending effectively allow other nations to outcompete Germany by increasing their own spending on things like infrastructure.

Recent external factors, such as continual pressure on energy prices and geopolitical turmoil, also threaten to cancel out the recent resurgence in the German economy. However, Merz’s government has put a number of policies into place to alleviate these pressures, through promoting investment, tax relief for lower and middle income workers, and a new private pension scheme which includes options with more risk for investors.

Regardless of the way Germany navigates the turbulent waters of geopolitics, it seems the government realises that a full return to strength requires fixing the entrenched foundational issues threatening to sink its economy.

Footnotes

  1. Statistisches Bundesamt (Destatis), Gross Domestic Product (opens in a new tab), 25th August 2026.

  2. Statistisches Bundesamt (Destatis), Consumer Price Index (opens in a new tab), 10th September 2026.

  3. Clean Energy Wire, Finance experts increasingly concerned about impact of Iran war on German economy (opens in a new tab), 20th March 2026.

  4. Statistisches Bundesamt (Destatis), Foreign Trade: Exports and Imports (opens in a new tab), 2026.

  5. International Monetary Fund, Drivers of Germany’s Growth Downturn (opens in a new tab), June 2026.

  6. Statistisches Bundesamt (Destatis), Labour Market: Unemployment (opens in a new tab), 2026.

  7. Trading Economics, Germany Labour Force Participation Rate (opens in a new tab), 2026.

  8. Deutsche Bundesbank, German General Government Debt (opens in a new tab), 31st March 2026.

  9. VoxEU, CEPR, The European Union’s new fiscal rules: A fine line between brilliant masterpiece and another chapter of déjà vu (opens in a new tab), 14th November 2025.

  10. The Guardian, The German problem? It’s an analogue country in a digital world (opens in a new tab), 1st September 2024.

  11. Heise Online, Missing Link: Germany's long road to fiber optics (opens in a new tab), 12th April 2026.

  12. Karl Storchmann, The rise and fall of German hard coal subsidies, Energy Policy (opens in a new tab), 2005.

  13. ESCP Business School, Report shows Germany lacks digital strategy (opens in a new tab), 26th February 2024.

  14. Deutsche Bundesbank, Structural challenges for the German economy (opens in a new tab), 8th May 2026.

  15. Federal Ministry for Economic Affairs and Energy, Making our everyday life easier and reducing the burden on business (opens in a new tab), 2026.

  16. CBRE, Germany in Focus: Navigating the Impact of U.S. Tariffs (opens in a new tab), 20th June 2025.

  17. Statistisches Bundesamt (Destatis), Ranking of Germany's trading partners in foreign trade (opens in a new tab), 2025.Reuters, German trade deficit with China grows as Beijing relies less on European industry (opens in a new tab), 10th August 2026.

  18. BBC News, G7 to release millions of barrels of oil and diesel after Trump threat (opens in a new tab), 3rd October 2026.Reuters, Could Germany run some of its coal-fired power plants longer? (opens in a new tab), 14th August 2026.

  19. Deutsche Bank (Flow), Germany Update: Breaking from the brake (opens in a new tab), 2025.

  20. Federal Ministry of Finance, Promoting fairness: German government provides relief for low and middle-income earners (opens in a new tab), 2026.

  21. BDO, Reform of subsidised private pension provision (opens in a new tab), 12th December 2025.

  22. Cross Channel Lawyers, German Labour Law: The Basics of Employee Protection against Dismissal (opens in a new tab), 11th June 2012.