Has the German economy been hit by the reality shock?

After years of economic success, Germany is facing a harsh reality check. Once seen as the powerhouse of Europe, the country is now grappling with recession, structural challenges, and global transformations. In this wide-ranging conversation, Dr. Jan Cernicky, Head of the Economy and Innovation Department at the Konrad-Adenauer-Stiftung, offers a frank diagnosis of the German economy’s struggles. As the world becomes more fragmented, he argues, dialogue and pragmatic alliances are more essential than ever.

In two years of recession, Germany has gone from being Europe’s model to its sick man. How is this possible? Is it a crisis of the model or simply a period of turmoil?

It’s always made more than one factor, but I think the main factor is that Germany is hit hardest by the different transformation processes that are happening around the world: demographic change, digitalisation, climate change or deglobalisation. If you look at these, we have an ageing population, which brings more cost in the social systems, and we are not very good in digitalisation. If you look at globalisation, Germany was profiting heavily from it, especially trade to China was skyrocketing and now things are going back to normal, which means it’s going down, especially for the car industry, that earned billions and billions in China. That is not possible anymore, things have changed.

The German economy, based on exports, will shrink to a certain level of normalcy. This is now increased also by the behaviour of Donald Trump and other people that try to limit global trade, so Germany is suffering heavily because global trade is not organized as it was before.

Last point is transformation to a climate neutral economy. The decision of German governments not to use nuclear energy anymore and just to rely on solar and wind energy has proven to be very expensive. Of course it is possible to do that, looking also at your capacity for storing energy, but it is very expensive and much more sensitive. We have chosen this path, and this makes energy expensive in Germany.

All these factors combined make it difficult for German companies to invest and innovate. On top of that, there’s an overwhelming amount of regulation, which is a broader issue across many Western countries. The situation I’ve described adds to this burden and creates a lot of frustration. Regulations need to be reduced to a more manageable level, and the new government is working on that. But taken together, all these challenges make things difficult.

The German economy is being hit hard by the reconfiguration of globalisation. How are German companies adapting, particularly in terms of supply chains?

I have my doubts when big companies talk about reshoring or bringing production back to their home countries — I’m not sure it’s always driven by economic reasoning. Sometimes, it seems more like they feel they need to change something in their supply chains anyway, so they might as well see if they can get state subsidies for it.

We did a study some years ago together with the ifo- Institute on risks in supply chains for German companies and we found that in 95% of all the supplies, there are no risks at all, so you can always find other solutions and suppliers. In the remaining 5%, 75% of the goods come from European

suppliers, so there is also no problem at all. What’s remaining is a double-digit number of supplies from China, and we had Russia in the picture before.

So, you have a very limited number of supplies that content risks – raw earth, magnets and some raw materials for chemicals, pharmaceuticals, communication equipment, etc. If you look at these things, I think yes, there is need to adapt to that and it’s a good reason for the companies to diversify their supply chains.

If we want to reorganize supply chains based on risk and resilience, we have to accept that it will cost more. That’s why I often repeated the argument that only in very serious situations — like a real risk of China cutting off access to critical supplies needed for things like pharmaceuticals — should we intervene. In such cases, we need to consider diversifying our supply chains, and governments should also provide some level of support.

German companies are also asking for support, but what I observe is that they are likely to invest anyway. That’s why I believe such support should only be granted in exceptional cases — and even then, subsidies might not be the best solution. Instead, we should be looking to build alliances with other countries to find alternative suppliers, mainly outside of China, even if they are more expensive. The key is to help companies make these alternative value chains profitable. Unfortunately, this shift isn’t happening as much as it should. So we’re trying to push decision-makers in that direction — not by insisting everything must be produced domestically, but by promoting a mix: investing in factories and production capacities at home and looking for competitive alternatives outside of Europe and Germany. In many cases, these alternatives are less expensive, which ultimately benefits the entire economy, because we all know global trade creates more value and prosperity for everyone.

From a French point of view, we’re watching the debate on Germany’s debt brake closely — especially as the country shifts toward a stronger defense role. How is this perceived in Germany, and could it lead to a constitutional change?

I think there are two questions here: one about defense, and the other about the debt brake. Here, reforms undertaken also allow the German Government to take on up to €500 billion in debt for infrastructure investment, something that wasn’t possible before. This marks a significant policy shift. As you might expect, the more left-wing parties are happy because they have always advocated for increased spending. Meanwhile, the conservative Christian Democrats are less enthusiastic, emphasizing the importance of maintaining a sound federal budget. However, very few people in Germany doubt the necessity of investing more in infrastructure.

The main problem with the large influx of funds is that the need to economize in other areas of the federal budget essentially vanishes. At the same time, Germany urgently needs reforms in its social systems, which are currently far too costly, alongside many other expenditures. Tax revenue is currently used to subsidize social systems, so there is a real need to reform these systems. Such reforms would create more financial room to invest in infrastructure. Of course, these reforms are politically difficult to implement, which is understandable given the current political landscape. For now, the chosen solution has been to raise funds through the bond market instead of making reforms.

Second part was the defence spending and here the general opinion thinks that there is a need to invest more in the German army, even the ones that were more pacifist in the past. Everybody knows that in the last at least 20 to 30 years, we have not spent enough money in the defence. The Russian aggression in Ukraine and other conflicts have made it clear that the army must be capable of fulfilling its role, and in many cases, it seems like it’s not the case now.

You mentioned alliances earlier, which inevitably brings us to the question of the so-called Franco-German couple. Our economies have diverged a lot since the past decade. At the same times we share lots of issues in common, beyond the defence. Can we find common ground for the coming years between France and Germany?

I’m very positive. Especially on the German side, the tone seems more open now. Emmanuel Macron clearly expressed his desire for greater cooperation, and while Chancellor Olaf Scholz wasn’t as explicit, Friedrich Merz has been more forthright. So, there is now a real window of opportunity for Franco-German cooperation, and it should be used quickly, before France enters the pre-election phase in about a year.

I think first and foremost, the German French couple is more successful when they work on reforming the European Union. They should then work on ideas to make the EU function better and there are many areas where this is needed. It’s encouraging to see the European Commission looking at how regulation can become more effective and the initiative on the single market is a step in the right direction. Germany and France should push for it. Infrastructure investment also offers strong potential for cooperation. In particular, large-scale projects in research and innovation — which often require billions in funding — would benefit from joint efforts, possibly with additional partners. Take satellite systems, for instance projects like Starlink, Europe needs its own secure alternatives. We can’t rely on Elon Musk deciding whether or not to keep services running. France and Germany could take the lead in creating a European consortium for this kind of infrastructure.

On the other hand, I don’t think that it would be a good idea – what many people express at the moment – that European economic champions should be formed by merging German and French companies. A better approach would be to focus on shared investment in infrastructure, research, and innovation.

This brings us to the question of dialogue, which seems increasingly difficult. The Global Economic Dialogue is an attempt to show that dialogue is still possible. What do you expect about this this event?

Yes, I do expect and look forward to that because we’ll meet people from all over the world. I believe that in the coming years, the world will become a more confused place where there will be need for many diverse alliances, at lower levels. Multilateral organisations like WTO still exist, but they no longer function as they used to, nor will they structure the worldwide relations in economy and trade as they used to do. Instead of reaching global consensus through one forum, we’ll need to build and maintain multiple alliances — five, ten, fifteen different groups — based on shared interests. That requires strong diplomatic and economic diplomacy capacities.

If we can use a place like Aix-en-Provence to begin building these informal connections — which are essential for later formal cooperation — then it becomes a very important space. In an increasingly unclear world, that kind of broad exchange is essential, and I’m really looking forward to it.

The theme of this year’s edition is “Facing reality, a call to action”. What does that evoke to you as a German or as a European?

It tells us, I think, that we need to accept that the world is not as it was 10 or 15 years ago. Donald Trump didn’t change things so much himself, but he showed very clearly that the world where cooperation was paramount has come to an end.

We can no longer expect that everyone understands cooperation as a source of shared welfare. There are actors — like Trump’s U.S. or China — who think only in terms of their own interests and no longer care about cooperation. So, we’re returning more and more to a zero-sum logic in international relations. We need to accept this reality and find ways for us, as Europeans, to maintain areas in the world where cooperation is still possible — because cooperation still brings more benefits than isolation.

That might mean working on smaller topics, but that‘s very important. In the short run, I don’t see any way back to a multilateral world with clear institutions solving global problems. We have to be active, build coalitions in which we can work with partners.