Germany : a case of long-covid ?

The German economy has been broadly stagnating over the last couple of years , with the level of economic activity now only slightly higher than before the pandemic. This is in stark contrast to other euro area countries , where real activity is now significantly higher than in pre-pandemic times. The inability of the German economy to reach escape velocity and to return to its old growth path reflects a combination of cyclical sluggishness in some sectors, less support from the fiscal side and structural changes that are affecting the German economy more than others. T he structural headwinds – the rise of China as a direct competitor and a semi- permanent upward shift in energy costs - have made the pre-exi s ting weak spots of the economy look more problematic than previously. Factors such as high wage costs and a high tax burden, which seemed acceptable in the pre-pandemic world, appear now more threating to the outlook of the German economy than in the “old world”. The continuing weakness of the industrial sector and corporate investment spending poses the risk of a self-re-enforcing downward adjustment. As industrial clusters shrink , productivity tends to decline as internal and external local economies of scale weaken. Whether this process has started now in earnest is hard to say . But what seems clear is that the nature of these challenges demand s more than a piecemeal response from the government.