Merkel Leaves the German Economy With Trouble Under the Hood

During her 16 years as Germany’s chancellor, Angela Merkel has become an international avatar of calm, reason and democratic values for the way she handled crises that included a near financial meltdown of the eurozone, the arrival of more than a million migrants and a pandemic.

Today Germany is an economic colossus, the engine of Europe, enjoying prosperity and near full employment despite the pandemic. But can it last?

That is the question looming as Ms. Merkel prepares to leave the political stage after national elections on Sept. 26. There are signs that Germany is economically vulnerable, losing competitiveness and unprepared for a future shaped by technology and the rivalry between the United States and China.

During her tenure, economists say, Germany neglected to build world-class digital infrastructure, bungled a hasty exit from nuclear power, and became alarmingly dependent on China as a market for its autos and other exports.

The China question is especially complex. Germany’s strong growth during Ms. Merkel’s tenure was largely a result of trade with China, which she helped promote. But, increasingly, China is becoming a competitor in areas like industrial machinery and electric vehicles.

Economists say that Germany has not invested enough in education and in emerging technologies like artificial intelligence and electric vehicles. Germans pay some of the highest energy prices in the world because Ms. Merkel pushed to close nuclear power plants, without expanding the country’s network of renewable energy sources enough to cover the deficit.

“That is going to come back to haunt Germany in the next 10 years,” said Guntram Wolff, director of Bruegel, a research institute in Brussels.

There was never much pressure on Ms. Merkel to focus on fundamental economic policy because the German economy has boomed during her tenure. Germany has recovered from the pandemic faster than other European countries like France or Italy.

But the pandemic has also exposed Germany’s economic dependence on China.

In 2005, China accounted for a fraction of German exports. Last year it surpassed the United States as Germany’s largest trading partner. China is the biggest market by far for the automakers Volkswagen, Mercedes-Benz and BMW. German companies have also thrived by equipping Chinese factories with machine tools and other industrial goods that made China an export powerhouse.

Ms. Merkel abandoned her early emphasis on human rights in her relations with the Chinese government and instead encouraged ever deeper economic ties. She hosted Chinese leaders in Berlin and traveled 12 times to Beijing and other cities in China, often with delegations of German business managers. But Germany’s economic entanglement with China has made it increasingly vulnerable to pressure from China’s president, Xi Jinping.

Late last year, while Germany took its official turn setting the agenda of the European Union, Ms. Merkel and President Emmanuel Macron of France pushed through an investment accord with China over the objections of the incoming Biden administration, largely bypassing other European allies.

“German trade with China dwarfs all other member states, and Germany clearly drives policy on China in the E.U.,” said Theresa Fallon, director of the Center for Russia Europe Asia Studies in Brussels. Germany’s economic dependence on China “is driving a wedge in trans-Atlantic relations,” Ms. Fallon said.

In recent years China has been using what it learned from German companies to compete with them. Chinese carmakers including Nio and BYD are beginning to sell electric vehicles in Europe. China has become the No. 2 exporter of industrial machinery, after Germany, according to the VDMA, which represents German engineering companies.

Ms. Merkel’s supporters say that she has helped the German economy dodge some bullets. Her sharp political instincts proved valuable during a eurozone debt crisis that began in 2010 and nearly destroyed the currency that Germany shares with 18 other countries. Ms. Merkel arguably kept hard-liners in her own Christian Democratic Union in check as the European Central Bank printed money to help stricken countries like Greece, Italy and Spain.

But her longtime finance minister, Wolfgang Schäuble, was also a leading enforcer of policies that protected German banks while imposing harsh austerity on southern Europe. At the time, Germany refused to back the idea of collective European debt — a position that Ms. Merkel abandoned last year, when faced with the fallout from a pandemic that threatened European unity.

Ms. Merkel had some luck on her side, too. The former communist states of East Germany largely caught up during her tenure. And Ms. Merkel profited from reforms made by her predecessor, Gerhard Schröder, which made it easier for firms to hire and fire and put pressure on unemployed people to take low-wage jobs.

Mr. Schröder’s economic overhaul led to a sharp decline in unemployment, from more than 11 percent when Ms. Merkel took office to less than 4 percent. But the changes were unpopular because they weakened regulations that shielded Germans from layoffs. They paved the way for Mr. Schröder’s defeat by Ms. Merkel in 2005.

The lesson for German politicians was that it was better not to tamper with Germans’ privileges, and for the most part Ms. Merkel did not. Many of the jobs created were low wage and offered limited chances for upward mobility. The result has also been a rise in social disparity, with a rapidly aging population increasingly threatened by poverty.

“Over the past 15 to 16 years we have seen a clear increase in the number of people who live below the poverty line and are threatened,” said Marcel Fratzscher, an economist at the D.I.W. research institute in Berlin. “Although the 2010 years were very economically successful, not everyone has benefited.”

Ms. Merkel’s failure to invest more in infrastructure, research and education, despite her background as a doctor of physics, also reflects the German aversion to public debt. Mr. Schäuble, as finance minister, enforced fiscal discipline that prioritized budget surpluses over investment. The German Parliament, controlled by Ms. Merkel’s party, even enshrined balanced budgets in law, a so-called debt brake.

The frugal policies were popular among Germans who associate deficit spending with runaway inflation. But they also let Germany fall behind other nations.

Since 2016 Germany has slipped from 15th to 18th place in rankings of digital competitiveness by the Institute for Management and Development in Lausanne, Switzerland, which attributed the decline partly to inferior training and education as well as government regulations. Between 40 to 50 percent of all workers in Germany will need to retrain in digital skills to keep working within the next decade, according to the Labor Ministry. Most German schools lack broadband internet and teachers are reluctant to use digital learning tools — a situation that became woefully apparent during the coronavirus lockdowns.

“Technology is strategic. It’s a key instrument in the systemic rivalry we have with China,” Omid Nouripour, a lawmaker who speaks for the Green Party on foreign affairs, said during an online discussion this month organized by Berenberg Bank. “We didn’t create enough awareness of that in the past.”

The need for Germany to modernize has become more urgent as climate change has become more tangible, and as a shift to electric vehicles threatens the hegemony of German luxury automakers. Tesla has already taken significant market share from BMW, Mercedes-Benz and Audi, and is building a factory near Berlin to challenge them on their home turf. Until last year, the financial incentives that the German government offered to buyers of electric cars were substantially smaller than the tax credits available in the United States.

“What is very important for Germany as an industrial nation, and also for Europe as a place for innovation, is a symbiosis between an ambitious climate policy and a very strong economic policy,” Ola Källenius, the chief executive of Daimler, told reporters at the IAA Mobility trade fair in Munich.

Auto executives do not criticize Ms. Merkel, who has been a strong advocate for their interests in Berlin and abroad. But they implicitly fault her government’s sluggish response to the shift to electric vehicles. While Germany has more charging stations per capita than the United States, there are not enough to support increasing demand for electric vehicles.

“The framework for this transition of the auto industry is not complete yet,” said Oliver Zipse, the chief executive of BMW and president of the European Automobile Manufacturers’ Association. “We need an industry policy framework that begins with charging infrastructure.”

Said Mr. Källenius of Daimler, “We are in an economic competition with the United States, North America with China, with other strong Asian countries. We need an economic policy that ensures that Europe remains attractive for investment.”