The German dilemma

Sean McDaniel and Daniel Bailey

Germany stands at a pivotal juncture. Its model of growth – defined by its highly successful export industries in high end cars and electrical goods – is being fundamentally challenged. Supply chain pressure emanating from COVID-19, energy price hikes, Chinese competition, and the new ‘green subsidies arms race’ intensified by The United States’ Inflation Reduction Act (IRA) have combined to put the self-styled Exportweltmeister (‘export world champion’) in an unenviable position. These pressures are pushing German policymakers to take significant policy action to protect its own national competitive position. In doing so, however, Germany risks undermining the unity and integrity of the EU.

Germany is Europe’s largest economy and most influential political actor, and as such has strongly shaped EU architecture. Traditionally, this has seen Germany’s (and the Deutsche Bundesbank’s) disposition towards fiscal conservatism, limited direct state intervention in the economy, and exchange rate stability become deeply entrenched in the EU institutions. For many years, Germany has benefited from such arrangements and its economy has soared in a global environment marked by growing economic integration and massively expanding demand for German exports from countries such as China. However, this is changing.

New challenges, growing anxieties

Firstly, China has significantly altered its economic stance in recent years and is pivoting away from importing luxury goods towards aiding domestic production to cater for its domestic market. This includes assisting its companies to get ahead of Western competitors, particularly in emerging ‘green’ markets for goods such as electric vehicle batteries and solar panels.

Second, there has been huge disruption to supply chains created first by the COVID-19 pandemic and then Russia’s invasion of Ukraine. COVID halted car production and the bottlenecks it created significantly raised costs. The war in Ukraine, moreover, has posed a huge energy dilemma for Germany and its energy-intensive manufacturing sector, which relied upon imports of cheap Russian gas.

Third, we have seen the emergence of the US as a significant player in the ‘green arms race’. The passage of the IRA, which pledges almost $400bn worth of subsidies to consumers and firms to shift production towards ‘greener’ technologies, has well and truly sounded the starting gun. European companies are beginning to see the US as a much more benign and less risky market to invest long-term capital into. Car manufacturers BMW and Volkwagen, as well as the electric battery producer Northvolt, have all publicly discussed how the IRA changes their investment plans and might see investment shift away from Europe towards America.

This has heightened anxiety across Europe. There are understandable fears over the loss of competitiveness, relocations of production and value added, and threats to jobs. While initially attempting to cajole the US into including European-based firms in its subsidy programme, and lambasting the IRA as ‘unfair’, the EU has changed tack and recognised the urgency of responding. The head of the European Commission, Ursula von der Leyen, has set out her own more muscular approach (more muscular, that is, by EU standards). This includes the loosening of state aid regulations, allowing European states to offer large-scale public funding for green projects if they match incentives offered elsewhere, including the US.

National interest or common good?

While pushed by France in particular, the Commission’s actions have not, however, received unanimous support throughout the bloc. The ‘frugal’ states of Northern Europe, including Ireland, Denmark and the Netherlands, have objected to increased EU-level borrowing. Southern and Eastern European states have similarly expressed concern that relaxing state aid rules and permitting higher spending on assistance for firms would only ‘allow the wealthiest countries, notably Germany and France, to subsidise their industries to the detriment of others’.

Germany finds itself in an awkward position. Traditionally, it has positioned itself as a leader of the more ‘frugal’ economies, desperate to not overcommit to EU-level funds or permit too much state aid. These positions have historically been integral to the protection of its own competitive status vis-à-vis its European rivals, especially France, that would seek to gain competitive advantages via state intervention, spending and currency devaluations. In the new era of ‘green’ global competition, however, this position is beginning to shift.

Germany did not block the EC’s watering down of state aid rules, precisely because this relaxation is designed to assist in the retention of a number of firms that were looking to invest large capital in Germany – including Northvolt and Volkswagen. Controversially, Germany has also taken unilateral action. In September 2022, it announced a €200bn “protective shield” to underwrite the costs of soaring energy for households and businesses. The measure, designed primarily to maintain economic competitiveness for German firms, was roundly criticised in Brussels for undermining the ‘level playing field’ at the heart of the Single Market. Yet, later in May 2023, the Economy Ministry further committed to subsidising 80 per cent of the electricity cost for energy-intensive companies until 2030.

Such measures were necessary, the Ministry argues, because of ‘tough international competition’ in sectors where competition was ‘not taking place on a level playing field’, given Chinese subsidies and Biden’s IRA. Germany has been able to take such measures because it can afford to and, perhaps more importantly, it has opted to do so domestically because its own measures are more targeted and more effective for transition the German economy than EU-wide programmes. The risk of undermining the Single Market, therefore, is being balanced finely against the risk of losing market share.

A New Germany, a new Europe?

The new global ‘green arms race’ could thus yet be the issue which fundamentally challenges European Union integrity. How Germany responds in the coming years will be hugely important for the whole of Europe. Three are a few possible scenarios.

First, Germany continues to prioritise its national economic interest and continues to exploit its privileged fiscal position to bolster the competitiveness of its firms. In doing so, it risks fatally undermining the notion of a ‘level playing field’ in the Single Market, something it advocated so strongly during the Brexit negotiations.

Second, Germany creates further tension inside the bloc by pushing for EU-wide programmes that benefit its firms disproportionately. This will further antagonise neighbouring member states who are either unable or unwilling to fund greater EU-level spending designed to help European economies compete with the US and China in the green arms race.

The third possibility is that Germany addresses some of the distributional dynamics across the Union resulting from a change in policy approach. If it chooses to do so, it may – perhaps unexpectedly – be a crucial player in shifting Europe towards a more interventionist, strategic economic player on the world stage. This will, however, necessitate greater economic redistribution and industrial rebalancing across the bloc – something German policymakers have long been hesitant to commit to given how this might play out domestically.

Whatever happens, something needs to give. Climate change, geopolitical instability and the emerging ‘green arms race’ are altering global economic dynamics. They are sure to reshape the European project along with it.

Sean McDaniel is a Senior Lecturer in Political Economy and will be joining the School of Politics and International Studies (POLIS) at the University of Leeds from September. His book, Divided They Fell: Crisis and the Collapse of Europe’s Centre-Left, is available now from Agenda Publishing.

Daniel Bailey is a Senior Lecturer in International Political Economy at Manchester Metropolitan University. His most recent publication, an analysis of the climate impact of the Bank of England’s emergency monetary policy measures during the Covid-19 pandemic, is available Open Access in British Politics.