STUDY. Germany is becoming less attractive as a business location: dilapidated infrastructure, a growing public sector, and expensive energy are hampering competitiveness. Reforms are long overdue.

Executive Summary

Germany is becoming less attractive as a business location: a dilapidated infrastructure, a growing unproductive state and expensive energy are hampering competitiveness. Market-based reforms are long overdue.

1. Growing challenges and declining performance
Since 2019, gross domestic product has been stagnating, industrial production has been declining and there is no improvement in sight for the near future.

With falling industrial production, an ageing society, dilapidated infrastructure and a lack of defence readiness, Germany is unprepared for the challenges of a future shaped by artificial intelligence.

Russia's war in Ukraine and US tariff policy are creating additional burdens from geopolitical and geo-economic tensions. What are the reasons for the economic weakness, and what is the solution?

2. Ailing infrastructure and the AI challenge

Germany's digital infrastructure is underdeveloped compared to other industrialised and EU countries. The regulation of artificial intelligence by the EU AI Act is expected to create a further barrier to competition. Electricity prices are too high by international standards.

The physical infrastructure (roads, bridges, rail transport) is in need of renovation, causing Germany to fall behind in its leading position in transport infrastructure.

PISA test results have fallen sharply. The higher education system has shortcomings. The number of apprentices is steadily declining. One strength of the education system remains the large proportion of students in engineering sciences.

3. A growing unproductive state

The public sector accounts for just under 50 per cent of gross domestic product. The proportion of people employed in the public sector has grown steadily, even though those employed in the private sector are more productive.

Proliferating regulation originating in the European Union is reducing the effectiveness of the administration and the productivity of the private sector.

Since the turn of the millennium, social security has increasingly displaced investment in infrastructure and defence as government tasks. High taxes and levies as well as dense regulation are slowing down growth.

Capital and high achievers are increasingly migrating away. Immigration into the welfare state generates high costs.

4. Macroeconomic causes of the loss of competitiveness

The European Central Bank's long-standing highly expansionary monetary policy has led to a significant increase in government revenue in Germany, which has been used primarily to expand the welfare state and environmental regulation.

Persistently low interest rates and subsidies have reduced the pressure on companies to drive efficiency gains and innovation. Expansionary monetary and fiscal policy has had distributional effects that favour large companies and administrative centres.

By expanding social security, the state has reduced supply in the labour market. Strong growth in public sector employment and increased regulation have boosted demand in the labour market. The result is a shortage of skilled workers and labour, which has driven up unit labour costs and thus undermined competitiveness.

5. Economic policy recommendations

Geopolitical influence is based on economic strength. Growth and prosperity are based on economic freedom.

Until the turn of the millennium, a market economy in Germany had created sufficient resources to finance the welfare state, defence and good infrastructure without excessive debt.

Specifically, what is needed is not debt, but a stability-oriented monetary policy, significant cuts in government spending and comprehensive deregulation. The tax and contribution burden would have to be reduced by cutting government consumption in order to harness the productivity potential of AI to secure the welfare state.

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Please note: This study is currently only available in German.