While Brussels celebrates past successes, the removal of the veto, the erosion of the Single Market, and accelerated enlargement threaten to turn the European project into something very different from what Spain and Portugal signed up to in 1986.
There is growing frustration in Germany over the nation’s economy. The stagnant economy has caused enormous political problems in Berlin, where tax revenue is nowhere near enough to pay for the perennially growing demands on the welfare state. Like in most of Europe, the stagnant German economy is also permanently impoverishing the young generation.
Echoing these frustrations, on January 5, Deutsche Welle business writer Arthur Sullivan asked if 2026 will be the year when Germany breaks free from its economic stagnation:
Any return to economic growth in Germany in 2026 is expected to be slower and weaker than previously anticipated, according to several economic forecasts.
Yes. Mine is one of them. Back in August, I reported:
Chancellor Merz has conceded that Germany can no longer sustain its expansive welfare state—a fiscal surrender to economic reality that other nations may soon be forced to replicate.
I also explained in detail how the German welfare state consumes two-thirds of the government budget and how it suppresses economic growth. This suppression, in turn, works as a feedback loop of unaffordability into the welfare state: the weaker the economic growth, the weaker the growth in tax revenue as well. The result is a budget deficit that erodes the nation’s economic future and makes it excessively difficult to form a sustainable government.
These are structural economic and political problems emanating directly from the economic stagnation. As Arthur Sullivan reports, that state of stagnation is not going to go away any time soon:
Europe’s erstwhile powerhouse is in the midst of a prolonged economic slump. It has been in recession since late 2022, with only modest growth of around 0.1% expected for 2025. While many economists believe it will return to stronger growth in 2026, hopes of a quick recovery are fading amid doubts over Berlin’s planned investment spree under Chancellor Friedrich Merz.
For the first three quarters of last year, the German economy did indeed expand at an inflation-adjusted 0.1%. Despite overall lethargic economic performance across most of Europe, Germany still managed to end up in 25th place out of the EU’s 27 member states:
Figure 1
The forecasting numbers that Sullivan quotes should have set off all alarm bells within Berlin’s political circles:
Before Christmas, Germany’s Bundesbank lowered its growth forecast for 2026 to 0.6%, down from its previous June forecast of 0.7%. However, the central bank raised the forecast for 2027 to 1.3%, predicting that the pace of economic activity would pick up from the second quarter of 2026. Bundesbank’s modest growth figure prediction chimes with other analyses. Germany’s ifo Institute recently downgraded its growth forecast for 2026 to 0.8%.
I am frankly surprised at how little the German media and political elite seem to care about this long-term economic slump. They cannot blame ignorance; in addition to my own writing on Germany, back in November, the German Council of Economic Experts, GCEE, released their annual report. To say that it painted a bleak picture is an understatement:
The German economy remains weak. While it is likely to grow in 2025 for the first time since 2022, growth will be minimal. The GCEE expects price-adjusted GDP growth of 0.2 per cent compared to the previous year. Weak private investment activity and a weak export economy are weighing on overall economic growth. The GCEE expects GDP to grow by 0.9 per cent in 2026. This is likely to be driven by increased government spending and the high number of working days due to calendar variations.
In other words, the only ‘hope’ for the German economy to grow by any measurable activity at all is that government continues to expand and that—yes—the calendar happens to define more days as workdays in 2026 than it did in 2025.
These are, quite frankly, two lousy sources of economic growth. In addition to making a mockery of the German economy, the quote from the GCEE report reveals a depressing truth: by not including business investments (capital formation) among the growth generators, the report reveals that Germany’s once-mighty corporate sector is no longer investing in the future of the nation’s economy.
Figure 2 illustrates the grim picture. It reports total quarterly business investments in Germany, adjusted for inflation. Check out the downward turn marked by the dark red trendline:
Figure 2
The decline in capital formation in the past few years means that German businesses are slowly rolling back their commitment to productive activities in Germany. They are still spending sizable amounts on factories, warehouses, offices, production and transportation equipment, computers, etc., but that amount is already 7.7% lower in real terms than it was at the end of 2021.
No amount or kind of government spending can replace the bedrock of economic growth that businesses provide as they form productive capital. By the same token, no government handouts can replace the prosperity engine that is private consumption; with consumer spending up only 1.1% after inflation since the end of 2021, there is really nothing left that can bring the German economy to grow again.
Not even the nation’s famous export industry can save it. In the past four years, the sales of German goods and services to other countries have declined more than 6.5% in real terms.
This is nothing short of a macroeconomic emergency. The power brokers in Berlin need to wake up and smell the coffee. When they do, they should immediately take three steps that would help bring GDP growth back to their ailing nation:
1. Immediate and officially declared ‘regulatory ceasefire’ vs. the corporate sector. No more regulations on energy production, pollution, infrastructure, the hiring and firing of labor, or the allocation and investment of capital. This promise not to introduce any new regulations is then followed by the implementation of a Trump-style deregulation plan: appoint a regulatory oversight committee whose job it is to remove regulations in an orderly but brisk fashion. This will gradually allow business owners and executives to ‘breathe’ again.
2. A tax reform aimed at removing disincentives to entrepreneurship and business investments. One of the components in such a reform should be to roll back taxation as a share of GDP from 46.8% (2024) to less than 43.5% (2005). While modest—especially if spread out over 2-3 years—this cut will bring Germany closer to the ‘sweet zone’ of GDP growth that the tax-to-GDP ratio is associated with. All in all, these measures create a pressure of frugality on the public sector without causing the urgent fiscal stress that austerity policies tend to give birth to.
3. Devise and gradually implement a plan to redesign welfare state benefits systems. Instead of using government outlays to redistribute income and consumption from the ‘rich’ to the ‘poor,’ Germany should copy the salient features of the Hungarian conservative welfare model. Its main feature is to support families regardless of income; a refocus of the German welfare state would place natural caps on spending but also revise and reinforce incentives toward employment and entrepreneurship.
I honestly do not believe that there is any configuration of parties in the German Bundestag that could take these three points seriously enough. However, hopefully that will change when they have emptied out all their unproductive government-based plans to make the economy grow again. That better happen soon, though: if the downslope in Figure 2 is allowed to progress much longer, there will not be much of a German industry to reinvest in.
