‘Decarbonisation, derisking and demographics’ top list of Germany’s policy priorities

‘We are preparing for a divided world’, warn industry representatives

In Berlin, OMFIF participated in a series of bilateral discussions with representatives from the government, banking sector and industry. Despite persistent inflation, continued monetary tightening and a wobbly global banking sector, the outlook on Germany’s financial conditions and stability seemed relatively sanguine. The future of the country’s industrial base is the present focus in political and economic spheres, as the economy grapples with increased energy prices, a fragmented global economy and a shrinking labour market.

Transitioning to a sustainable and sovereign energy supply is prime concern

After getting burned due to the European energy crisis last year spurred by the Russia-Ukraine conflict, the energy transition is the top priority for Germany. For decades, cheap gas imports fuelled the country’s industrial base. But since the war, the true cost of Russian gas is coming to light: ‘Germany never priced in the negative externalities into the cost of Russian energy imports,’ one official explained. This includes Russia’s lack of regulation and an oftentimes negligent system regarding environmental degradation.

As the country speeds up its exit from coal and nuclear energy, this is estimated to cost approximately €600bn. While much of this must come from the private sector, there was agreement that this cannot be done solely via banking financing. Most finance in Germany is provided by banks, but German (and European) capital markets need to develop in order to allocate the level of capital needed to facilitate the energy transition.

At present, the investment environment in Germany is difficult for foreign investors, who are competing with ‘local, cheap and public money’, according to one institutional investor. Since the introduction of the Inflation Reduction Act and its subsidy scheme for green infrastructure, there is competition with the US for capital for sustainable project financing.

Though the energy transition is a key imperative for Chancellor Olaf Scholz’ Social Democratic Party and the Greens, the Free Democrats have indicated that they will be taking a harder stance on fiscal expansion. Internal strife within the coalition may hinder progression of the net-zero agenda.

Increasing wariness over China

On the geopolitical front, one industry representative explained that ‘we are preparing for a divided world’. They stated that they are working as quickly as possible to become less dependent and diversify away from China. While Germany does not have the same level of dependency on China as the country had on Russian gas, Germany imports around 90% of its critical raw materials from China. Many of these commodities are essential to produce electric cars and wind turbines.

Unlike the importance of gas exports to the Russian economy, Germany’s share of China’s raw material exports is negligible. The power imbalance here has led to uneasiness for both German policy-makers and industry. One industry representative explained their strategy to diversify away from Chinese raw materials by investing in Canada, Chile and Australia and other countries, ‘but it will take years to derisk’.

The consensus seemed to be that while German industrial production will not be fully repatriating from China. They are anticipating a strategic bifurcation of production streams, described by one representative as ‘East versus West’. Much of the supply chain may remain in China. But strategic and critically important technologies – including high-tech, software and semiconductors – will be ‘nearshored’ to western countries and political allies.

Labour shortages increasingly disruptive to German economy

A rapidly ageing population has led to record-high vacancy rates in Germany, which will drag on long-term growth. Those we spoke with remarked that shortages are not due to the price sensitivity of labour, but rather that ‘there is a structural lack of labour in the Germany economy’.

This chimes with the findings of an industry survey conducted by the Federation of German Industries in June. Labour costs and shortages of skilled workers was the number one challenge to business operations among 200 German small- and medium-sized enterprises, as listed by 76% of respondents. Bureaucracy was listed by 37%, making it the third most common challenge after energy and raw materials costs (62%).

To address the labour market challenges, the government plans to overhaul Germany’s immigration policy. A new legislative proposal (the Skilled Immigration Act) has been put forth by the ministries of labour and the interior. The new policy would seek to attract more non-EU workers to fill the generational gap among a fast ageing population. The proposal has received approval from the cabinet and must now be approved by both houses of parliament before coming into force.

Taylor Pearce is Senior Economist at OMFIF.

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