Worst is over in German manufacturing sector

• In 2023, Germany's economy fared the worst among major economies, with GDP declining by 0.3% year-on-year and industrial production dropping by 2.5% compared to 2021. This can be attributed to its heavy reliance on manufacturing, past reliance on Russian gas, weak construction sector, and reduced global trade.

• The cyclical factors explaining the weak manufacturing sector are expected to ease further so the German manufacturing sector will be able to muddle through nearterm and seize growth opportunities.

• The German manufacturing sector faces significant structural challenges from a declining work force, higher energy prices, and uncertainty about climate and fiscal policies, which means structural growth will be weak in coming years.

German economy lags peers due to reliance on manufacturing

The German economy's underperformance compared to peers is largely due to its heavy reliance on manufacturing. Industrial production in Germany has declined over the past two years, notably dropping by 2.5% in 2023 compared to 2021. This decline mirrors a broader trend seen across the euro area, attributed to the significant increase in borrowing costs following ECB policy tightening. The impact on the German economy is amplified by the substantial contribution of manufacturing and construction sectors, accounting for 31% of the economy, exceeding the euro area average of 23%.

Germany falters due to Russian gas supply shutdown

The German manufacturing sector has faced pronounced challenges compared to its euro area counterparts, largely due to its historical dependence on Russian gas. In 2021, 60% of German natural gas consumption came from Russia, with 33% and 24% of oil and coal, respectively, also originating from there. The cessation of Russian gas imports in 2022 exacerbated the increase in energy prices for German manufacturing. As a result, energy-intensive sectors experienced a notable 16% decline in production since 2021, while overall industrial production decreased by 2.5%. These energy-intensive industries accounted for 26% and 22% of total industrial production in 2022 and 2023, respectively. In 2023, these sectors, making up 16% of manufacturing employment, saw a 0.2% decrease in employment, while others’ rose by 1.3%, and thus, marginally cooled the labour market.

Germany weak due to openness of the economy

The highly open nature of the German economy has rendered it particularly vulnerable to the downturn in global trade witnessed last year. With trade to GDP ratio standing at 90% in Germany, in stark contrast to 67% in France and 18% in the US, the German economy's heavy reliance on exports is evident. Notably, vehicles, machinery, and electric equipment collectively constitute 45% of German goods exports. The reduction in the volume of world trade coupled with subdued demand for manufactured goods in trading partner nations, as indicated by our German export barometer (see chart on next page), have coincided with the decline observed in German exports.

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