MNI INTERVIEW: Pricey Energy Means Tough Decade For Germany

Germany’s economy faces a decade or longer to drag itself away from over-reliance on manufacturing while grappling with higher energy prices, green transition costs and de-risking its relationship with China, the head of the Berlin-based German Council on Foreign Relations told MNI in an interview.

Despite expensive efforts to achieve energy independence, Europe and Germany face uncompetitive energy prices for the next 10 or 20 years, Guntram Wolff said, necessitating “painful transitions, and some actual reallocation of our economy [...] towards a model where services become more important, high-end products become more important, knowledge intensive industries become more important, digitalisation becomes more important.”

The next 10 years “really will be the most difficult in terms of the climate transition, “ he added, “because if you look at the cost curves of many of these green technologies, they are coming down rapidly. At the moment, however, some technologies are just still too expensive which explains some of the push-back the German government gets.”

The country’s coalition government last week passed a EUR30 billion top-up to its extra-budgetary Climate and Transformation Fund - which will finance investment in electric vehicles, hydrogen and semiconductor production, and railway infrastructure - taking the package’s total value to EUR212 billion by 2027. Together with boosting climate spending, Germany is also committed to increase defence spending to 2% of GDP.

But the government has had to trim EUR30 billion from its 2024 budget, which Wolff said was probably an unavoidable decision given the need to bring annual borrowing back in line with debt brake rules but an exemplary one at a time when the European Central Bank is frustrated by excessive government deficits as it tries to bring inflation down. (See MNI INTERVIEW: German Court Threatens EUR180 Bln Spending Plan)

CHINA DILEMMA

Another painful adjustment will come as Berlin is compelled to take a clearer line on German investment in China, where DAX-listed companies make up a disproportionate number of all European firms spending money.

"The government needs to credibly commit that it will not cover for eventual losses due to geopolitical developments for these companies to influence their risk-taking behaviour. As a first step, investment guarantees are phased out,” Wolff said. “Since some of these companies are actually big and closely connected with jobs or even government ownership, it is important that more precise guidance is given, perhaps through some outbound investment screening mechanism."

Adding to the financial challenge of managing the transition, ECB interest rates - currently at 3.75% - are unlikely to decline significantly in the near future, said Wolff, who was head of the Brussels-based Breugel economic think tank from 2013 to 2022. (See MNI INTERVIEW: Europe Faces Slow Growth- German Gov't Advisor)

“I don't see interest rates falling for the time being. I see them stabilising, perhaps not increasing further. If you have 2% inflation and 1.5% productivity growth then you end up basically with a 3.5% nominal rate. This whole idea of going back to zero interest rates is for a world in which there's massive overcapacity and an r* that is negative, and I just don’t see that.”