Europe’s biggest economy is in crisis. Just look at Volkswagen

Analysis By Hanna Ziady, CNN

London (CNN) — Germany narrowly escaped a recession in the third quarter, official data showed Wednesday, offering some relief to Europe’s biggest economy as its fortunes falter.

Gross domestic product rose 0.2% in the July-to-September period driven by an increase in government and household spending, following a 0.3% contraction in the three months prior, according to Germany’s Federal Statistical Office (Destatis). Destatis revised down GDP figures for the second quarter from -0.1% previously.

Germany’s economy shrank last year for the first time since the onset of the Covid-19 pandemic. The outlook isn’t much brighter: the International Monetary Fund sees zero economic growth this year, marking the weakest performance among major economies.

A sharp drop in profit at Volkswagen only intensified the bad news on economic growth. The troubles facing the German economy are captured by the crisis at the country’s largest manufacturer, which could close factories in its home country for the first time in its 87-year history and cut thousands of jobs.

Volkswagen said Wednesday that operating profit for the nine months to the end of September fell 21% on the previous year to €12.9 billion ($14 billion), hurt by poor performance at its flagship brand and restructuring costs. Vehicle sales slipped 4% on particularly weak demand in China.

The results “demonstrate the urgent need for action in a volatile environment characterized by intense competition,” chief financial officer Arno Antlitz said on a call with analysts and reporters, warning of “painful” decisions.

“We have not forgotten how to build great cars,” Antlitz continued, but stressed that costs in the automaker’s German operations “are far from being competitive.”

“Things cannot continue as they are now,” he added. The company will resume talks with labor unions and employee representatives Wednesday and discuss “possible plant closures in Germany,” Antlitz said.

Volkswagen’s weak earnings point to worsening conditions in the private sector in Germany. According to a survey published last week by S&P Global and Hamburg Commercial bank, manufacturing and services businesses recorded the steepest drop in employment in nearly four-and-a-half years this month.

Business and consumer confidence are at a low ebb. “The biggest worry is currently the big pessimism in Germany,” said Marcel Fratzcher, president of the German Institute for Economic Research in Berlin.

“This mental depression, this incredible pessimism is maybe the strongest impediment in the short run,” he told CNN.

Volkswagen’s woes mirror Germany’s

Volkswagen encapsulates the negativity gripping Germany. The carmaker’s woes will ripple through the entire automotive industry, which is the country’s single largest sector accounting for 5% of GDP and employing almost 800,000 people — about 37% of whom work for Volkswagen, many in well paid jobs.

Volkswagen, which also owns Audi and Porsche, epitomizes the manufacturing prowess and export success that has turned Germany into one of the world’s biggest economies — which is now under grave threat.

“We are not experiencing a crisis in the automotive industry, we are experiencing a crisis in Germany as a business location,” a spokesperson for Germany’s auto association VDA said in a statement following an auto summit last month.

Like Volkswagen, Germany faces high labor costs, weak productivity and competition from China. It can no longer rely on red-hot demand for its exports in the world’s second largest economy, which is increasingly producing locally many of the goods that it used to import from Europe.

“China has become a rival (to Germany),” said Carsten Brzeski, global head of macroeconomics at Dutch bank ING.

According to a recent study commissioned by the Federation of German Industries (BDI), an umbrella organization for business lobby groups, one fifth of Germany’s industrial output is at risk between now and 2030, primarily due to high energy costs and shrinking markets for German goods.

“The lead that the country has built up over decades in areas such as combustion technology is losing importance, and the German export model is increasingly under pressure due to growing geopolitical tensions, global protectionism, and locational weaknesses,” the report, co-authored by the German Economic Institute (IW) and Boston Consulting Group, notes.

It points to Germany’s traditional cost disadvantages, such as high taxes and elevated labor and energy costs, and also cites the threat that an aging population poses to a traditionally strong supply of skilled workers.

The study concludes that the German economy needs “the biggest transformation effort since the postwar period,” requiring additional investments in everything from infrastructure and innovation to education and green technologies of around €1.4 trillion ($1.5 trillion) by 2030.

Brighter fortunes to remain elusive

Yet an economic overhaul on this scale looks unlikely given tight constraints on government borrowing — the so-called “debt brake” — enshrined in Germany’s constitution.

A fractious three-way governing coalition has also obstructed policymaking for months and left the government lacking a clear vision for the country.

While lower inflation could help boost consumption next year, brighter economic fortunes may only come in 2026 when a new government is in place following general elections expected next September, according to Brzeski of ING.

“In my base case scenario we will have another year of a more or less stagnating economy,” he said.

This story has been updated with additional information.

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