3 Economic Challenges Facing Germany in the 2020s

Germany plays a key leadership role among its surrounding eurozone countries. The nation had the largest economy in Europe and relatively low unemployment compared to other euro area countries as of late 2020. Christine Lagarde was the managing director of the International Monetary Fund (IMF) in 2018 and listed three issues of concern for Germany both in terms of its own future and other European nations.

In 2020, the coronavirus crisis substantially changed the economic outlook in Germany and the rest of Europe. Lagarde later became President of the European Central Bank (ECB), where she pursued aggressive stimulus measures, despite objections from German policymakers.

In the short run, the need to deal with the virus and the economic impact of containment measures dominates public attention. However, the issues identified by Lagarde in 2018 are likely to continue throughout the 2020s. If anything, the coronavirus crisis seems likely to increase some of these imbalances.

1. Low Wage Growth and Inflation

One challenge Germany faces is improving wage growth for workers. Following the 2008 global financial crisis, German workers accepted low wage growth in return for job security.

However, Germany still had a relatively low unemployment rate in 2020, despite much higher unemployment in many other countries. If German workers received wage increases, they might be inclined to spend more and save less, which would boost the German economy.

According to Lagarde, an increase in wage growth in Germany would also help other euro area countries. It would bring the euro area's inflation rate closer to the European Central Bank's target and keep prices stable.

According to the Phillips curve, economic growth leads to inflation. That means Germany's famously low inflation rate leaves room for more pro-growth policies.

2. An Aging Society and Low Debt

Germany had a budget surplus before the coronavirus crisis, and its public debt ratio was lower than most other developed countries. Hence, there is more room for the government to increase public spending.

However, the government must choose how to allocate resources to long-term investment initiatives while also saving money to pay for its aging population's pensions and healthcare. Some of these initiatives include road construction, training programs for the recent influx of refugees, quality child care, and after school programs.

Germany relies heavily on its auto industry and exports to Asian countries, many of which are industrializing. But some economists see a need for Germany to invest more in digital ventures and R&D. The government is spending more to provide the impetus for venture capital investment in small and mid-size businesses that pursue software and technology innovations.

3. Balanced Savings and Investments

Germany had the largest current account surplus in the world, which means that the country exported more than it imported. But this implies that German citizens are saving rather than spending, which hampers economic growth. Lagarde considers the current account surplus too large. She saw a significant challenge for Germany in terms of reducing the need for the population to save for retirement by encouraging older workers to stay in the workforce.

It is true that the coronavirus crisis led to temporary border closures and a reduction in trade. On the other hand, Germany's relatively low coronavirus-related deaths and early reopening of the economy could increase its advantages as trade resumes.

Europe and Increased Cross-Border Risk

The whole euro area was showing signs of potential strong growth in 2018, according to Lagarde. However, she wisely foresaw that Germany and its neighbors needed a cushion to provide relief during the next economic downturn. Lagarde called for the advancement of the capital markets union to encourage cross-border sharing of risks. That would require countries with high debt levels to reform their budgets and all countries to increase their productivity.

Unfortunately, productivity has been mostly stagnant since the global financial crisis. Furthermore, the temporary breakdown of open borders within Europe during the coronavirus crisis highlighted the need to strengthen European integration.

Germany entered 2020 with a rosy economic outlook, but that was before the coronavirus recession. The country will undoubtedly be affected by the speed of reforms in the euro area, which are slower than Germany would like. Barriers to trade were already on the rise and increased dramatically during the spread of the virus. All of these factors could hinder Germany's growth and that of other European countries.

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