Elections in Germany won’t improve a weak economic outlook

Germany’s election takes place later this month with its economy in a perilous state. The incoming administration faces an uphill battle just to keep economic growth in positive territory, and a third consecutive year of contraction can’t be ruled out.

We currently expect the German economy to return to growth in 2025, but only just. A predicted 0.4% rise comes as a small relief after contractions in 2023 and 2024, but with prevailing headwinds to trade and investment still largely in place, even this meagre uptick is far from guaranteed. With an unpredictable new President across the Atlantic, trade risks may even rise.

Even so, if the outlook for 2025 and 2026 is bleak, it’s not entirely without hope. The new government can do much to improve conditions for German business, if it can reconcile its own internal tensions.

A state of malaise

It’s impossible to sugarcoat the current state of the German economy. In 2024 exports fell by 0.7% and fixed investment by 2.7%. Exports contracted for the second consecutive year after a weak performance by the electrical equipment, machinery and automotive sectors. We expect industrial production to contract by 2% in 2025, while the consumer sector - hamstrung by higher inflation - is expected to grow by just 1.3%.

Key sectors are fighting to escape stagnation’s grip. Germany’s celebrated car industry is expected to grow by maximum 2% in 2025, after suffering a 4% contraction in 2024. Construction output is set to level off after a 3% decline in 2024. Machinery production is unlikely to climb out of negative territory, with a 0.7% contraction following a 5.7% decline last year.

While the figures are discouraging, at least they are mostly moving in the right direction, albeit at snail's pace. Unfortunately, a new problem for Germany’s tepid economy has just moved into the White House.

“The export sector was already having a hard time, but the election of President Trump in the US may just have made a bad situation worse,” says Theo Smid, economist at Atradius. “Exporters are facing an increasingly gloomy outlook as President Trump threatens tariffs against the EU and in particular German car exports.”

The impact of recently imposed US steel and aluminium tariffs on German exports will be modest, but the possibility of across-the-board tariffs on imports from the EU remains high. According to an Oxford Economics analysis, a 10% blanket US tariff on EU exports would cause a drag on German economic growth of 0.3 percentage points this year and 0.4 percentage points in 2026.

“That could be enough to drag the German economy down to almost zero growth this year,” says Smid. “And this at a time when German manufacturers are also struggling to compete with cheaper Chinese goods in global markets.”

Business alarm bells are ringing

The sense of gloom afflicting the German economy is reflected in business sentiment, which sits at a seriously low ebb.

An Atradius survey of more than 470 German companies, conducted at the end of last year, found that only 14% expect the economy to improve in 2025. Nearly a third of respondents (32%) expect the economic situation to deteriorate while over half (54%) think it will get neither better nor worse.

This pessimism is easy to understand. German business insolvencies increased by 24.3% year-on-year in 2024. Nearly a third (30%) of the companies we surveyed say the risk of bankruptcy in their sector is high.

What can the eurozone’s most important economy do to reverse its fortunes? Our respondents want the government to focus on four issues in particular. Nearly four fifths (82%) want a reduction in bureaucracy and 73% a reduction in energy costs, while 61% call for tax relief and 54% for political stability.

Is a new government the answer?

And so all eyes turn to the snap election of 23 February, and what the result might mean for the chances of economic renewal.

“The outcome is likely to deliver a less fractious governing coalition than the previous one, and that is positive for the prospects of political stability,” says Christian Bürger, senior editor at Atradius. “At the same time, it’s unlikely that the new administration will be able to deliver a swift structural reform agenda or major growth impetus in the short term. Any expectation of a rapid change in Germany’s fortunes is probably wide of the mark.”

The next government will likely be made up of uncomfortable bedfellows from the centre-right and centre-left of the political spectrum. The conservative, centre-right CDU/CSU is currently leading the polls, but it is likely to require at least one partner from the centre-left, which means either the Social Democratic Party (SPD) or the Greens.

“Much depends on whether the liberal FDP, the left wing-nationalist BSW and the Left party manage to cross the 5% vote-share threshold to enter parliament,” says Bürger. “The performance of the far right AfD is also an important factor. Coalition negotiations that drag on for longer than expected can’t be ruled out.”

Compromise between government partners should come easier in the coming term, but major differences in outlook will likely slow reforms and bias outcomes towards the status-quo. But the status quo is not what the economy needs.

No more empty promises

To kick start the economy, the new government must instead make difficult decisions quickly. In this, the omens are not positive. There might be bipartisan plans to reduce excessive bureaucracy and cut costs, but Germany has been here before. In recent years promise has rarely translated into action.

In other areas, likely coalition partners hold opposing views, which could paralyse government action. For example, the CDU, SPD and Greens all propose support for business, but disagree on what that means. And while the right supports social spending cuts, the left opposes any substantial reduction in social support.

Similarly, there is cross-party support for a further easing of energy costs, but the transition to green energy is more controversial. For instance, the CDU plans to abolish a major reform of heating regulations spearheaded by the Greens.

“One interesting area is the debt brake,” says Bürger. “The CDU has cautiously opened the door to reform of Germany's debt brake, which restricts the size of the federal government’s budget deficit to 0.35% of GDP, enshrined in the constitution. Reform could allow wider structural deficits in order to pursue much-needed public investments and provide financial leeway.”

But this, too, faces obstacles. Many in the CDU itself are sceptical, and a major revision would require opposition support in parliament. Nevertheless, some kind of reform of the debt brake, or a new off-budget vehicle to circumvent it, looks increasingly likely, even if the lack of detail and probable implementation delays mean any impact will not be felt till 2026 at the earliest.

An uncertain outlook

While expectations of the incoming government will be high, its impact on the economy is likely to be low in the short term. Headwinds are too strong, and government activity likely too constrained, for significant progress in 2025.

There may be some exceptions. In industrial policy, support for the ailing automotive industry - and the huge number of jobs it supports - could be a priority of the new administration. But in general, German businesses can expect more of the same over the next 12 months. Fiscal prudence will limit capital spending on infrastructure and construction is likely to remain subdued.

“Overall, we expect the economy to struggle this year, with a maximum 0.4% GDP growth,” says Smid. “For 2026 we forecast a modest 0.8% expansion, taking into account blanket US tariffs of 10% on EU imports. Uncertainty will remain high. Abrupt changes in the US trade policy as well as forceful demands for higher defence spending cast a shadow.”

More optimistically, coalition partners could put their differences aside in the face of US volatility and geopolitical uncertainty, and lead a reforming administration that drives the fundamental change German businesses are asking for. At this point that seems unlikely, but the need for decisive action is becoming critical.