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Industrial Policy

Mittel-kaput? German industry stares into the abyss

FRANKFURT — Is this the beginning of the end for German industry?

Europe’s manufacturing powerhouse is set to scrape by this winter thanks to gas reserves built up over the last eight months, avoiding an energy blackout.

But a darker scenario lurks just over the horizon, as high energy prices and lower gas reserves could conspire to trigger a wave of shutdowns among mid-sized companies unable to weather the storm as larger firms with deeper pockets seek safer economic ground in other countries.

Without relief in the form of cheaper power, the nightmare in 2023 and beyond could be a hollowing out of Germany’s heavy industry — which not only underpins its export-led economy but is also inextricably linked to thousands of suppliers in neighboring EU countries like the Czech Republic and Slovakia. For them, and for the rest of the EU’s economy, the consequences of deindustrialization in Europe’s biggest economy could be catastrophic.

“When we look back at the current energy crisis in 10 years or so, we might consider this time as the starting point for an accelerated deindustrialization in Germany,” said Deutsche Bank economist Stefan Schneider.

In a sign of what may be coming, chemical giant BASF — a pillar of German industry founded 157 years ago — announced at the end of October that it would be “permanently” downsizing its operations in Europe to escape high energy costs. Others are expected to follow.

While BASF is a huge energy consumer whose main site in Europe uses as much gas as Switzerland, pharmaceutical companies and manufacturers are also voracious users that may be tempted to seek cheaper energy elsewhere. Indeed some 9 percent of companies in the Mittelstand — Germany’s famed small- and medium-sized industrial sector — are seriously considering moving their production abroad, according to a survey commissioned by the Foundation for Family Businesses in Germany and Europe, up from 6 percent six months ago.

“There is a baseline expectation that many of the high-energy manufacturing activities, especially in chemicals and pharmaceuticals, will leave to other locations,” said Institute of International Finance Chief Economist Robin Brooks.

Those who lack the financial firepower to uproot and relocate may have no choice but to shut down — including business owners like Per Kadach, a fifth-generation butchershop owner who employs 100 people in Spremburg, eastern Germany, and whose business dates back to before the Franco-Prussian War.

Under new gas contracts effective next year, Kadach said he would have to pay eight times his current bill, while the price of raw materials he needs to run his business has rocketed upwards. 

“The price for the glass we use for [packaging] our liver sausage has doubled over the past year,” he said. “I cannot tell you how much longer we can survive unless things change.”

Scant comfort

For now, Europe’s largest economy is holding up. Gross domestic product grew by 0.3 percent in the third quarter, and Goldman Sachs, which has been more bearish about Germany than other financial institutions, predicts a 1.1-percent contraction in 2023 — painful, but not catastrophic.

“We expect a significant recession, but moderate compared to what we have seen during the financial crisis and the pandemic crisis,” said Jari Stehn, an economist at Goldman Sachs.

Optimists point to the fact that Germany has been able to build up significant gas reserves, and that spot prices have eased from their highs, as reasons to be hopeful. Plus, Germany’s government has put €200 billion on the table to cushion the hit from high energy prices. “Risks of energy rationing have diminished somewhat relative to what we saw a few weeks ago,” added Stehn.

Yet the reprieve is a fragile one.

Germany’s economy is far more dependent on Russian gas than most of its neighbors and has no easy alternative to reach for, given that the Greens in government are hell-bent on opposing any extension of nuclear power beyond a current deadline of 2023. 

In the meantime, there’s little hope that gas prices will drop back to their pre-pandemic levels anytime soon. While medium-term projections are blurry at best, most investors expect the price for natural gas to drop below €100 per MWh only by 2025, which remains five times higher than before the pandemic.

The longer prices remain high, the harder things get for German manufacturers and other energy-intensive industries.

That’s why the International Monetary Fund and other institutions are warning that the real danger for Germany isn’t this winter — it’s the next one. “The winter will be difficult but the winter of 2023 could be even worse,” IMF First Deputy Managing Director Gita Gopinath said in a recent interview. 

Stehn concurred: “Once you come out of this winter, we think that storage tanks are going to be pretty low and Germany will find it much more difficult next year than this year to refill the storage tanks without significant Russian gas flows, particularly if China rebounds and China starts to buy more liquid gas off the global market.”

It is not just rising energy costs — “de-globalization and disentangling from China are likely to remain a headwind for years to come,” said Natixis economist Dirk Schumacher. “The German economy may be potentially heading for years of underperformance vis-à-vis many of its European peers as it has to reinvent itself.”

In that vein, Stehn points to patents as well as research and development in the green sectors as future economic drivers for Germany. The Pfizer-BioNTech COVID-19 vaccine is a shining example of how this edge can turn into real economic value, contributing an estimated 0.5 to German GDP in 2021.

Also, Germany’s low public debt level will help the government provide more aid, if need be.

“This is exactly the kind of medium-term shock in which Germany can now use the fiscal space that it has to smooth the transition, to help people retain jobs, and subsidized industries as it restructures,” added Brooks of the Institute of International Finance.

But Kadach, for one, isn’t hopeful.

“Even the carpenter said he is running out of business because nobody can afford them anymore. Roofers are running out of work because there are no roof tiles. With these energy prices, its simply too expensive to bake the tiles,” he said.

“Unless things change, companies will go out of business.”

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