Amidst the backdrop of Germany recently overtaking Japan as the third-largest economy in the world, its economic minister’s proclamation that the German economy is performing “dramatically bad” may seem strange and out of tune. Yet, his words hint at organizational flaws within the sector of the economy most responsible for Germany’s rapid and sustained economic success: manufacturing. Over the past few decades, Germany has cemented itself as a world leader in an array of different engineered goods, from aircraft and medical devices, to centrifuges used in nuclear energy. Whatever needs to be made to the highest standard, there is probably a German factory making it. Or that at least used to be the case.

A long list of internal and external challenges have put significant pressure on the German industries, to the point where many economists and commentators are predicting that the country could lose its industrial dominance entirely. This claim, if true, would represent a significant shift in national, regional, and even global trade dynamics. Yet, even if it does come true, the future may not be as detrimental as it sounds, seeing that Germany is the world's third-largest economy. To understand why, let's examine how German manufacturing became strong in the first place.

German manufacturing strengths lie in the economic concept of comparative advantage. Essentially, as the world has opened up, goods and services are traded more freely between countries around the world. There has been a general shift towards countries focusing on what they can best excel in through specializing in sectors where they can produce goods more cheaply or easily than other countries. Accordingly, German manufacturing success can be attributed to the comparative advantage it derives from a highly skilled workforce in engineering and manufacturing disciplines, its advantageous geographic position within Europe, and decades of access to very cheap energy. Unfortunately, the very areas from which it derives its comparative advantage are the same areas most under siege by geopolitical events.

For example, energy is of paramount importance to the highly mechanized industry in Germany. Since the mid-1990s, this has been one of the country's core strengths, owing to its ability to pump very cheap natural gas directly from Russia and Norway. However, due to the War in Ukraine, critical supply issues and disruptions in energy transfer to Germany have arisen. These higher energy costs are affecting German manufacturing particularly hard as the country falls behind in its green energy transition and remains dependent on cheap fossil fuels to power factories that consume incredible amounts of energy. Energy problems, though, are just the tip of the iceberg.

Thanks to generous retirement benefits, the incredibly talented and highly skilled German workforce is retiring at a more rapid rate than expected. Having been a key cornerstone of the country's economic system for decades, these benefits are viewed as a right rather than a privilege by large portions of the German electorate. As a result, any attempts at reform are nearly impossible unless a political party is willing to permanently damage its electoral prospects. Typically, advanced economies can offset this by attracting skilled migrants from countries with lower living standards, but Germany has also encountered difficulties in this regard.

Skilled workers are simply not as attracted to Germany as they are to its English-speaking counterparts like the US and UK. The root causes of this phenomenon are complex, but regardless of the reasons, the outcome remains the same: Germany is facing a severe shortage of manpower, with over 750,000 job vacancies in some of the country's key industries remaining unfilled. Moreover, to exacerbate its problems, competition poses a significant concern. Presently, Chinese manufacturing is no longer lagging as far behind German manufacturing as it once did. China's output in advanced manufacturing now competes with that of Germany. In fact, there are now more BMWs being produced in China than in Germany. While this metric may be considered a national embarrassment, it also sheds light on how Germany may move forward. Specifically, if German manufacturing is indeed in decline as statistics like these indicate, a transition could be the way forward.

Similar to how most other advanced economies scaled back manufacturing and transitioned the bulk of their workforce to the service sector, Germany can also make a long-overdue pivot. Instead of overseeing manufacturing themselves, workers could spend their time setting up infrastructure and training teams in other countries to handle it. The USA is currently the largest economy in the world, largely due to being home to companies that conduct most of their operations overseas while still reaping the benefits of the wealth generated from these activities. However, this doesn't imply that there won't be significant issues with such a transition. Mass offshoring could undermine the historically harmonious relations between workers and their companies, as well as the highly egalitarian economic system on which modern Germany has been built. Only time will tell what path Germany chooses to take, when all paths are fraught with downsides.