Germany: Recession over! Current forecast predicts economic recovery by 2026 – but skepticism remains – Image: Xpert.Digital
Can Germany maintain its positive trend? Why Germany still faces major challenges
Germany's economy between hope and reality – What is the current situation of the German economy?
The German economy will reach a turning point at the end of 2025. After two years of recession and a sustained period of weakness, hope for a tangible recovery is emerging for the first time. The leading German economic research institutes have presented their forecasts for the coming years in their latest autumn report, which provide both reason for optimism and caution.
Economic development in recent years has been marked by a series of serious crises and structural challenges. Russia's war of aggression against Ukraine, which violated international law, the associated energy price increases, the aftermath of the coronavirus pandemic, and growing geopolitical tensions have plunged the German economy into a deep crisis. Core industrial sectors such as the chemical and automotive industries were particularly hard hit, suffering from both weak demand and rising energy costs.
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What do economic institutes expect for the coming years?
For the current year, 2025, leading economic research institutes expect modest growth of just 0.2 percent of gross domestic product. While this weak growth marks the end of the recession, it can hardly be considered a breakthrough toward a sustained recovery. The development thus falls far short of the expectations for this period just a few years ago.
The outlook for 2026 is significantly more optimistic. The institutes forecast growth of 1.3 percent. Experts even anticipate a further increase to 1.4 percent in 2027. These forecasts are largely based on the federal government's planned investment programs, which are expected to take full effect starting in 2026.
The ifo Institute is somewhat more optimistic in its own forecast, predicting growth of 0.2 percent for 2025, 1.3 percent for 2026, and even 1.6 percent for 2027. This slight upward deviation reflects the different methodological approaches and assessments of the various research institutes.
Why are experts skeptical despite the positive forecasts?
Despite the seemingly encouraging growth forecasts for 2026 and 2027, economic experts are clearly skeptical about the sustainable development of the German economy. Geraldine Dany-Knedlik of the German Institute for Economic Research, who heads the economic research team at DIW Berlin, sums up the problem: "The German economy remains on shaky ground. While it will recover noticeably in the next two years, this momentum will not last, given persistent structural weaknesses."
The researchers' skepticism is based on the realization that the expected growth is primarily due to government investment programs and not to a fundamental improvement in the competitiveness of the German economy. While the domestic economy is noticeably picking up speed, this only masks the structural problems, not solves them. The institutes urgently warn that without fundamental structural reforms, the positive momentum will be short-lived.
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What structural problems do the German economy burden?
The German economy is grappling with a multitude of structural challenges that threaten its long-term competitiveness. These problems have been building up over the years and are being exacerbated by current global developments.
A key problem is the high energy and unit labor costs compared to other countries. German industrial consumers pay up to five times more for gas and 1.5 to 2.5 times more for electricity than their major geopolitical competitors. This cost burden makes German products less competitive on global markets and is leading companies to increasingly shift investments abroad.
The shortage of skilled workers is further exacerbating the situation. Germany is facing a dramatic demographic shift, with the baby boomer generation entering retirement while at the same time there is a shortage of young workers to replace them. This development is significantly reducing the available labor supply and thus the production potential of the German economy.
The competitiveness of German industry is continuously declining. This is reflected both in declining market shares on global markets and in Germany's declining attractiveness as a business location for international investors. Energy-intensive sectors, which traditionally formed the backbone of German industry, are under enormous pressure.
What is the impact of government investment programs?
The German government has launched extensive investment programs designed to revive the economy. These programs include direct government investments in infrastructure and defense, as well as tax incentives for companies. The immediate investment program, known as the "Investment Booster," will provide companies with a total of €48 billion in relief through 2029.
The most important measures include declining-balance depreciation of up to 30 percent for investments in machinery, equipment, and vehicles acquired between 2025 and 2027. In addition, the corporate tax rate will be gradually reduced from 15 to 10 percent starting in 2028. These measures are intended to strengthen companies' willingness to invest and thus stimulate economic growth.
The fiscal stimulus amounts to €9 billion in 2025, €38 billion in 2026, and €19 billion in 2027. Estimates suggest that gross domestic product could increase by a total of €29 billion by 2029, corresponding to additional growth of approximately 0.15 percent per year.
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Why do the institutes call for comprehensive structural reforms?
While the economic institutes see the government investment programs as an important short-term stimulus, they warn emphatically that they alone will not be sufficient to sustainably strengthen the German economy. The autumn report bears the telling title "Expansive Fiscal Policy Masks Weak Growth," which underlines the researchers' critical stance.
The institutes have developed a twelve-point plan for structural reforms covering various areas of economic policy. These reform proposals aim to sustainably improve Germany's competitiveness and increase its production potential.
A key issue is the stabilization of social security contributions. Demographic trends are leading to rising costs in pension, health, and long-term care insurance, which is driving up non-wage labor costs and reducing companies' competitiveness. The institutes are therefore calling for efficiency improvements in the healthcare system and a slowdown in pension increases.
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Reducing bureaucracy and digitization as growth drivers?
What role does energy policy play in the future?
Energy policy is one of the decisive factors for the future of the German economy. High energy costs not only threaten the competitiveness of energy-intensive industries, but also burden all other sectors of the economy. German companies currently pay significantly more for energy than their international competitors, weakening their market position.
The energy transition, which is fundamentally necessary to achieve climate goals, brings with it further challenges. Without careful planning and implementation, it threatens to lead to further cost increases. Particularly problematic are the high grid fees and energy taxes compared to other countries, which place an additional burden on German companies.
The institutes therefore call for a reform of energy policy that places greater emphasis on price signals. The CO2 price should be used as a market-based instrument instead of relying on complex regulations. At the same time, electricity taxes must be reduced to the EU minimum level and grid charges stabilized.
The expansion of hydrogen infrastructure is another important building block for the decarbonization of industry. Germany must both advance domestic development and develop international partnerships for the import of green hydrogen.
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How is the production potential of the German economy developing?
Potential output, i.e., the maximum economic output that can be achieved at full employment and normal capacity utilization, has declined dramatically in Germany in recent decades. While potential growth was around 3.3 percent in the 1970s, it has fallen to an average of 0.4 percent in the 2020s.
This development is particularly worrying because it limits the long-term growth potential of the German economy. Germany's production potential is currently more than five percent below the level expected in 2019 for 2024. Compared to other countries, Germany is thus lagging significantly behind.
The reasons for this decline are manifold. Demographic change is leading to a shrinking labor force. Investment activity is too low by international standards, weakening the economy's capital base. At the same time, total factor productivity, which is primarily determined by technological progress and efficient resource allocation, has grown only weakly.
What can be done to strengthen growth potential?
To increase the growth potential of the German economy again, comprehensive reforms in various areas are necessary. Economic institutes have developed concrete proposals that can bring about both short-term and long-term improvements.
One important approach is to better utilize the existing labor force. This includes increasing the employment rate of women, older workers, and existing immigrants. At the same time, the integration of immigrants into the labor market must be improved. Increasing net immigration from 250,000 to 400,000 people per year could increase production potential by about one percent in 2030.
Extending working life is another important component. Early retirement without penalty should be made less attractive to create incentives for longer working lives. This would not only increase the workload but also reduce the burden on social security systems.
Investments in education and training are crucial for increasing productivity. Germany must invest more in the training and development of its workforce while simultaneously reducing barriers to the immigration of skilled foreign workers.
What is the importance of reducing bureaucracy and administrative reform?
Reducing bureaucracy and modernizing administration are key demands of economic institutes. German companies suffer from excessive bureaucracy, which not only incurs costs but also hampers innovation and delays investment decisions.
The German government has set itself the goal of reducing bureaucratic costs for businesses by 25 percent, equivalent to approximately 16 billion euros. However, the progress made so far is not yet sufficient to bring about noticeable improvements for companies.
The lengthy approval procedures for infrastructure projects and industrial facilities are particularly problematic. These not only delay important investments but also make Germany unattractive for international investors. Accelerating and digitizing administrative procedures is therefore urgently needed.
The institutes also call for a reduction in administrative staff while simultaneously increasing efficiency. Modern technologies, especially digitalization, can help simplify and accelerate administrative processes.
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How do international developments affect Germany?
Germany, as a strongly export-oriented economy, is particularly affected by international developments. The increasing fragmentation of the global economy, protectionist measures, and escalating geopolitical tensions are placing a significant strain on German industry.
The US trade policy is particularly problematic. The import tariffs already imposed will impact German economic growth by 0.1 percentage points in 2025 and 0.3 percentage points in 2026. A further escalation of the trade conflict could even trigger a renewed recession.
German industry is losing international competitiveness and is facing a difficult situation. US tariff policy, in particular, has severely impacted global trade and German export prospects. This is leading German companies to increasingly shift their investments abroad.
At the same time, the diversification of trade relations opens up new opportunities. Germany must reduce its dependence on individual markets and build new partnerships. The institutes therefore call for the advancement of trade agreements such as the one with the South American countries.
What does this mean for the future of Germany as a business location?
The future of Germany as a business location depends crucially on whether it succeeds in overcoming its structural weaknesses and sustainably strengthening its competitiveness. While current forecasts indicate a short-term recovery, this will not be sustainable without far-reaching reforms.
Germany is at a turning point in economic policy. The coming years will determine whether the German economy can return to sustainable growth rates or whether it will remain in a prolonged period of weakness. The time for half-heartedness and piecemeal measures is over – decisive and comprehensive structural reforms are now needed.
Demographic developments, the energy transition, digitalization, and geopolitical changes are challenges that require a new economic policy. Germany must preserve its strengths as an industrial nation while successfully mastering the transition to a climate-neutral and digitalized economy.
Success will depend on whether politics, business, and society work together to address the necessary changes. The institutes have made an important contribution to the discussion with their reform plan. Now it is up to political decision-makers to implement these recommendations and prepare Germany for the future as a business location.
The coming years will show whether Germany can emerge from the crisis or whether structural problems will derail the hoped-for recovery. The course must be set now – an "autumn of reforms" is urgently needed to put the German economy back on a sustainable growth path.
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