Drivers of Germany’s Growth Downturn

Germany’s economy experienced a pronounced recession during 2023–24, with real GDP contracting and growth falling notably behind the rest of the euro area. This paper systematically examines the underlying causes of this downturn using four complementary approaches. We find that about 60 percent of Germany’s growth underperformance was due to lower potential growth while about 40 percent reflected cyclical factors. The downturn was broad-based, with nearly all major expenditure categories—but particularly investment and exports—weighing on activity. On the production side, the recession was concentrated in manufacturing and construction, which together accounted for the bulk of the growth gap relative to the euro area. The analysis further shows that the decline in output was driven primarily by falling productivity, especially in industry and construction, rather than by a reduction in hours worked. This decline in productivity partly reflected cyclical labor hoarding amid weak aggregate demand. However, structural challenges—including (i) longer-term subdued productivity growth due to structural factors such as persistent underinvestment in public infrastructure, skills, and innovation as well as excessive red tape; (ii) population aging; (iii) one-off adverse effects from the 2022 energy-price shock, and (iv) deteriorating external competitiveness (although the level of the current account surplus remains substantial)—amplified the cyclical downturn.