Germany embraces the far right: what does it mean for the economy?

In Germany’s regional elections last week, the far right AfD party scored a major breakthrough in the east of the country. It capitalised on a failing economy and a revolt against mass immigration to come first in Thuringia and second in Saxony. The coalition of the Social Democrats, Liberals and Greens led by chancellor Olaf Scholz now looks certain to lose power next year, and may well struggle to last that long.

When that happens, the country will face a political stalemate, with none of the major parties willing to work with the AfD, nor able to govern without them. The result will be a political mess, against the backdrop of a slow-motion economic crisis. The latest data at the end of August showed the economy shrinking yet again, with output falling by 0.1% in the past quarter. Investment in Germany fell sharply, as did consumer spending. It was only rising government spending that limited the decline. Germany is the slowest-growing economy in the G7, and another recession by the end of the year looks certain.

Germany's structural crisis

Yet the problem goes far deeper than that. Germany is not simply experiencing a cyclical downturn, but a structural crisis. Demand for its exports has powered the economy for much of the last 20 years. Germany supplied the machine tools that transformed China into the second-largest economy in the world. However, that opportunity is now slowing down rapidly as the process is completed, and as Chinese manufacturers compete against German firms in their market. Meanwhile, the switch from petrol to electric vehicles is destroying the mighty automotive industry on which it depends for its prosperity. Only this week Volkswagen raised the prospect of closing some factories for the first time in its history as sales struggle to match expectations. At the same time, there is no sign of new industries emerging to replace the old ones.

To make matters even worse, the country made a big bet on cheap Russian gas to power its heavy industry, closing down its nuclear power stations . The result: its energy is now mostly imported and it is twice as expensive as in the United States. That would be painful enough if Germany were a services-based economy such as the UK. For a manufacturing one, it is a crippling burden to carry.

No easy fix for Germany's woes

There is no easy fix to these problems.

There is no immediate replacement for cheap Russian gas. Germany is building green energy , and wind power has risen to 22% of its electricity capacity, but it is still behind coal at 27%. Nuclear power stations take at least five years to build, if not more, and the political establishment is still completely opposed to them. So Germany’s power will remain among the most expensive in the world for many years.

The EU might loosen the rules a little on phasing out petrol cars , but with strict net-zero targets , it is too late to save the car industry and the 800,000 jobs it sustains now. The damage has already been done. Likewise, although Germany is one of the most technologically brilliant countries in the world, it is so far behind in the race to create digital industries that it will be very hard to create them now.

Worst, there is no sign of the political leadership that reform would need. The AfD and the far-left Wagenknecht party campaign on immigration. They have nothing of significance to say about lowering taxes, reducing red tape or restoring competitiveness. None of the mainstream parties will work with them, yet they will not be able to form a majority on their own. With no stable government, nothing can be changed.

So Germany is trapped in a structural slump that will last for a decade or more. Weak demand in what was once the powerhouse of the continent will depress the entire eurozone . It will become more and more reluctant to pay the bills for the rest of the EU. Its politics will become more and more unstable, and extreme, perhaps reviving memories of the chaotic 1920s. At some point, Germany will reinvent its economy – but it will be a long wait.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription .