Volkswagen's warning last week of job cuts and potential production line closures in its home market for the first time in its 87-year history sent shockwaves through the country.

The storm clouds for Germany's largest carmaker have, however, been forming for several years, due to soaring production costs, a weaker domestic economy post COVID-19 and intense competition from China. VW's faltering electric-vehicle (EV) strategy is adding to the company's revenue woes.

The automaker must make some €10 billion ($11.1 billion) in cost savings over the next three years, which could mean thousands of job losses and the likely shutdown of some of its 10 German assembly lines.

VW said Tuesday it had formally terminated a three-decade-old job security deal with unions, opening the door for compulsory redundancies. The state premier of Lower Saxony, where several of VW's German factories are located, was due to meet with staff representatives over the job cuts on Wednesday.

Meanwhile, the announcement of a massive recall of 1.5 million vehicles by fellow German carmaker BMW added to the problems facing the automotive sector on Tuesday. BMW's shares dropped 11% on the news.

Germany's rivals catching up

VW's painful reforms can be seen as part of the broader challenges facing Germany's €4.2 trillion economy, where supply chain disruptions, the energy crisis — particularly due to the reduction in Russian gas supplies — and loss of competitive edge have hurt growth.

"Volkswagen represents the success of German industry over the last nine decades," Carsten Brzeski, ING bank's chief economist for Germany, told DW last week. "But this story tells us what four years of economic stagnation and 10 years of deteriorating international competitiveness can do to an economy. They make investments less attractive."

Germany's economy contracted 0.3% last year, according to the national statistics agency Destatis. Three leading economic institutes have forecast a 0% increase in gross domestic product (GDP) in 2024. This contrasts with the 10 consecutive years of growth that Germany experienced before the coronavirus pandemic — its longest period of growth since reunification in 1990.

Are German industry's days numbered?

VW's bombshell, alongside negative news about other German industrial giants — including BASF, Siemens and ThyssenKrupp — has helped push a narrative that Germany's best days may be behind it and that economic decline is inevitable.

"The VW announcement is certainly a symptom of a broader malaise across German industry, rather than an isolated case," Franziska Palmas, senior Europe economist at the London-based Capital Economics, told DW, noting how industrial production in July was almost 10% below its level at the start of 2023 and how industrial output has been on a 6-year downward trend.

As well as the issues affecting Germany's auto sector, Palmas spoke of a "permanent loss of production capacity in energy-intensive industry" since the 2022 energy crisis, fueled by Russia's full-scale invasion of Ukraine. Capital Economics expects the industrial sector's share of Germany's GDP to "continue to decline in the coming decade."

Rise of populism obstructed reforms

Sudha David-Wilp, director of the Berlin office of the German Marshall Fund think tank, thinks the country's troubles are a result of a reluctance by successive governments to push through necessary but painful reforms. Among the reasons, she said, is the rise of parties like the far-right Alternative for Germany (AfD) over the last decade.

"The Merkel years were quite comfortable, and Germany was wealthy enough to navigate through the COVID crisis," David-Wilp told DW. "But with the rise of populism, the established parties want to make sure Germans feel secure economically, so they don't fall prey to parties that fear-monger." 

This kind of strategy only puts off the inevitable, however, as economic headwinds from lower-cost competitors continue to eat into Germany's share of the global economic pie. Worsening geopolitical issues, meanwhile — particularly between the West, Russia and China — threaten to further roll back globalization, of which Germany has been a major beneficiary.

VW reforms a 'final wake-up call'

"The world is changing, and our sources of economic growth are changing," ING's Bjeske said. "[VW's problems] should be the final wake-up call for German policymakers to start investing and reforming so that the country can again become more attractive."

How quickly these reforms can happen remains uncertain, as Germany's so-called debt brake — which restricts annual structural budget deficits to 0.35% of GDP — and infighting between Chancellor Olaf Scholz's coalition partners over the 2025 federal budget, means there is little room for more fiscal stimulus.

Despite the stream of negative news, Germany remains a key location for international investments. In the past 18 months, the likes of Google, Microsoft, Eli Lily, Amazon and Chinese automaker BYD have announced big spending plans. 

Berlin has set aside subsidies of around €20 billion to boost the domestic semiconductor sector, particularly in eastern Germany, backing investments by Taiwanese chipmaker TSMC and Intel.

Germany's new direction emerges

Biotech, green technologies, artificial intelligence (AI) and defense are other growing sectors for the German economy, David-Wilp told DW, which the government could support further as it carves out its new industrial strategy.

"It's not all doom and gloom. There are pathways ahead for growth," she said. "Things need to get bad before they get better, and this sense of innovation needs to be rekindled."

Those reforms, however, will likely have to wait until after the next federal elections, scheduled for September 2025, which could see Scholz's coalition — made up of the center-left Social Democrats, the environmentalists Greens and the liberal Free Democrats (FDP) — replaced.

The current anguish is a reminder of Germany's economic malaise in the late 1990s and early 2000s, where the country was nicknamed the "Sick Man of Europe." 

Finance Minister Christian Lindner (FDP) denied that the monicker was appropriate this time, telling delegates at the World Economic Forum in January that Germany was instead a "tired man" in need of "a good cup of coffee" of structural reforms.

Edited by: Uwe Hessler

This story was updated on September 11, 2024, with details of how VW is ending a job security plan, as well as details of a large vehicle recall by BMW.