A reckoning with new realities - the impact of the Ukraine war on Germany

Introduction

Russia’s assault on Ukraine has had profound economic and political ramifications for Germany, the largest economy in Europe. The conflict has disrupted energy supplies, escalated living costs, and compelled a fundamental re-evaluation of the nation’s foreign policy and defence strategies. As Germany grapples with the immediate challenges of the energy transition, economic stagnation, and a divided coalition government, it faces a critical juncture. This analysis explores the multifaceted implications of the war, focusing on its effects on Germany’s economy, internal politics, and international relations.

Economic Implications

The war in Ukraine exposed Germany’s misguided energy and industrial policies, leading to a deep crisis: while prior to Moscow’s full-scale invasion of Ukraine, Germany's economy relied on Russia for about 55% of its natural gas, the conflict and Russia’s subsequent gas embargo led to a sharp reduction in gas supplies, triggering a gas crisis that resulted in soaring energy prices, inflation, and increased living costs.

The industrial sector, particularly manufacturing and automotive industries, faced significant disruptions due to rising energy costs and supply chain challenges. The government acted swiftly, seeking alternative energy sources, notably liquefied natural gas (LNG) from the USA and Gulf states, requiring rapid expansion of LNG terminal infrastructure. Germany managed these challenges while also investing in renewable energy to enhance energy security, though this shift necessitated substantial financial outlays and long-term planning.

Nonetheless, deeper structural problems remain in the industrial sector as the current crisis within Germany’s automotive sector shows. And despite the government’s €10 billion subsidy offer to Intel, the firm shelved its plan to build a chip factory. In the short term, the German economy has entered stagnation, with growth forecasts downgraded. Consumer confidence has waned, adversely affecting domestic spending. Moreover, the government has significantly increased defence spending, straining public finances while adhering to its constitutional debt brake.

Overall, the war has catalysed a re-evaluation of Germany's energy and industrial policies.  As Germany navigates this transition, the long-term economic landscape may become more resilient, albeit at significant immediate cost.

Political Implications

The war in Ukraine has triggered significant political repercussions for Germany, reshaping its domestic and foreign policy landscape. Traditionally cautious regarding military engagement, Germany's response marks a pivotal shift. Chancellor Olaf Scholz’s government has committed to increased defence spending and military support for Ukraine, significantly moving away from recent decades of a more pacifist stand.

This shift reflected a growing consensus among Germany’s centrist political parties, uniting them in a robust response to Russian aggression. Public sentiment has evolved, with increased support for a firm stance against Russia and solidarity with Ukraine. However, as the war extends into a third winter, segments of German society are calling for peace negotiations and improved relations with Russia. This sentiment was particularly evident during recent regional elections in East Germany, where extreme right and left parties advocating for better relations with Russia made significant gains. Discussions about Germany’s relation with its military, the financing and strengthening of its forces versus a continued emphasis on diplomatic engagement is likely to define the German political debate in the coming years.

Germany's foreign relations are being redefined as the country has strengthened its ties with the United States and aligns closely with NATO partners. The war has sparked broader discussions about European unity and security. Still, despite Germany’s significant support to Ukraine and many allies calling for German leadership, the country is not positioning itself as such. Currently, the German government is debating a national Defence Industrial Strategy to equip armed forces and allies with necessary military tools. This strategy aims to create essential political, economic, regulatory, and societal conditions to bolster the defence industry.

Foreign Policy Implications

Russia

Since the onset of the Ukraine war, German-Russian relations have dramatically transformed, revealing that "Wandel durch Handel" (change through trade) has proven ineffective. Before the conflict, Germany had a strong economic relationship with Russia, but the war has left many German firms with stranded assets and substantial financial losses.

Chancellor Scholz initially sought to maintain dialogue, engaging with President Putin for a considerable time into the war. However, recent attempts to re-establish communication have been rebuffed, highlighting the growing chasm between the two nations. Despite hesitations regarding the delivery and usage of advanced weapon systems for Ukraine, Germany has become Ukraine’s second-largest supplier of aid and equipment, surpassed only by the US.

With an eye on the next federal elections in 2025, Scholz is navigating a complex political landscape, aiming to position himself as the "Friedenskanzler" (Chancellor of Peace) within his party and the broader German public while continuing to support Ukraine. As Germany reassesses its approach, the future of its relationship with Russia remains uncertain, marked by the need to reconcile economic interests with national security concerns in an increasingly polarised geopolitical environment.

USA

In contrast, German-US relations have strengthened significantly, marked by increased cooperation on energy and defence. In response to the energy crisis, Germany has boosted LNG imports from the United States. And at the recent NATO summit in Washington, the countries agreed on the deployment of American conventionally armed ground-launched intermediate-range missiles in Germany on a rotational basis beginning in 2026.

Chancellor Scholz and President Biden have collaborated very closely and aligned their positions on military support for Ukraine, with Germany for example only committing to send Leopard tanks once the US agreed to provide Abrams tanks. In practical terms, Germany has basically oriented its Ukraine policy entirely on the US. The close cooperation is exemplified by the strategic military hub at Rammstein Air Base, vital for coordinating NATO’s response. However, the bilateral relationship and in particular the close alignment between chancellor and US president may be reshaped significantly with a new US administration (and Germany's upcoming federal elections).

Britain

British-German relations have equally evolved positively, marked by renewed cooperation after the Brexit years. The UK's robust support for Ukraine has strengthened ties between London and Berlin, prompting a reset in relations vital for European security.

A key development has been the establishment of the Trinity House Agreement, a commitment to enhance bilateral defence cooperation and seeking to integrate the UK defence industry into the European market, overcoming post-Brexit hurdles. Additionally, a British-German Friendship Treaty is in the works, symbolising intentions to deepen ties across various sectors, including trade and security.

As both countries navigate post-Brexit complexities, their partnership is increasingly vital for addressing shared challenges. The united front in supporting Ukraine and enhancing defence collaboration underscores the potential for a strengthened British-German alliance.

France

Conversely, Franco-German relations have faced significant challenges, revealing a malfunctioning "European Engine." While both nations pay lip service to their Friendship Treaty, substantive action is lacking. Chancellor Scholz and President Macron often find themselves at odds, particularly on key EU issues. Exemplary here is the balancing act for Germany between the traditional Franco-German alliance while Central and Eastern European countries wish to see a stronger leadership from the German side, particularly on security and defence matters. This disconnect raises concerns about the effectiveness of Franco-German cooperation in addressing pressing European challenges.

China

Sino-German relations have become increasingly complex, driven by growing concerns over Germany's economic exposure to China as well as its position on Ukraine. As China strengthens ties with Russia, Germany faces a delicate balancing act between pursuing economic cooperation and addressing trade imbalances alongside security concerns. The EU's car tariffs exemplify these challenges. While some German small and medium-sized enterprises (SMEs) are exiting China, major firms like BASF continue to invest heavily in the People’s Republic. This situation underscores the necessity for Germany to avoid over-reliance on a single country, as seen with energy imports from Russia, and to diversify its economic partnerships to mitigate dependency on the Chinese market.

Outlook

With the German Constitutional Court’s November 2023 decision to tighten the rules of the constitutional debt brake, the traffic light coalition has struggled to find financial resources to maintain cohesion among the ideologically diverse SPD, Greens, and Liberals. Compounding these difficulties, Germany’s economy is expected to remain in recession throughout 2024, weighed down by structural labour shortages, high energy prices, and onerous regulations. Budgetary questions remain a core divergence, in particular, the debate over how German defence spending will be financed once the government’s special fund for the German military runs out in 2027 remains entirely unresolved and will be a core issue in the next legislative term.

Yesterday evening (6/11/24) the governing coalition came to an end when chancellor Scholz (SPD) dismissed finance minister Lindner (Liberals). A minority government of SPD and Greens will continue to run the country until January 15th when chancellor Scholz wants to call a vote of confidence, paving the way for early elections in March 2025 (originally scheduled for September 2025). Current polling suggests a CDU-led government as the most likely scenario after the next elections, followed by difficult coalition negotiations.

The Scholz-led minority government is unlikely able to pass through significant reform packages, let alone a budget for 2025. Yet the absence of a budget for 2025 will not result in a government shutdown as only discretionary spending will be affected and all legally mandated expenses will continue. Constrained in domestic and fiscal policy, the minority government could concentrate on foreign affairs, particularly the critical issue of Ukraine.

Conclusion

In conclusion, the war in Ukraine has profoundly impacted Germany, reshaping its economic landscape, political dynamics, and international relations. As the nation grapples with energy crises and economic stagnation, its dependence on Russian energy has catalysed a decisive shift towards alternative sources and a re-evaluation of defence policies. Domestically, the country will be absorbed in campaigning mode, unable to address crucial reforms before the next government is formed. Internationally, Germany's relationships with the US and the UK have strengthened, while ties with Russia and China are increasingly complex. As Germany navigates these turbulent waters, the path forward will require deft political manoeuvring and a commitment to redefining Germany's role on the global stage.