Public spending is coming to the rescue for an economy that is facing severe structural problems

After two years of recession, it seemed that Germany's economy had stabilized in 2025 and was even inching in the direction of a return to growth. Sure, nobody was sounding the trumpets of a full-fledged recovery, but it seemed the worst had passed.

That was, admittedly, before the US-Israeli war on Iran muddied those waters. But even apart from this black swan event, what has really been going on in the German economy deserves a closer look. After all, there are different ways of generating GDP growth and not all of them have the same deeper implications.

In Germany's case, it turns out the nascent recovery was almost entirely fueled by state spending while the private sector is in virtual free-fall. This, incidentally, goes some way toward explaining the ongoing rearmament in Germany in response to the supposed threat from Russia - a threat that very conveniently is breathing new life into unsustainable industry. This is no less than military Keynesianism, a phenomenon few expected to see in Germany. And it is being tasked to address several major structural shifts at once.

RT Newsroom explains what's going on.

2025 marked an inflection point

The German economy broke a two-year recession, growing by 0.2% in 2025, following a 0.5% contraction in 2024. However, the growth was driven in large part by government spending. There was a late-year pickup in industrial and construction output - also government-driven - while exports continued to lag.

Public spending, however, rose 5.6% in 2025 and now represents more than 50% of GDP. This number itself isn't particularly eye-popping in a European context. Several EU countries have higher ratios. But Germany has historically been more fiscally conservative with an economy much more oriented toward private industry and exports. Helmut Kohl, German chancellor in the 1980s and '90s, once called a spending ratio above 50% socialism. This is a threshold beyond which Germany would be seen as having adopted a different economic model.

That different economic model is now here. But think about it from this angle: What happens when you boost public spending by over 5% and still can only barely eke out any economic growth? It means the private sector is crumbling.

Digging into the data

A widening split has opened in Germany's economy since 2022, dividing industries more exposed to market forces from those being backstopped by public spending. Traditional sectors - especially the automotive and chemical industries - have struggled with high energy costs and global competition. This has been reflected in the share prices, which have been very sluggish, with Porsche leading the way among the declines.

The weakness is also visible in underlying demand, with domestic orders broadly declining, although amid volatility, since 2022. Last year saw periodic spikes driven by large contracts - almost certainly state-driven - whereas underlying demand remained weak. Exports were weak, so was private investment. Capital goods orders, a key gauge of private-sector investment, have been falling, pointing to continued contraction in market-driven industrial activity.

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At the same time, defense contractors and state-backed industrial firms have surged on the back of government spending. Rheinmetall shares have rocketed more than 1,000% since early 2022, with its market cap rising from about €4 billion to roughly €67 billion. Hensoldt and Renk have also posted strong gains, while even adjacent players such as Infineon have nearly doubled in value.

Construction and industrial groups tied to public projects - including Hochtief, Heidelberg Materials, and Bilfinger - have also rallied sharply, in some cases climbing several-fold from 2022 lows.

This has all come while the economy has been in recession and the manufacturing sector has been hemorrhaging jobs. What this points to is that Germany's headline market gains are masking a lack of real recovery. While the country's stock market, the DAX, has risen strongly, most of the growth is concentrated in a narrow, state-backed segment.

What this means

The contrast reflects very different operating conditions. Automakers and chemical firms compete in open global markets, where rising energy and labor costs erode competitiveness and push production to cheaper regions. Consumers can choose from many options. Defense contractors, by contrast, operate largely outside these pressures, relying on government-funded demand. Arms deals are driven by political and strategic decisions rather than market pricing, meaning input costs such as energy matter far less.

Rising costs have made large parts of Germany's traditional industrial base less competitive. The response of the German state to that has been to shift toward sectors insulated from the market. Industry is not recovering in a conventional sense, but being redirected to where demand is state-driven rather than market-driven.

This shift is already reshaping Germany's manufacturing base. According to the German Chamber of Industry and Commerce (DIHK), about 17% of industrial firms are now tied to the defense supply chain, with involvement particularly high in vehicle manufacturing at 36%. Some struggling auto plants are being repurposed for military production.

Volkswagen is exploring the possibility of producing military vehicles at its Osnabruck factory and is in talks with Rheinmetall. Schaeffler, hit by a shrinking auto business and job cuts, is also pivoting to defense, while Deutz now supplies engines for air defense systems, drones, and armored vehicles. DIHK estimates that up to a quarter of German companies could soon be directly or indirectly linked to the defense sector, deepening the divide between a market-driven industrial base and a state-funded one.

The role of debt

Germany has long had an aversion to high debt levels. The country's fiscal mindset was shaped by the Weimar hyperinflation and the lesson that was seared into the collective mindset of German policymaking: macroeconomic instability means social and political breakdown. This tendency toward restraint was institutionalized under Angela Merkel, who instituted what was called the "debt brake," which limited the federal deficit to 0.35% of GDP, a very low figure by European standards. The so-called Schwarze Null, or "black zero," indicating a balanced budget was an imperative.

In recent years, however, things have started to slip. In 2022, an amendment was passed under then-Chancellor Olaf Scholz that allowed the creation of a €100 billion defense fund that would not count toward the brake. Another amendment was passed that exempted defense spending over 1% of GDP.

This has unleashed a significant amount of funds that is finding its way into the economy via state contracts. The German government plans to double defense spending over the next five years from current levels, with $761 billion to be spent by the end of 2029, of which more than half ($469 billion) will be funded through new debt.

Decline in industrial jobs in context

Germany's manufacturing sector has shed nearly a quarter of a million jobs since 2019. This figure is often bandied about as self-evidently catastrophically large but without much context. In itself it isn't a staggering figure: Germany's industrial employment has generally been around 7.5 million workers - figures vary depending on how they're counted - so the 245,000 job losses represent about 3.25% of sector employment over six years (through 2025).

Is that a lot or a little? The United States lost 5-6 million manufacturing jobs over the decade of 2000-2010, representing some 25-30% of the sector. Germany's job losses obviously pale in comparison. So why is this a big deal for Germany?

First of all, it's the pace of the losses, which has been picking up. If the total for the past six years has been around a quarter of a million, the figure for 2025 alone was 120,000 - or half of the six-year total. The trend is extremely worrying.

Second, the problem is that manufacturing plays a much more prominent role in the German economy than it played in the US. It sits at the center of dense networks of supply chains, meaning that each industrial job supports additional jobs elsewhere. This is called a multiplier effect. So even a relatively modest change in employment can trigger a much larger shift in the broader economy.

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The deindustrialization in the US was traumatic but the economy was less dependent on manufacturing as its central organizing pillar. The US economy, already highly financialized and more dependent on other sectors such as services, technology, and healthcare, was, to a larger extent, able to absorb these job losses. In fact, unlike the German economy, the US continued to post growth for nearly that entire period when those manufacturing jobs were disappearing.

For Germany, which held to a much more export-oriented model driven by the private sector, the decrease in manufacturing employment is hitting much closer to the heart.

Military Keynesianism as the solution to three problems at once

The term military Keynesianism has gained a certain currency in Europe in recent years and for good reason. This is an economic policy where a government attempts to boost economic growth and employment by significantly increasing military spending. It is an offshoot of the economic theories associated with John Maynard Keynes which hold that aggregate demand rather than mere private investment is the primary driver of the economy and that the government should manage this when the private sector weakens.

Military Keynesianism can absolutely produce growth, but it does so without solving underlying productivity or competitiveness problems. Defense output is ultimately economically non-reproductive. A machine tool - a specialty of German industry - sold to a civilian manufacturer can produce goods for decades, thus expanding the economic value-added. A tank shell, by contrast, generates nothing once produced.

Germany's old model depended on three pillars: cheap Russian energy, Chinese export demand, and American security guarantees. All three have weakened simultaneously. Germany is attempting to confront all three merely by throwing the state's fiscal ledger at them - all while the private sector shrivels away.

(RT.com)