Germany's Economy Is Forecast to Outperform in 2026

The German government’s increased spending on infrastructure and defense is forecast to boost economic growth above its potential and above the prevailing consensus among economists for the next several years, according to Goldman Sachs Research.

The government of Friedrich Merz, who became Chancellor after elections earlier this year, plans to increase infrastructure spending by €500 billion over the next 12 years and has created room for higher defense spending by amending the country’s constitutional debt rule.

Our economists expect German GDP growth to rise from 0.3% this year to 1.4% in 2026 and 1.8% in 2027. This is significantly above the 0.8% potential rate of growth and the consensus among economists surveyed by Bloomberg.

“After years of economic underperformance, we have turned notably more optimistic on Germany’s economic outlook,” Goldman Sachs Research economists Niklas Garnadt and Jari Stehn write.

How much will Germany’s fiscal plans boost GDP growth?

German defense spending is expected rise from 2% of GDP in 2024 to 3.5% in 2029. Overall public spending is anticipated to rise by 2.2% of GDP by 2027.

In the near term, the government is likely to focus on the speed and execution of the fiscal package. It could support these aims by streamlining and fast-tracking planning and permitting processes for public investment. For instance, it could designate specific projects as being in the “overriding public interest,” the team writes. That would help counter Germany’s recent track record of underdelivering on budgeted investments.

The fiscal expansion could also pave the way for politically difficult reforms. That was the case in the early 2000s, when the German government initiated a number of labor market reforms that transformed the country into a growth engine over the subsequent decade.

“The Merz government has a window of opportunity to build on this improved macro picture with reforms that lead to a lasting improvement in Germany’s economic performance,” Garnadt and Stehn write.

What has restricted Germany’s economic growth?

Even with higher government spending and other positives, the German economy’s potential growth faces headwinds:

• Reliance on global trade: Germany is one of the most open advanced economies, and this leaves it highly exposed to global protectionism and slowing world trade. Germany’s relationship with China has become more complicated as that nation has moved from a dynamic export market to a key competitor.

• Less exposure to growth industries: Germany still relies on “old” industries such as auto manufacturing and it’s underinvesting in technology-related growth industries that are less susceptible to trade tensions.
• High energy prices: Energy prices have fallen sharply since the 2022 peak but remain around 80% higher than before the energy crisis, compared with around 25% in the US and 5% in China. Germany’s decarbonization commitments compound the issue, as carbon prices are required to rise notably in coming years to reduce emissions.
• Too much red tape: The economy suffers from excess regulations and inefficient public administration relative to other advanced economies.
• Skilled labor shortages: The supply of labor is under pressure from falling educational achievements and skills mismatches, with a particular lack of workers in technology sectors.

How can Germany improve its economic potential?

There are several critical areas where policymakers have opportunities to improve Germany’s growth potential on a sustainable basis, according to Goldman Sachs Research. “Investors are now focused on whether the Merz government can build on the improved cyclical outlook by addressing the structural challenges and raise growth sustainably,” Garnadt and Stehn write.

Net migration by EU nationals, which had contributed significantly to labor supply growth over the past 15 years, turned negative in 2024 and is unlikely to support the labor pool going forward. One possible solution is to expand a program for incentivizing immigration from the Western Balkans to other countries such as Turkey and Egypt. “Targeted labour immigration is crucial to limit Germany’s labour supply shortage,” Garnadt and Stehn write.

Initiatives to reduce red tape and improve the efficiency of government services could make the state more business-friendly, supporting start-ups and investment. Simplifying the income tax code, harmonizing rules across states, and centralizing supervisory institutions could reduce regulatory complexity.

While energy price relief is likely as supplies of liquefied natural gas rise sharply, keeping electricity prices in check sustainably would likely require curbing non-energy costs, which make up a large share of electricity prices in Germany. The government could reduce network charges by incentivizing localized electricity supply and demand, such as by dividing the single German bidding zone and encouraging regional price differentiation. Other incentives are needed to target the high variability of renewables-based electricity supplies by flexing demand, such as through smart meter rollouts, dynamic network charging, and the build-out of flexible generation capacity.

In addition, there’s scope for policymakers to introduce initiatives to diversify trade and reduce dependences on individual markets and reform social security to reduce complexity and support incentives to work. Meanwhile limiting early retirements could relieve some of the pressure on the public pension system, and adopting more digital health technologies and data-driven capacity planning could help make the healthcare system more efficient.
 

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