How the economy is changing in times of war and climate crisis

It’s not enough: if climate-destroying emissions of greenhouse gases fall by an average of 15.5 million tons per year, as was the case from 1990 to 2022, then Germany will not become climate neutral in 2045 as planned, but only 20 years later, in 2065. With that, the prospect of the country helping achieve the 1.5-degree target would vanish for good.

In purely mathematical terms, two scenarios are conceivable in which Germany could reach its climate goals within the desired time frame. Possibility #1: If greenhouse-gas emissions per euro of economic output – known as emissions intensity – were to decline at the same rate as they have over the past 30 years, Germany’s real gross domestic product would have to fall by more than 7 percent per year on average. Possibility #2: If GDP were to increase by 1.25 percent per year on average, as it has over the past 30 years, then emissions intensity would have to fall by more than 11 percent per year on average by 2045.

The alternative would be to reduce emissions per euro of GDP, that is, decouple economic output and emissions as much as possible and thus refute the purported logic that economic growth must always be harmful to the environment. Our experts have worked through what that would look like. Hard to comprehend? Perhaps. But anyone can easily see for themselves how emissions and growth are linked – using our decoupling calculator. And visualized in this way, the results send a clear message.

This much is certain: the goal cannot be reached without innovating. And this is precisely where the German economy has some catching up to do. The share of innovative enterprises in the country has declined rapidly in the past three years. Today, only one German company in five can still be considered highly innovative. In 2019, it was one in four. In contrast, the share of companies no longer actively pursuing innovative technologies has grown from 27 to 38 percent. In a study on innovative business culture in Germany, our experts looked at where companies have a lot of lost ground to make up for, and what a truly pro-innovation business environment would look like. In our podcast “Zukunft gestalten” (Shaping the Future), Almut Rademacher, CEO of trade association OWL Maschinenbau, explains why innovation is so important and how it is driving the success of both recognized and hidden champions in the East Westphalia–Lippe region.

One obstacle to achieving these goals is the convoluted state of Germany’s subsidy policies. What is actually counted as a subsidy? Which types of assistance simply get lost in the shuffle? Reducing "superfluous, ineffective and ecologically and environmentally harmful" subsidies is part of the coalition agreement signed by the country’s current government. Yet the prospects of achieving that objective are extremely poor, for a variety of reasons. If you ask the German Environment Agency (Umweltbundesamt – UBA), in 2018 the German state offered 41 subsidies in the form of financial assistance and tax breaks that promote the use of fossil fuels, thus undermining efforts to effectively protect the environment. And the amount is huge: At a minimum of €65 billion each year, the subsidies are equivalent to the third round of relief measures passed by the German government in response to the energy crisis. Some streamlining is urgently needed here.

However emissions are reduced, the cement, steel and basic chemicals industries will have a key role to play, since these three sectors account for 70 percent of emissions. As a result, Germany’s Economics Ministry wants to support them using “climate-protection agreements.” The government wants to give those companies a helping hand that are willing to implement the necessary changes. Yet how high do these subsidies actually have to be to cover the considerable costs of switching to new technologies? And how long should they last? Which technological levers would be effective? No one-size-fits-all solution exists here either, that much is clear. For the first time, however, what does exist is a realistic and very insightful simulation for assessing what will help where, and for how long.

Politicians and economic experts have repeatedly noted the important role that "green hydrogen" can play. However, since hydrogen only occurs in nature in combination with other substances, it must be separated from them. That requires energy. And only if this energy comes from renewable sources is hydrogen really "green." A host of measures is needed to create the infrastructure for using green hydrogen, as our experts explain. For example, competition-distorting subsidies for other energy sources must be reduced, while the use of renewable energies must be expanded. Many changes are also required to policies in the areas of employment, education and social affairs, not to mention foreign trade.

The backbone of Germany’s economy is the Mittelstand, the country’s small and medium-sized enterprises. Many of them, however, have been particularly hard hit by the Covid pandemic, interrupted supply chains and the economic crisis. The government has stepped in with sort-term assistance, but if the energy transformation is to succeed, a change in tax policy is also needed. Currently, Germany’s tax system creates disincentives that prevent companies from introducing innovations which would reduce emissions through the use of more energy-efficient technologies. There is, however, another way. Introducing financial rewards for investing in digitalization and climate protection  would help. In addition to developing a strategy for creating a circular economy, the government could support the transformation by imposing a per-unit tax on the use of primary building materials, our experts say. This would make alternative, especially secondary, materials more competitive, while investments and innovation would be stimulated that lead to circular value creation.

It is not enough, however, to focus on transforming the economy over an indefinite period in the future. Man-made climate change is already generating huge costs. Catastrophes – such as the flash flooding in Germany’s Ahr Valley which claimed over 100 lives – have caused billions in damage. The flooding, drought and storms in Germany in the past year alone have resulted in more than €42 billion in damage. In addition to the immediate costs, climate change is also confronting the financial system with new challenges, our experts warn. For example, taxes on labor and capital have risen much more in recent years than environmental taxes, such as vehicle taxes, truck tolls and CO₂ pricing. At the same time, environmentally harmful activities are being subsidized to the tune of €65 billion. Yet reforming the ten most climate-damaging subsidies alone would generate up to €46 billion in additional revenue and reduce greenhouse-gas emissions by almost 100 million tons. 

Introducing technical innovations and revamping the tax system are important aspects, but they will not be sufficient if attitudes do not change among business leaders. The question therefore arises: How is the topic of sustainability being addressed in Germany’s companies? The Bertelsmann Stiftung and its partners use the Sustainability Transformation Monitor to measure the mindset toward sustainability in the business world. As its findings show, the topic has become a core issue for corporate players. In Germany’s real economy, for example, 84 percent of managers responsible for sustainability at business organizations say that the subject has become more important. In the financial economy, the figure is not much lower at 73 percent. 

A consistent implementation of the circular economy would help save natural resources and reduce the impact on the environment. Those are the findings from a recent study by WWF, for which the Bertelsmann Stiftung served as a knowledge partner. Compared with a business-as-usual scenario, consumption of raw materials could fall by some 179 million tons, or 27 percent, while emissions of C0₂ equivalents could decline by 186 megatons, or 26 percent of greenhouse gases. That would reduce global environmental costs by up to €157 billion. The study also shows, however, that the change in consumption and the reduced use of primary resources could lead to a decline in value creation and employment in the economy’s industrial sectors – with attendant consequences for the social fabric. However, depending on how jobs are created and income is spent in other areas as a result of structural change, there could also be an overall positive economic effect in 2045 – as our policy brief on the topic shows . The circular economy is also a prime example of how key, overarching goals must be tackled centrally and not left to be crushed between the millstones of competing government ministries and departments. Achieving that goal in Germany will mean appointing “mission owners” who report directly to the country’s chancellor.

The public’s attention can quickly shift from one topic to another, as we recently saw after Russia’s invasion of Ukraine. Germany’s chancellor spoke of a "turning point"; for most people, rapidly rising prices became the main concern, in addition to a fear of war. It soon became clear that conventional means would be insufficient to tame inflation.  Why the central banks cannot overcome the problem on their own and what an effective economic policy response might look like are the subject of our policy brief on inflation.

The European Central Bank plays a crucial role in fighting inflation. Its most important tool to date has been its ability to increase the prime rate at regular intervals. Yet taking such a step has also drawn criticism: a growing number of experts have warned that the ECB should not “overdo” the interest rate hikes, since that could jeopardize the economy, employment and, above all, climate goals. There are, in fact, alternatives to the central bank’s across-the-board interest rate policy.

Something else is different in these times of high inflation: none other than its most important partner, the United States, is raining on Europe’s parade – since the Inflation Reduction Act provides subsidies to companies producing in the US, giving them a major advantage. That is a distortion of competition, Europeans say. Yet there is also a positive side, since it is mostly companies and products that are part of a “green” economy which are receiving support. The competitive pressures resulting from measures like the IRA can have another positive external effect: other parts of the world must do more to bring about an ecological transformation of their economies, our experts note. This could lead to a “race to the top” as smart policy measures are put in place to achieve such a transformation. Europe, too, could strengthen and expand its existing efforts in this area.