Germany: demographic challenges require reforms amid political fragmentation

Germany is facing severe demographic challenges with more acute structural pressures than other advanced economies. Labour-market and pension reforms are essential, but fragmented politics risks eroding the country’s competitiveness.

By Eiko Sievert and Elena Klare , Sovereign and Public Sector

These structural weaknesses are expected to become increasingly relevant over the coming years as the risk of political gridlock compounds other pressures on maintaining Germany’s economic competitiveness.

Germany is already among the worst-placed large economies measured by number of hours worked per worker and yearly shrinkage in the labour force (Figure 1).

Credit outlook stable but demographic pressure set to intensify

Germany’s robust public finances and diversified economy continue to support its AAA rating which we reaffirmed on 27 September.

However, the productivity gains which have long offset the relatively lower hours worked in Germany may no longer be sustainable in the face of a shrinking workforce. Demographic pressures could strain productivity particularly in manufacturing, threatening Germany’s global competitiveness and pushing companies to accelerate automation or outsource.

Addressing this challenge requires labour-market reforms, increased immigration with the aim to attract and retain highly skilled workers, new policies encouraging higher labour-participation rates, and increased automation to maintain productivity and economic growth.

Germany’s working-age population is set to decline by more than 8% by 2030 compared with 2023. Shortages of skilled labour will worsen due to the country’s comparatively short working hours, which are among the lowest in the EU. Employees worked 34 hours a week on average in 2023, less than in Italy, Spain and France with an average working week of around 36 hours.

In contrast, most other AAA-rated sovereigns expect the number of people of working age to remain broadly stable, such as the Netherlands and Denmark (both +0.3%) or increase slightly as in Norway and Sweden (+3%). Several other countries will also benefit from increases in the working-age population, partly through immigration, including Ireland (+7.0%), the UK (+2.8%) and the US (+1.6%).

Rising pension liabilities strain future budgets

With fewer workers to support an ageing population and, with the number of hours worked per worker declining in recent years, the pressure on Germany’s social-security system is set to increase.

Government efforts to reduce the future pension burden, including the introduction of a EUR 200bn share-based pension fund by 2036, are welcome. Still, further reform is essential as these efforts will likely reduce the expected rise in pension contributions – to around 22.3% of gross salaries by 2045 from 18.6% today -- by only 0.4pps of gross salaries.

The government has earmarked EUR 132bn or 27.2% of the total 2025 draft budget for pension spending. Previous studies have indicated that this share could double by 2050 with the old age dependency ratio rising to more than 50%.

This rising financial burden could limit fiscal space for discretionary spending and Germany’s ability to respond to economic shocks or invest in long-term growth without increasing debt or implementing difficult fiscal reforms. The IMF estimates the net present value of pension spending between 2023-50 to be 24.5% of GDP, which is significantly higher than for the UK (9.6%) or France (-0.1%).

Political fragmentation complicates immigration, labour-market policy The growing influence of smaller and more polarised political parties, reflected in recent regional election results, complicates consensus-building on critical reforms such as increasing net migration and encouraging higher labour-force participation, both crucial for addressing the country's demographic challenges.

This political gridlock delays much needed policy reforms, exacerbating the economic risks posed by a shrinking workforce and increasing pension liabilities, even if Germany continues to attract skilled workers.

The challenges are significant given the scale of the demographic deficit the economy is facing. Germany needs average annual net immigration of 480,000 people of working age, well above recent rates. Average annual total net migration since 2000 -- excluding the crisis years of 2015 and 2022 – amounted to 253,000 people.

With high bureaucracy and comparatively lower cultural inclusiveness partly helping to explain why Germany has become less appealing as a destination for skilled workers compared with English-speaking countries, increased efforts to encourage labour-force participation and boost productivity will be needed.

Such reforms combined with substantial investments in the country’s capital stock would help to stabilise Germany’s diminishing growth potential which we still estimate at around 0.8% a year.

Stay up to date with Scope’s ratings and research by signing up to our newsletters across credit, ESG and funds. Click here to register.