Germany’s strategic agenda: Reforming the future

The past few months has given us the opportunity to interact directly with some key figures with insight into the economic and geopolitical changes we see happening across Europe. Earlier in the summer, we were fortunate enough to share dinner and conversation with two leading experts on EU defence and Europe’s broader security backdrop, summarised here: “From summit to strategy.”

Most recently, we took a policy field trip to Berlin, where we met with various federal government minsters, secretaries of state, military advisors, and two former German Vice Chancellors. They were willing to share their perception of the political transformation happening in the country, and how this compared with similar pressures for change within the EU.

Invest, reform, consolidate – domestic change is non-negotiable.

The most surprising thing to see was the very clear realisation that policy change is an urgent necessity, with the next three years seen as crucial. We were struck by the passion and motivation that these ministries have under the new government, driving Chancellor Merz’s ‘Autumn of Reform’. We identified a clear intent to raise the structural growth potential of the German economy, focusing on cutting red tape, and reviewing the way government is run in the country. We even heard talk of using AI to deregulate and reduce the cost and delays associated with the existing heavily bureaucratic system. We saw this as a very ambitious agenda.

Possibly the most tangible new stimulus was the imminent launch of a €100bn ‘Germany Fund’ (Deutschlandfonds). This is targeted at the strategic funding for small- and mid-sized companies, with a particular focus on innovative/tech startups, as well as the power distribution grid, cultivating partnerships with investors.

We also had insight into progress around the €500bn special infrastructure fund, with the first tranches due from October. This seems to be intentionally front-loaded, with 50-60% of the total allocation from the federal budget to be deployed over the next four years (the full allocation to be spread over the next ten years in total). Emphasis is initially on the development and upgrading of the rail network, followed by roads.

An initial tranche of €27bn is still planned for this year, which seems potentially hard to spend within such a short timescale. But one possibility is that the allocation could be used to backfill any spending overdraft from Deutsche Bahn, the state-owned national railway company.

On defence

Germany’s strong commitment to higher defence spending remained evident, with Merz and his team determined to reach and maintain a spending target of 3.5% of GDP. This was perhaps less of a surprise, in the context of US President Trump’s ‘America first’ policy that represents a withdrawal from the country’s post-WW2 stance on Europe, and a belief in Germany that support for Ukraine forms part of a long-term defence strategy. What was particularly interesting was the positive outcomes of simulations from the Ministry of Finance on debt sustainability at the current level of defence spending.

The backdrop for this discussion was important, at a time when we are seeing reports of drone crossings from Russia into Romania, Lithuania, and now Poland and Denmark, and the recent interception of Russian planes over Estonia. The perception is that Russia continues to challenge Europe across different dimensions of hybrid warfare, testing for strengths and weakness, rather than in terms of escalation or de-escalation.

A key challenge for Europe is how the US, or any other intervention-averse countries within NATO, might react should Article 5 get triggered. But what seems clear within Germany is the perception that economic power without the backing of military might is a risk to security. The country seems intent on rebuilding its military infrastructure, across air defences, long-range weapons systems, transport, support, munitions production and supply, with discussions about how the country can integrate newer technologies like drones and electromagnetic defences.

Pension and worker reform

Chancellor Merz has highlighted the welfare state as an area of real concern, arguing that it is “no longer economically sustainable with what we are producing as a national economy”. Municipalities in the country are suffering from rapidly rising welfare expenses, which have for years weighed on the ability to channel spending to local improvements, eg. refurbishment of schools, hospitals, etc.

The government has proposed multiple reforms to strengthen and ‘future proof’ its pension system, but there have been some concerns that proposed changes might not be as far-reaching as necessary, given the structural problems of an ageing population, muted growth and relatively low engagement on pension savings. At approximately €100bn, the state contribution required to cover the current pension system shortfall is a significant sum, and these liabilities are expected to grow.

The government is establishing a commission to find ways to incentivise workers into the pensions system, with ‘early start’ proposals aimed at encouraging more private saving options, alongside full capital guaranteed options. The target is to reach the 30-40% of the population who are not making any private contributions to their pensions.

Roadblocks in the EU

While we were generally encouraged by the signs of progress on the domestic side for Germany, our hopes for positive news on big reforms in the EU took a hit. Feedback on the initial draft of securitisation market reform – something we see as potentially meaningful for the region: “Has the European Commission Taken A Step Forward With EU Securitisation?” – was disappointing. But there is still time for this to change. From Germany’s perspective, Brussels seemed to be seen as a roadblock to various reforms, with agreement over the big prize of a Savings & Investment Union (SIU), a single EU financial system designed to improve market efficiency in the bloc, still proving elusive.

But while changes on EU regulation are not moving as fast as we would like – we see little pressure from Von der Leyen, President of the European Commission, to push for similar structural change – they still seem to be moving in the right direction. And while we are less optimistic on the prospect of sizeable EU bank equity capital relief, we should learn more on this topic from an upcoming paper from the European Central Bank, to be published in December.

Overall, this trip reinforced our positive stance on Germany, where we see an ongoing transformation to a more outwardly focused fiscal impetus, with measures to address existing headwinds (growth, bureaucracy, technology investment and financial regulation), and significant investment to upgrade infrastructure and defence. Challenges remain at the EU level, particularly in achieving consensus on regulatory reforms and financial integration. Nonetheless, Germany’s proactive approach is setting a precedent for leadership in the region, presenting new opportunities for investors and positioning the country as a pivotal player in shaping Europe’s future.