(Bloomberg):On a Monday afternoon in mid-August, workers looked grim at work at Volkswagen’s electric vehicle plant in Zwickau, eastern Germany, where the company had scrapped the night shift after laying off hundreds of temporary workers.

There was already a sense of foreboding. “The mood was tense, to be honest,” said Ronny Zehe, assembly manager at VW’s Zwickau plant, one of its newest and most efficient.

Three weeks later, VW, the maker of the Beetle, warned it might have to close factories for the first time in its 87-year history, putting the futures of VW factory workers at risk.

VW’s shock announcement came after far-right forces won landslide victories in elections in two former East German states, setting off political alarm bells.

With its largest manufacturer preparing to cross the Rubicon of no return by closing its factories, Germany is facing one of the most emblematic moments in its story of industrial decline.

VW’s announcement is more than just a belated recognition of business reality: it’s a blow to Germany’s image as an auto powerhouse and to an economy that was once the world’s top exporter.

When the Berlin Wall fell in 1989, the unification of East and West Germany was rushed, but cultural and economic disparities remained.

The far-right Alternative for Germany (AfD) party made strong gains in state elections in two eastern German states on the 1st. Mainstream parties are powerless to stop the momentum of the AfD and left-wing populists, which are highlighting the divide between East and West.

Challenges

The AfD’s rise is not just a blow to Chancellor Olaf Scholz’s coalition government, it is forcing it to address the root causes of voter discontent as the 2025 general election looms.

Much will depend on whether Germany can pull off a new economic miracle – quickly transitioning from an export-led car-making powerhouse to a cutting-edge clean-energy powerhouse in areas like semiconductors and electric vehicle batteries.

VW’s demise is a warning about companies that are behind the times and a pitfall in the German model of success. It raises doubts about whether Germany, which has been the driving force behind Europe’s economy, can continue to lead the continent in the future.

“While VW’s problems are partly a result of poor business decisions and its own actions, they also provide an example of the challenges facing Germany as a business location,” Carsten Brzeski, head of macro at ING, said.

“Germany has been losing its competitiveness for many years and this is affecting Volkswagen, once the jewel of the German economy,” he said.

VW produced 247,000 fully electric vehicles and 12,000 bodies for Lamborghini and Bentley in the mid-sized eastern city of Zwickau last year, but cost-cutting was already underway before the possibility of closing the plant emerged.

The Zwickau plant is fully exposed to the slow adoption of electric vehicles in Europe, where cars remain expensive and incentives for their purchases are being rolled back.

VW is still making a lot of profits, but initially stuck to diesel engines, then aimed to make a full-scale EV offensive, but the road to shifting its business has been extremely difficult.

“Although the auto industry’s importance to the German economy has declined in recent years, it remains a very important sector,” Martin Ademar, economist at Bloomberg Economics, said.

Successive crises

The car is an essential part of modern identity in Germany and a political lightning rod: Indeed, the story of VW is one of Germany’s own postwar recovery, tied to the country’s growth against the odds and postwar miracle that transformed a war-torn country into Europe’s leading industrial power.

At the start of the 21st century, VW succeeded in tapping into demand among the middle class in the Chinese market, setting itself apart from struggling American automakers. But its reliance on Asian consumers later became a problem.

Germany’s industrial production peaked in 2017 as the country was hit by successive crises, including the increasing sophistication of Chinese manufacturing, the coronavirus pandemic and the suspension of cheap Russian gas imports after Russia’s invasion of Ukraine.

More broadly, Germany struggles to be a good place to do business, with decades of stifled investment in the name of balanced budgets, aging infrastructure and constant complaints from companies about red tape.

The Munich-based Ifo institute concluded in a survey of 180 economists in May that Germany was becoming less attractive for businesses.

To appease eastern voters, the Scholz government has resorted to stopgap measures, mainly offering heavy subsidies to companies that set up factories locally.

But Jens Spahn, a member of the opposition Christian Democratic Union (CDU) and member of the Bundestag’s economics committee, believes that such an approach alone will not be enough to improve Germany’s declining international competitiveness in the long term, and he is not unafraid to hide his concern that “VW is just the tip of a big iceberg.”

Monica Schnitzer, an economist who advises the German government, says it is too early for Germany to give up its status as an industrial powerhouse.

“German companies can continue to be successful if they can gain an advantage through modern technology and high-quality products while keeping costs down,” he said, explaining that Germany still has many hidden global companies, especially those controlling niche markets.

Original title: VW’s Woes Force Germany to Confront Its Waning Industrial Power (excerpt)

–With reporting assistance from Elisabeth Behrmann, Kamil Kowalcze, Alex Newman and Christoph Rauwald.

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