Germany faces economic strain as Merz warns of austerity and pension costs

BERLIN — Chancellor Friedrich Merz acknowledged on Monday that Germany has been living beyond its means for years, warning that without sweeping reforms the country could face ruin. He pointed to the pension system as a mounting burden, noting that spending on pensions has climbed to more than 31% of GDP, a share that ranks among the highest in Europe. Merz said the country must confront a difficult, long-term reform agenda and prepare for a period of painful adjustments to secure the prospects of younger generations.

To illustrate the scale of the challenge, Merz described a “profound epochal break” in fiscal policy and argued that Germany cannot continue to shoulder the current level of commitments without changes to both revenues and benefits. He signaled that reforms would be politically costly but necessary to prevent a gradual erosion of living standards and to maintain room for essential social programs across generations.

Economic adviser Marcel Fratzscher, who heads the German Institute for Economic Research, warned that the government must tackle a €400 billion-a-year pension bill that is already expected to rise over the next decade. His remarks come as the economics ministry’s latest assessment described the pension system as dysfunctional and a grave risk to economic stability. The ministry projected that by the middle of the next decade there would be about one pensioner for every two working-age people, a looming demographic squeeze that would intensify fiscal pressures.

Economics Minister Katharina Reiche echoed the urgency, saying there was a profound and urgent need for reform to ensure that Germany can afford its pension commitments. In contrast, Bärbel Bas, the Social Democratic Party’s labor and social affairs minister, dismissed Merz’s claims as inappropriate rhetoric aimed at scoring political points. President Frank-Walter Steinmeier, while praising the welfare state as a national treasure, acknowledged that the system is cracking under mounting pressures.

The remarks come after a year in which Germany’s economy contracted for the second consecutive year in 2024, preliminary statistics showed. The Federal Statistics Office reported a 0.2% GDP decline, continuing a downturn that began in 2023. The stagnation followed external shocks and domestic frictions, including bureaucratic hurdles and a longstanding shortage of skilled labor that has hindered productivity and growth.

Germany, the eurozone’s largest economy, has long relied on a robust welfare state and strong public services. Yet analysts warn that demographic changes and escalating pension costs threaten long-term sustainability unless structural reforms are enacted. Merz’s call for painful austerity signals a broader debate about the balance between preserving social protections and ensuring fiscal room for investment in growth, education, and modernization.

Observers say the current trajectory, if unaltered, could constrain Germany’s growth potential and complicate its role in European economic policy. Supporters of reform argue that reconfiguring pension benefits, retirement ages, and other social programs could header off larger deficits and support competitiveness in a changing global economy. Critics caution that rapid retrenchment could widen social disparities and slow recovery from recent shocks.

As Germany debates its fiscal path, business leaders and policymakers are watching closely for a credible plan that can command broad political support. The coming months are expected to feature intense negotiations over pension design, tax reform, and public investment, with implications for Germany’s citizens, European neighbors, and global markets.