By Ambrose Evans-Pritchard

The German economic supercycle peaked two years ago. Angela Merkel’s unenviable task over her fourth term is to manage national decline, whatever the state of the next coalition. The pathologies eating away at its pre-digital economy have been masked by distortions of monetary union, and by the “QE boom” and cyclical overheating. Monetary policy is far too loose for German conditions.

The Bundesbank warns that this year’s economic expansion is not sustainable. It estimates that trend growth will fall to 0.75 per cent a year by 2021 unless action is taken to revive Germany’s stagnant productivity.

This is “Japanization”, and it is happening for much the same reasons as in Japan. The workforce has already flattened. The Bundesbank assumes it will shrink by 200,000 a year in the early 2020s under any plausible scenario for immigration — and that calculation was made before the anti-Muslim AfD party swept into the German parliament on a backlash vote.

The “demographic dividend” of the baby boom is expiring. Half a million Germans will retire each year from now on. The old-age dependency ratio will rise from 26.5 per cent to 39.3 per cent by 2025, before spiraling up to 56 per cent by mid-century. “It is likely to affect technological progress and will have a dampening effect on macroeconomic productivity growth,” said the Bundesbank.

Germany’s Council of Economic Experts rebukes Merkel’s coalition for failing to fix the roof while the sun is shining. The political class is “resting on its laurels”, lulled by a cheap exchange rate and a temporary remission in the eurozone crisis. “The economically successful period was not used sufficiently to prepare the German economy for disruptive technological changes,” it said.

These challenges are dissected in Die Deutschland Illusion by Marcel Fratzscher, head of the German Economic Institute (DIW), who says foreigners who fawn over the German model do the country no favours.

There is no miracle in his view. Growth since 2000 has been dismal by its own standards. The country has lost dynamism compared to East Asia, the Anglo-Saxon countries and Scandinavia. German industry may have perfected the proverbial spark plug but it has been left behind by the information and data revolution. Less than 1.8 per cent of broadband is high-speed fibre — lower than Turkey and Mexico, and the lowest in the OECD club.

The government refused to exploit the lowest borrowing costs in history to upgrade its outdated infrastructure. Net public investment has been negative for most of the past 15 years. Finance minister Wolfgang Schauble has pursued his Holy Grail of a balanced budget, disregarding all else. This is written into the constitution.

Historians may one day deem this to be a blunder. Germany is reliant on an engineering model in a world where digital technology and artificial intelligence are changing everything.

Angela Merkel and Dieter Zetsche at the Frankfurt Auto Show last earlier this month. German automakers risk being overtaken by the electric vehicle push.

The big German carmakers will fight back hard with electric vehicles (EVs) after wasting years deriding the Tesla threat. But as Daimler chief Dieter Zetsche said last week, profits on EVs may be half what it makes on the internal combustion engine. Since EVs have far fewer moving parts and last much longer, they will not for long support an automotive sector that makes up 14 per cent of German GDP.

The car industry bet the farm on diesel and will struggle to extract itself quickly. These diesel engines were supposed to be the bridge to the EU’s low-emission standards of 95 grams of CO2 per kilometre by 2021. But diesel production is now in run-off. Paris, Madrid and Athens have bans coming into force. Asia is closing the door.

German carmakers can of course switch back to petrol quickly. The core problem is they are not ready to meet emission targets with petrol engines.

Worse yet — for them — China has imposed rules stipulating that zero-emission vehicles must make up 8 per cent of total sales next year, rising to 10 per cent in 2019, and 12 per cent in 2020. This is an earthquake. German manufacturers cannot come close. They risk being shut out of the largest car market.

It touches on Germany’s problem with China. For a decade exporters rode the “China wave”, but this phase is over. The German Council of Experts says exports to China have stalled since 2015 and now something more threatening is happening. “China is increasingly exporting products that coincide with Germany’s top export categories,” it said.

Part of the Wirtschaftswunder over the past 12 years has been real, but part is a mirage caused by the structure of monetary union. The euro system allowed the country to lock in a 15 per cent to 20 per cent advantage in intra-EMU competitiveness by holding down wages in an “internal devaluation”.

Unit labour costs in manufacturing fell. It also caused the pauperization of Germany’s working class. “People are struggling,” says Richard Werner, a German economist at Southampton University. “Hidden unemployment is at least one million.”

As Adam Smith wrote, there is much ruin in a great nation. These are slow, corrosive effects. Britain knows them well. They are also hard to reverse.

By the time Merkel hands the Kanzleramt to her successor in 2021, the trajectory will be obvious to everybody.

The Daily Telegraph