High costs, not climate policy, main drag on German industry – business think tank

Germany’s long industrial slump is mainly caused by high labour, energy and tax costs rather than by the effects of climate policy although carbon costs will weigh more heavily on companies as free emissions allowances are phased out, according to a report by the business-funded German Economic Institute (IW). 

Blaming the industry's current crisis on climate policy alone was too simplistic, said IW energy expert Malte Küper, who painted a bleak picture of Germany as an industrial location. “Where we are weak, we are not getting better, and even where we were once strong, other countries are overtaking us,” he said. 

The analysis was commissioned by KlimaUnion, a climate-focused group close to chancellor Friedrich Merz’s conservative Christian Democratic Union (CDU) party. It is likely aimed at a debate within the party, where some, including the CDU business wing, have argued for loosening climate rules in light of the industry crisis, Tagesspiegel Background reported.

Germany aims to become climate neutral by 2045, and finding a way to make industry climate-friendly is one of the hardest parts of that task. The shift to low-emission production methods requires many billions of euros in investments at a time when companies are already struggling with slowing global demand, Chinese competition, US tariffs, and other headwinds.

Facing these challenges, many energy-intensive companies have stepped up calls to weaken the EU’s carbon trading system (ETS). But the IW authors argued that carbon pricing “is not a sufficient explanation for the slump in [energy-intensive] industry in the period from 2015 to 2024.” 

The IW researchers compared Germany’s industrial development since 2015 with that of France, Poland, Spain, the UK, the US, China and India. German labour costs rose 29 percent over the period, leaving Germany in the last place among the eight countries, and corporate taxes of just over 30 percent are higher than in almost all the other countries. The authors stress that their comparison is descriptive and cannot isolate the effect of single factors.

Energy-intensive companies paid around 49 euros per megawatt hour for gas in 2025, more than double the 2019 level, almost entirely because of higher procurement costs after Russian pipeline supplies ended and Germany switched to liquefied natural gas (LNG), the study said. The carbon price has so far played only a minor role in rising energy costs, as most heavy industry receives a large share of its emissions certificates for free. 

The researchers found that the decline of German energy-intensive industries began already around 2017/2018, well before the energy crisis that started in 2021, when global demand picked up again following the coronavirus pandemic. The contraction escalated after Russia’s invasion of Ukraine, while the same sectors in EU countries under the same carbon pricing regime still grew at the time. Between 2019 and 2024, however, output in these sectors fell by around a quarter in both Germany and France, while China and India grew strongly. 

The analysis found that climate policy costs are set to become a larger burden on industry in the future. The European Commission proposed in July to extend free allowances for industry and tie them to decarbonisation investments. However, without an effective carbon border levy (CBAM), EU production risked becoming even less competitive compared with China or the US, the authors said. They recommended lowering labour costs, taxes and red tape, continuing electricity price relief, speeding up the move away from gas and supporting hydrogen and carbon capture and storage (CCS) with so-called carbon contracts for difference.

Chancellor Merz this week joined the ranks of those opposing a comprehensive weakening of carbon trading. In a letter to European Commission president Ursula von der Leyen, Merz wrote: “I am counting on the European Commission to stay the course on emissions trading and thereby give European companies and households planning certainty.”