Germany’s Auto Sector at a Crossroads: Strategic Opportunities in a Shifting Global Auto Landscape

Germany’s automotive sector, long a pillar of the nation’s industrial might, now faces a pivotal juncture. Under Chancellor Friedrich Merz’s leadership, the country is recalibrating its industrial strategy amid a perfect storm of trade tensions, global electrification shifts, and domestic policy reforms. For investors, the sector presents a paradox: structural risks coexist with untapped opportunities, demanding a nuanced understanding of policy dynamics and market forces.

Merz’s Industrial Policy: A Balancing Act

Merz’s government has positioned itself as a pro-business, anti-bureaucracy force, prioritizing competitiveness through energy affordability, streamlined regulations, and digital transformation [6]. A cornerstone of this agenda is the proposed tariff offsetting mechanism with the U.S., allowing EU cars to enter the American market duty-free in exchange for reciprocal access for German vehicles [1]. This move aims to counter U.S. tariffs, which surged to 27.5% on EU-made cars in 2025, causing a €10 billion cash flow hit for German automakers [2].

However, progress on structural reforms has been uneven. While the government supports autonomous driving innovation and technology neutrality (e.g., promoting e-fuels and hydrogen alongside EVs), critics argue that slow energy market reforms and a reluctance to phase out combustion engines could undermine long-term competitiveness [3]. The VDA’s push to revise the EU’s 2035 combustion engine ban—allowing limited ICE registrations beyond that date—has found political traction but clashes with climate goals and the SPD’s pro-EV stance [3].

Trade Tensions: A Double-Edged Sword

The U.S.-China trade war has created a volatile backdrop for German automakers. U.S. tariffs on European cars have forced companies like Volkswagen and Mercedes-Benz to pivot to China, where they are investing heavily in EV production. Volkswagen’s €2.5 billion Hefei plant and BMW’s €2.8 billion Shenyang facility upgrades exemplify this strategy, aiming to localize supply chains and counter Chinese EV startups [1].

Yet, China’s aggressive EV subsidies and rising domestic competition have eroded German market share. Mercedes-Benz reported a 20% year-on-year sales decline in China in 2025, while BMW faces margin pressures in the U.S. [3]. Meanwhile, the EU’s 38.1% tariffs on Chinese EVs—aimed at countering subsidies—risk retaliatory measures, adding uncertainty to cross-border trade [5].

Investment Implications: Navigating Risks and Opportunities

For investors, the German auto sector’s future hinges on three key factors:

1. Policy Execution: Merz’s €500 billion infrastructure and modernization fund could catalyze growth in EV charging networks and green hydrogen production [5]. However, delays in energy reforms and tax hikes to address a 2027 budget shortfall may dampen private investment [1].

2. Global Supply Chain Resilience: German automakers are diversifying production to mitigate U.S. tariff risks. BMW’s $1.7 billion U.S. investments and Audi’s potential shift to domestic manufacturing highlight this trend [3]. Yet, such moves require significant capital and may not offset China’s cost advantages.

3. Technological Adaptation: The sector’s ability to innovate in software, autonomous driving, and battery technology will determine its global standing. Companies like Bosch and ZF Friedrichshafen are pivoting to software-driven solutions, but legacy automakers face stiff competition from Tesla and Chinese EV startups [4].

Conclusion: A Sector in Transition

Germany’s auto industry is at a crossroads, torn between its industrial heritage and the demands of a decarbonized, digitized future. Merz’s policies offer a roadmap for competitiveness, but their success depends on swift execution and global trade stability. For investors, the sector’s risks—tariff volatility, slow reforms, and China’s rise—are tempered by opportunities in EV localization, infrastructure funding, and technological innovation. Those who can navigate this complexity may find themselves positioned to capitalize on a sector poised for reinvention.

Source:
[1] Germany's Merz eyes car tariff offsetting mechanism after Trump talks [https://www.reuters.com/business/autos-transportation/germanys-merz-eyes-car-tariff-offsetting-mechanism-after-trump-talks-2025-06-06/]
[2] German carmakers set for €10bn cash flow hit as Trump ... [https://www.ft.com/content/7e836a6f-c3c0-41ea-93c3-2d8272d29430]
[3] German car industry calls for reversal of EU 2035 combustion engine ban [https://www.cleanenergywire.org/news/german-car-industry-calls-reversal-eu-2035-combustion-engine-ban]
[4] In 2025, German auto industry faces make-or-break year [https://www.dw.com/en/in-2025-german-auto-industry-faces-make-or-break-year/a-71148148]
[5] EU hits Chinese EVs with tariffs, drawing rebuke from Beijing [https://www.reuters.com/business/autos-transportation/eu-impose-multi-billion-euro-tariffs-chinese-evs-ft-reports-2024-06-12/]
[6] A Growth Agenda for Germany: Industrial & Innovation [https://www.bcg.com/publications/2025/growth-agenda-germany]