KEY ISSUESContext:? Germany fundamentals are sound: balance sheets are generally healthy,unemployment is at a historic low, and the fiscal position is strong.? While a recovery is underway, medium-term growth prospects are subdued and thecurrent account surplus remains high. The economy also faces a still weakinternational environment, lingering uncertainty (including about future energycosts), and fast approaching adverse demographic changes.? Germany could do more to increase its growth, thus strengthening its role as anengine of euro area recovery.Policy recommendations:? Germany has the fiscal space to finance an increase in needed public investment,particularly in the transport infrastructure. Unlike public consumption, this woulddurably raise German output and have measurable growth spillovers on the rest ofthe euro area.? Further reforms in services sector regulation would boost competition andproductivity.? Greater clarity about the future energy sector regulatory framework wouldencourage private investment in the energy infrastructure and beyond andstrengthen the outlook.? Decisions on the future level of the minimum wage should take into account theemployment effects in certain regions.? Banks should keep strengthening their capital position ahead of the completion ofthe ECB’s Comprehensive Assessment.? The macroprudential framework needs to be ready as monetary conditions are set toremain accommodative for a prolonged period.
I would like to convey my authorities’ gratitude for productive and insightful discussions during this year’s Article IV consultation. As in previous years, staff reached out to a broad range of stakeholders such as think tanks, economic associations, and the financial sector, which has resulted in a comprehensive and at the same time candid and balanced assessment of the German economy. My authorities also welcome the section “Questions and Answers on Staff Analysis” and the excellent in-depth analysis in the “Germany - Selected Issues”, which is highly appreciated. My authorities agree to the main thrust of the staff appraisal.
Economic Development and Ooutlook
I broadly share the staff’s assessment of the current economic situation in Germany and the outlook for 2014. The German economy is indeed in a remarkably good shape: rising employment and low unemployment, elevated consumer sentiment, low corporate leverage and very favorable financing conditions. Gross fixed capital formation is expected to grow robustly in the coming years, for 2015 my authorities assume an even stronger dynamic than staff. Consequently, domestic demand is expected to make a significant contribution to growth of 1.8% in 2014 and 2.0% in 2015, while the external sector is expected to have virtually no contribution in both years.
Given its high degree of openness and its integration in global supply chains, Germany is depending on global economic developments. Insofar, a slowdown in major trading partners would dampen growth in Germany. But openness also offers growth opportunities for Germany in case of stronger growth in the global economy. For 2014 and 2015 I expect GDP growth to outpace potential output growth. Against the backdrop of generally favorable economic conditions and particularly high migration surpluses, potential growth might be at around 1½ % p.a. in 2014 and 2015.
External Stability and the Euro Area
Staff’s analysis of Germany’s current account in the staff report and the 2014 Pilot External Sector Report is welcome. Regarding the external surplus, I would like to highlight that Germany has already contributed significantly to regional rebalancing. Driven by sound macroeconomic developments and government policies domestic demand in terms of both investment (private and public) and consumption is on an expansionary path. In addition, Germany is providing bilateral financial and technical assistance to countries hit hardest by the crisis in parts of the euro area in order to relax constraints on the financing situation of SMEs. The bilateral current account surplus with the rest of the euro area has already declined substantially since 2007 and will – considering the ongoing adjustments to regain competitiveness in many countries – most likely continue to do so. There is consensus with the staff regarding the prediction that the current account surplus may shrink in the coming years as some factors contributing to the surplus are likely to diminish. I emphasize, however, that the amount and the dynamics of Germany’s current account is determined not only by the balance of trade, but also by the income and services accounts. In this context it should be noted that earnings on foreign assets and a structural improvement in the services balance have gained substantially in significance in recent years.
As in earlier Article IV discussions, I would like to highlight that the German current account surplus reflects the outcome of market processes and high (especially non-price) competitiveness of German enterprises. It is not the result of targeted policy measures. However, while the current account surplus is not an indication for market distortions and disincentives, I agree that structural policy initiatives should set the course towards new growth opportunities and encourage greater investment in Germany. For instance, some professional services could be further deregulated and competition in the railway sector could be further enhanced. Such structural policies could indirectly narrow the current account surplus. However, since services are more and more tradable it is not obvious that service sector reforms would automatically reduce the current account surplus.
In a European perspective, I agree with staff that the German economy plays an important role as an anchor of stability. This puts a premium on prudent policies to safeguard Germany’s sound balance sheets and ensure sustainable debt to GDP ratios in the household, corporate and government sectors. As already discussed in the German-Central European Supply Chain-Cluster, we consider healthy balance sheets to serve as an important buffer against shocks and to generate positive spillovers that extend well beyond Germany. My authorities are therefore committed to ensuring that the enhanced European procedures for economic and budgetary monitoring are implemented rigorously. There must be no relaxation in the efforts to reform – this also applies to Germany. Moreover, my authorities are fully committed to an integrated and well-functioning EU and euro area that serves the interest of all member states. A strengthened European integration is crucial to the long-run prosperity of Germany with its very open economy. Against this background, Germany fully subscribes that changes to the EMU architecture are necessary to create a stronger and more sustainable and resilient monetary union. I would like to emphasize that substantial progress has already been achieved in this regard but remaining issues need to be addressed.
In 2013, the general government balance was slightly stronger than planned. However, this was not the result of discretionary decisions by the government but reflected a better than envisaged economic development with higher tax revenues, moderate growth in social payments and falling interest expenditures. This outcome contributed to the reduction of public debt. The fiscal balance is projected to stay close-to-balance or in surplus also in the coming years.
With regard to the sharp increase in public investment of some 0.5 percent of GDP per year (for four years) that staff is arguing for, it is important to note that the described efficiency and spillover effects are highly uncertain. Results strongly depend on model specifications; alternative specifications show only negligible regional spillovers. However, keeping a safety margin from national debt brake limits and the medium-term objective (structural deficit of max. 0.5 percent of GDP for general government) is essential for strengthening the confidence in and the credibility of public finance, thus fulfilling our role as regional stability anchor. Moreover, one should also have in mind that each fiscal stimulus would be pro-cyclical for Germany. In an environment of already strong investment in housing and construction and – as the staff mentioned in the report – capacity utilization in the construction sector above long term average, fiscal stimulus might accelerate price increases. A risk of overheating in the construction sector might emerge. Finally, in last year’s Article IV report, staff found that “Fiscal stimulus is likely to have a relatively small impact on the rest of the euro area…” and highlighted Germany’s role as an anchor of stability in the region. While we recognize that staff distinguishes between government consumption and investment in its analysis, the significantly modified staff analysis on fiscal spillovers from Germany to other euro area countries is noteworthy.
More generally, I would like to emphasize that the debt-to-GDP ratio in Germany is still high and demographic pressures are looming. Therefore, it is important that fiscal policy further focuses on medium term consolidation. It is my authorities’ objective to reduce the debt ratio by maintaining the current targets for the structural fiscal balance in compliance with the “debt brake” enshrined in the constitution and the commitments at the EU and euro area level. The debt-to-GDP ratio – which rose markedly in particular due to the stabilization measures taken in response to the crisis – is forecasted to decline to below 70 percent of GDP by 2016.
Structural reforms are indispensable to address the demographic challenges Germany is facing and to increase potential growth. Against this background, my authorities are committed to further increasing the overall efficiency of public expenditure and to further reforms on the labor market, improving infrastructure, a comprehensive energy strategy, higher and more effective R&D spending, improving the general framework for competition, and facilitating access to financing for SMEs.
The positive developments on the labor market in recent years resulted not only from the good economic situation, but in large part from labor market reforms, reliable labor relations, and prudent wage agreements. It is now important to build on this success and further improve the functioning of the labor market. My authorities’ comprehensive Skilled Workers Strategy is geared towards averting shortages of skilled labor and mobilizing individuals through new opportunities. Improving parents’ ability to combine career and family commitments through promoting a family-friendly working environment and an expansion of childcare facilities is a central part of this strategy. Furthermore, education and training are strengthened and the EU Directive on Highly Qualified Employment was implemented to attract skilled workers from abroad.
I appreciate the comprehensive analysis concerning the introduction of a statutory minimum wage in Germany. The introduction of a minimum wage was motivated by considerations of social equality and fairness without unduly undermining potential growth and the long term sustainability of Germany’s social security system. The introduction of the statutory minimum wage in Germany is a historical step that, from 1 January 2015 onwards, will benefit some 3.7 million workers according to projections by the Federal Ministry of Labor and Social Affairs. In order to contain adverse employment effects and negative impacts on affected sectors, specific groups are exempted.
My authorities are aware of concerns that the recent measures on pensions could have a negative impact on labour market participation and ceteris paribus increases contribution rates. In this regard, it is important to emphasize that the new law leaves no room for earlier retirement than has been possible under the old scheme. The earliest age for receiving old-age pension without penalties continues to be 63. To prevent early retirement via planned unemployment, periods of short-time unemployment at the age of 61 and 62 will not count toward the 45 years of contributions under the new pension law. Furthermore, the effects of the new pension law will taper off over the long term. The minimum retirement age will increase gradually up to the age of 65 in 2029 in line with the specified increase in the legal retirement age from age 65 to age 67 in the same period. At that time, the situation is the same as before the recent changes to the system; workers are able to retire at the age of 65 without any deductions when they fulfil the requirement of 45 contribution years (including periods of short-time unemployment).
Staff addresses the foregoing reduction of contribution rates as well as an increase of social contribution rates because of the new pension benefits in the longer-term. Because of the high uncertainty in estimates on the take-up of the new benefits staff recommends periodic reviews of fiscal costs. The law on the new benefits already includes an agreement on periodic reviews. The first periodic review will be executed in 2018.
My authorities agree to the findings of the staff that substantial investment is needed in the energy sector, with the focus on private investment in the fields of grid expansion and renewable energy production. In order to provide clarity about the energy sector regulatory framework, the German government is fully committed to its energy reforms and is pushing firmly ahead with the restructuring of the energy system. As Germany implements the energy reforms, it is important that the German government give equal priority to the objectives of security of supply, economic viability (i.e. cost-efficiency, affordability) and environmental compatibility/climate aspects. Electricity prices are crucial for the competitiveness of companies in Germany and in Europe and for the budgets of private households. Because it is clear that the energy reforms will not come free of charge, cost efficiency is a central criterion in their implementation. My authorities have therefore reformed the Renewable Energy Sources Act (to pass through parliament before the summer recess and to enter into force on 1 August 2014). With this reform Germany puts the necessary policies in place for a predictable and cost-efficient route towards a nuclear-free energy supply with a rising share of renewables. In order to accelerate the expansion of the grid, key policies have already been rolled out (e.g. Federal Requirements Plan Act, Grid Expansion Acceleration Act, rules on offshore liability) and the relevant players have been brought around one table on the Grid Platform.
I fully agree that good quality infrastructure is very important for the economy. Infrastructure investment is one of the priority measures in the coalition agreement. In recent years, the Federal Government has invested more than 10 billion euro per year in the transport sector. For further upgrading and maintenance, an additional 5 billion euro will be provided between 2014 and 2017 for investment in the transport infrastructure. In this respect, I agree that also private investments play an important role and the government will further improve conditions in order to facilitate and foster private investments.
However, I am not convinced by a transport infrastructure investment need of 0.2 – 0.4 percent of GDP per year as mentioned by staff. The German Council of Economic Experts considers an overall infrastructure investment need of 3.8 billion euro or about 0.1 percent of GDP per year as justified. Besides stepping up investment the federal government aims at increasing efficiency, e.g. the potential of public private partnerships will be further explored. Furthermore, in view of the highly developed infrastructure already in place, priority will be given to maintenance of existing infrastructure. Investment spending should not simply be expanded across the board just to increase its share of GDP. Case-by-case decision is required to determine whether there is a need for replacement or whether a bottleneck needs to be eliminated. Shrinking demand for certain infrastructure and in some regions due to demographic developments must also be taken into account.
Federal Government spending on R&D is rising continuously. The High-Tech Strategy foresees R&D activities in five main areas: climate/energy, health/nutrition, communications, mobility, and security. Also in the context of the High-Tech Strategy, an innovation policy concept has been drafted with a view to taking further measures to strengthen Germany’s already high innovative capacities.
I share staff’s views on the changes in the banking sector. Progress with regard to the various transitions – e.g. new capital and liquidity regulation, recovery and resolution frameworks, and the Single Supervisory Mechanism - is on track.
On the macro-prudential framework, the German Financial Stability Committee (FSC) has been founded with appropriate analytical capacities and tools to limit systemic risk if necessary. As envisaged, the FSC has presented its first report to the Parliament and the report is publicly available. Work currently focuses on further developing the macroprudential strategy and instruments. We are monitoring closely the experiences of other countries regarding the application of macroprudential instruments. These experiences indicate that tools provided by CRD IV/CRR may not be sufficient to address certain types of systemic risks and that additional tools may be needed. An expanded set of macro-prudential instruments could possibly include LTV- and DTI-requirements to tackle possibly emerging risks in the German housing markets.