Abstract
In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.
III. Which Policies can Boost German Growth and Reduce the Current Account Surplus?1
This chapter argues that certain policies which would boost domestic demand are not only in Germany’s best interest, but are also associated with positive spillovers which could support activity across the euro area. Motivated by pressing infrastructure needs, simulations suggest that higher public investment would stimulate domestic demand in the near term, but also raise German output over the longer term and decrease the current account surplus. In addition, beneficial spillovers would support the recovery across the region. Greater investment to reduce energy-sector bottlenecks would have similarly beneficial domestic and regional effects. The current low-interest rate environment presents a window of opportunity to finance higher investment at historically favorable rates. Implementing reforms in the nontraded service sector would also durably increase Germany’s GDP and productivity.
1. Over the last few years, weak investment and lagging service sector productivity have been a drag on German growth. In spite of strong corporate savings, domestic demand has been weighed down by weak private investment (Appendix Figure 1), which has contributed to the persistent current account surpluses. Weak domestic demand and reliance on export–led growth in Germany against the background of large negative output gaps in the euro area periphery and beyond have raised concerns about adverse spillovers from Germany to the rest of the world. Germany also has the second lowest public investment-to-GDP ratio in the OECD and net public investment has been negative since 2003 (Appendix Figure 2), while pressing infrastructure needs have been identified, particularly in the areas of transportation (for example, owing to aging bridges and roadways).2 In addition, the rising importance of renewable energy sources in the context of the Energiewende requires substantial investment, in part to alleviate capacity bottlenecks, while uncertainty over future energy prices appears to be holding back private investment. At the same time, productivity in the nontraded services sector lags that in the export-oriented manufacturing industries, and despite continuous improvement in economy-wide product market regulation, there is still scope for reducing barriers to competition in some services sectors.
2. This note explores the quantitative implications of policies which aim to raise German growth and, as a byproduct, lower the current account surplus as well as generating positive regional growth spillovers. Specifically, model-based simulations are used to trace out and compare the domestic impact and spillovers associated with three policy experiments: (1) an increase in government investment, (2) an increase in private energy sector investment, and (3) reforms that reduce mark-ups in the services sector. An extended version of the IMF’s Global Integrated Monetary and Fiscal model (GIMF) is calibrated to capture the main features of Germany, the “GIIPS” (Greece, Ireland, Italy, Portugal, and Spain), other euro area countries (“OEA”), the United States, Emerging Asia, and the rest of the world (ROW).3
A. Higher Public Investment
3. In contrast to other forms of fiscal stimulus, higher German public investment holds the most promise for durably raising real GDP. The impact on real GDP (as a percent deviation from the baseline) and the current account balance (as a percent of GDP, difference from baseline) in Germany, the OEA, and the GIIPS from two alternative policies: (1) a ½ percent of GDP, 4-year, debt-financed increase in government investment; and (2) an equivalent increase in government consumption is shown in Figure 1. In contrast with an increase in public consumption, an increase in public investment raises productive capacity permanently as it adds to the government stock of capital. In addition, in line with the literature, improved public infrastructure is assumed to have a positive effect on total factor productivity in the private sector, which, in turn, fosters higher private investment and a further permanent increase in productive capacity.4 Moreover, because a part of the expansion is productivity-induced, the increase in aggregate demand has a smaller impact on inflation than an increase in government consumption, muting the response of monetary policy. All in all, the simulations suggest that German real GDP rises by ¾ percent and ¼ percent relative to baseline (in year four) in response to the public investment or consumption increases, respectively. The peak impact (in year two) on the German current account, at around 0.4 percentage points, is more modest and similar for the two policy experiments.
Germany: Higher Public Spending
(Deviation from baseline)
Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A003
Sources: Staff calculations.Note: Fiscal stimulus is a ½ percent of GDP per year debt-financed increase in public consumption or investment for 4 years. Real GDP and the current account (-to-GDP ratio) are measured in percent and percentage points, respectively.4. The beneficial spillovers associated with higher German public investment can be meaningful, while those associated with public consumption are limited. Comparing the two types of stimuli also makes it clear that higher German public investment has greater growth spillovers than higher public consumption (Figure 1). Specifically, the peak effect is higher GDP of 0.11 and 0.06 in the OEA and the GIIPS, respectively, in the case of the public investment stimulus, in contrast to negligible increases in the case of public consumption. This reflects the stronger and more persistent effect of public investment on Germany’s aggregate demand and the more limited effects on euro area inflation (and thereby less monetary tightening by the ECB). While the model treats the GIIPS as a group, effects vary depending on, inter alia, the strength of the trade linkages with Germany, implying larger spillovers to Italy, for example. Spillovers on the current account balance in the GIIPS, however, are smaller regardless of the policy.
Germany: Higher Public Investment
(Deviation from baseline)
Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A003
Sources: Staff calculations.Note: Fiscal stimulus is a ½ percent of GDP per year debt-financed increase in public investment for 4 years including with monetary accommodation and a credit crunch. Real GDP and the current account (-to-GDP ratio) are measured in percent and percentage points, respectively.B. Accommodative Regional Monetary Policy
5. The domestic impact of higher German public investment and the associated spillovers are even larger if monetary policy remains accommodative. The model assumes that before the policies are implemented the economy is operating at full capacity—that is the output gap is zero. Thus, any policy experiment that leads to an expansion of aggregate demand in the euro area leads to an increase in inflation, triggering a tightening of monetary policy because of the central bank’s reaction function (the ECB has a price stability objective). However, in the present circumstances, in which there is a sizable negative output gap in the euro area and the ECB stance is constrained by the zero lower bound, it may be more plausible to assume that an expansion in German public investment will not cause a monetary tightening. Accordingly, the simulations are repeated with policy rates kept unchanged for four years (Figure 2). The result is that the positive effect of higher public investment on growth both in Germany, the OEA, and the GIIPS is larger, because of the lower prevailing real interest rates (0.86, 0.35, and 0.30 percent, respectively)—with the marked increase in the beneficial spillovers to the GIIPS, for example, under monetary accommodation especially noteworthy (with GDP increasing by 0.30 percent, instead of 0.06 percent).
6. Regional spillovers from higher German public investment could be even larger if there is a credit crunch in the euro area periphery. While regional financing conditions have generally improved more recently, household access to credit is still tight and corporate spreads are still relatively high. In such an environment (a mild “credit crunch”), spillovers are larger, including when monetary policy is accommodative (Figure 2). Higher growth triggered by the German stimulus helps relax the borrowing constraints in the region, and boosts consumption (especially for liquidity-constrained agents) and investment across the OEA and the GIIPS.
C. Implementation Delays
7. Implementation delays associated with higher German public investment postpone the eventual rise in GDP. Many projects, especially infrastructure, require coordination among federal, state, and local governments and have to go through a long process of planning, bidding, contracting, construction, and evaluation. In fact, as noted in Leeper and others (2010), the amount of government investment authorized often deviates substantially from contemporaneous outlays, even for some projects which are claimed to be “shovel ready.” To model these delays, the IMF’s GIMF is extended to incorporate a time-to-build setup to characterize the formation of public capital in the spirit of Kydland and Prescott (1982). 5 The same benchmark increase in German public investment is simulated, but with investment delays (time-to-build), and with monetary accommodation (Figure 3). In contrast to the benchmark calibration, the increase in real GDP is more gradual because it takes time to build up the stock of government capital (which only increases the productivity of labor and private capital upon completion). With implementation delays, government investment boosts aggregate demand in the short run, but the producitivty gains and higher growth potential associated with a higher stock of public capital occur with a lag. Hence, while the short-run growth implications differ depending on whether or not the simulations incorporoate implementation delays, the longer-run output gains are similar. Moreover, even with implementation delays, regional spillovers are appreciable when monetary policy remains accommodative. A byproduct of implemetation delays is a deferred and somewhat smoother deficit profile, implying less of an annual budgetary burden.
Higher German Public Investment With and Without Time-to-Build
Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A003
Source: Staff calculations.Note: Fiscal stimulus is a 4-year ½ percent of GDP per year debt-financed increase in public investment, with and without 4 years of monetary accommocation (MA) with and without a 3-year time-to-build (TTB) feature. Real GDP and the current account (-to-GDP ratio) are measured in percent and percentage points, respectively.D. Financing
8. The positive effects of public investment on short-term growth would be smaller if the projects were financed by instruments other than debt. There are various ways to finance greater German public investment. Because public investment presumably would also benefit future generations, from an intergenerational equity perspective, it appears justified to finance these outlays partly via debt issuance. In addition, the current low-interest rate environment presents a window of opportunity to finance higher investment at historically favorable rates. Alternatively, higher government investment could be financed by a combination of government consumption or transfer reductions, or through higher taxes. Simulations suggest that a budget neutral increase in public investment financed via higher taxes or lower transfers are generally associated with the lowest and highest impacts on real GDP, respectively (Figure 4).
Germany: Financing Public Investment
(Deviation from baseline)
Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A003
Sources: Staff calculations.Note: Fiscal stimulus is a 4-year ½ percent of GDP per year budget-neutral increase in public investment counterfinanced using other instruments. Real GDP and the current account (-to-GDP ratio) are measured in percent and percentage points, respectively.E. Higher Private Investment
9. Higher energy sector investment in Germany would boost growth, facilitate rebalancing, and generate positive spillovers. The rising importance of renewable energy (RE) requires substantial investment in the national electrical grid to deliver electricity from suppliers to consumers, which are typically not close. This significant increase of RE in the North and the reduced nuclear capacity in the more industrial South along with a slow pace of network expansion have led to bottlenecks. Accordingly, estimates show that considerable investments are required for the expansion of RE for electricity and heat generation, power grids (transmission and distribution), systems integration (storage), and energy-efficient building. These investments needs correspond to €27–38 billion, or 1-1½ percent of GDP, per year until 2020. While energy sector reforms are planned, public opposition to grid expansion and uncertainty about future costs, exemptions, and the regulatory framework more generally seem to be holding back investment as indicated by industry surveys. Therefore, an earlier resolution of uncertainty associated with energy policy would facilitate future planning and could thereby boost private sector investment within and outside the energy sector. In this context, to assess the implications of higher German private investment, a 4-year, ½ percent of GDP (per year) increase in private investment is simulated (in part to facilitate comparability to the public investment scenarios discussed above, Figure 5). German GDP increases by 0.5 percent above baseline, and the current account balance is reduced by 0.3 percentage point (mainly on account of higher imports associated with the more elevated level of domestic demand). Regional spillovers are appreciable and even higher when monetary policy is accommodative.6
Germany: Higher Private Investment
(Deviation from baseline)
Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A003
Sources: Staff calculations.Note: A 4-year, ½ percent of GDP increase in private investment with and without monetary accommodation is simulated. Real GDP and the current account (-to-GDP ratio) are measured in percent and percentage points, respectively.F. Service Sector Reforms
10. Service sector reforms which lift German potential output would also reduce the current account surplus and could be associated with some positive regional growth spillovers. While there have been continuous improvements in economy-wide product market competition over the past 15 years, certain sectors, for example, those pertaining to retail and professional service remain relatively overregulated (see Chapter 3, Selected Issues Papers). Therefore, to mimic the implications of a renewed comprehensive reform effort targeting the services sector, the price markup in the non-tradable sector is permanently reduced by 2 percentage points over 4 years from 20 to 18 percent.7 These lower markups could be interpreted as the result of lowering entry barriers and therefore decreasing the price-setting power of incumbent firms (which operate in a monopolistically competitive environment). As a result, demand for the factors of production increase, which raises output in the non-tradable sector. Increased labor demand pushes up the real wage, leading to higher household purchasing power, which raises consumption. While the real (effective) exchange rate depreciation promotes export growth, the higher demand for capital stimulates investment, both in non-tradable and tradable sectors, and therefore yields a reduction in the German current account surplus by 0.2 percentage point of real GDP (Figure 6).8 The corresponding increase in German GDP is appreciable, over 0.4 percent after 4 years, or higher growth of 0.1 percent per year over the four-year period. Similar results would obtain if instead of a reduction in mark-ups, more competition boosted non-traded sector productivity by around 0.1 percent per year over 4 years.9 Regional growth spillovers are more modest.
Germany: Services Sector Reforms
(Deviation from baseline)
Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A003
Sources: Service sector reforms are simulated by a permanent 2 percentage point reduction in the non-tradeable sector price markup over 4 years. Real GDP and the current account (-to-GDP ratio) are measured in percent and percentage points, respectively.11. In sum, higher public and private investment as well as service sector reforms can raise German real GDP durably. At the same time, while decreasing Germany’s current account surplus temporarily, these policies are associated with positive regional growth spillovers, albeit to a varying degree, which can promote economic recovery in the euro area. These policies are characterized by yielding higher productivity gains in Germany, which result in more durable growth gains than temporary demand stimulus policies alone.
Private Investment
Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A003
Source: DIHK; Haver Analytics; Baker, Bloom, and Davis (2012); policyuncertainty.com, and IMF staff calculations.Public Investment
Citation: IMF Staff Country Reports 2014, 217; 10.5089/9781498328524.002.A003
Source: Haver Analytics and staff calculations.Note: It is important to note that even within the euro area there can be differences in what is recorded as public versus private investment because the perimeter of general government varies across countries.References
Aschauer, D.A., 1989, “Is Public Expenditure Productive?” Journal of Monetary Economics Vol. 23, pp. 177–200.
Christopoulou, R., and P. Vermeulen, 2008, “Markups in the Euro Area and the U.S. Over the Period 1981-2004: A Comparison of 50 Sectors,” ECB Working Paper, No. 856.
Elekdag, S. and D. Muir, 2013, “Trade Linkages, Balance Sheets, and Spillovers: The Germany–Central European Supply Chain,” IMF Working Paper 13/263.
European Central Bank, 2006, “Competition, Productivity and Prices in the Euro Area Services Sector,” Occasional Paper, No. 44.
Glomm, G, and B. Ravikumar, 1997, “Productive Government Expenditures and Long-Run Growth,” Journal of Economic Dynamics and Control Dynamics, Vol. 21, pp. 183–204.
In’t Veld, J., 2013, “Fiscal Consolidations and Spillovers in the Euro Area Periphery and Core,’ European Commission Economic Papers No. 506.
Kydland, F.E. and E.C. Prescott, 1982, “Time to Build and Aggregate Fluctuations,” Econometrica, Vol. 50, No. 6, pp. 1345–70.
Leeper, E.M., T.B. Walker, and S-C.S. Yang, 2010, “Government Investment and Fiscal Stimulus,” IMF Working Paper 10/229.
Ligthart, J.E., and M Suarez, 2011, “The Productivity of Public Capital: A Meta-Analysis,” in W. Jonkhoff and W. Manshanden (Eds.), Infrastructure Productivity Evaluation, pp. 5–33, New York: Springer-Verlag. (Springer Briefs in Economics Series, 1).
Varga, J, and J. in’t Veld, 2013, “The Growth Impact of Structural Reforms” Quarterly Report on the Euro Area, Vol. 12, No. 4 (Chapter 2).
Prepared by Selim Elekdag (EUR) and Dirk Muir (RES).
Various studies place public infrastructure needs in transport alone at 0.2–0.4 percent of GDP per year, particularly owing to aging bridges and roadways. Estimates by the Cologne Institute for Economic Research (IW) suggest transport infrastructure needs of around €4 billion per year, while the “Daehre Commision Report” suggests a minimal need of €7.2 billion. The think tank DIW reports an estimate of around €10 billion per year (including pent-up needs) for maintenance and extension of the transport network. More generally, schools and kindergartens, particularly at the municipal level, represent other examples of infrastructure backlogs. Indeed, KfW surveys indicate a perceived municipal investment backlog of over €100 billion, of which transport (€27–31 billion), schools (€24–27 billion), and public administration buildings (€11 billion) comprise the largest needs. Relatedly, IW estimates needs of €120 billion over the next decade, split evenly between transport (already noted above), broadband communications network, and the energy sector (with the latter in the purview of the private sector).
For further details, see, for example, Elekdag, S. and D. Muir, 2013, “Trade Linkages, Balance Sheets, and Spillovers: The Germany-Central European Supply Chain,” IMF Working Paper 13/263.
As in other studies, public investment is assumed to raise aggregate productivity in GIMF (in’t Veld, 2013). The output elasticity of public capital is conservatively calibrated at 0.14 following Ligthart and Suarez (2011), in contrast to values ranging from 0.1 to 0.4 with an average greater than 0.2 (Aschauer, 1989; Glomm and Ravikumar, 1997). This value is set at 0.1, and sensitivity analysis using alternative values of 0.05 and 0.15 yield results similar to those report in the paper.
In this model, government investment turns into public capital through a time-to-build process, reflecting the lags between project initiation and completion that are observed in reality. The time-to-build process implies a distinction between when spending is authorized for a project, to when it is disbursed, and the investment actually occurs. It is often the case for public spending projects that the proportion of investment that occur each period is a small fraction of the authorized appropriation. As in Leeper and other (2010), this modeling approach differs from others in the literature, which typically assume that authorized spending is immediately implemented and is immediately productive.
The energy sector is not modeled separately in GIMF, so the shock is to aggregate investment.
This version of GIMF has two sectors: traded and non-traded (which include non-traded services). The model is calibrated to match the value added of the traded sector which is about 40 percent (comprising agriculture, forestry, and fishing; total industry including construction; and accommodation and food services). For the non-traded sector, reforms are presumed to have an impact on industries outside of public administration and defense, education, and human health and social work (the latter comprising 18 percent of gross valued added). As noted, the simulation is conducted by reducing the baseline non-traded sector mark-up which is set at 20 percent (for a gross mark-up of 1.2). This calibration of the markup seems to be conservative, given the wide range of estimates in the literature. On the lower end, Varga and int’ Veld (2013) use 14 percent for German services sector (citing previous work by the EC for final, and not necessarily non-traded, goods over 1996–2007). In contrast, other studies find much higher mark-up estimates. For example, the ECB (2006) presents mark-ups for the total economy and non-financial business services for Germany exceeding 1.5 (that is, 50 percent) and 2.0, respectively, over 1981–2003. Christopoulou and Vermeulen (2008) estimate mark-ups for German market services exceeding 1.5 (1981–2004). Their sector specific mark-ups are also quite revealing. For Germany, mark-ups for financial intermediation (excluding insurance and pension funding), activities related to financial intermediation, real estate activities, other business activities, and other services activities are 1.99, 1.52, 3.27, 1.82, and 2.37, respectively.
It may be worth emphasizing that the decline in the current account balance hinges on the higher investment response characterized by the simulated service sector reforms. Moreover, note that in the model, that the non-traded (services) sector is not an input for the tradable sector, which could therefore downplay the full impact on export growth associated with these simulated service sector reforms.
This is because lower mark-ups or higher productivity affect the wedge between the non-traded sector price and marginal cost in a broadly similar fashion. For concreteness, consider a simplified and linearized representation of the non-traded price, which is a function of the mark-up, µ, marginal cost, MC, and productivity, A: PN,t = µN,t + MCN,t − AN,t.
