Germany: 2018 Article IV Consultation—Press Release; Staff Report and Statement by the Executive Director for Germany
Author: International Monetary Fund. European Dept.
Publication Date:
04 Jul 2018
eISBN:
9781484366158
ISBN:
9781484366158
Language:
English
Keywords:
ISCR; CR; surplus; core inflation; IMF staff calculation; government; interest rate; staff; return on equity; labor market; output gap; IMF staff estimate
Download PDF (6.5 MB)

The Germany economy has performed very well in recent years, supported by prudent economic management and past structural reforms.

Abstract

The Germany economy has performed very well in recent years, supported by prudent economic management and past structural reforms.

Impressive Recent Economic Performance

1. The economy surprised on the upside in 2017. Real GDP growth picked up sharply, reaching 2.5 percent, as exports rebounded and triggered a much-awaited pickup in investment. Strong private consumption, supported by a robust labor market, was offset by a slowdown in public consumption as refugee-related expenditures stabilized. Although both exports and imports grew strongly, the contribution of net exports turned positive again. The labor market continued to tighten: even though employment grew more slowly than in previous years, reflecting diminished migrant inflows, job creation was strong enough to bring the unemployment rate to a new post-reunification low of 3.6 percent (Figure 4).1 In the first quarter of 2018, growth slowed to 0.3 percent (qoq), reflecting a normal correction following unusually strong growth in late 2017 and temporary factors (strikes, a particularly nasty flu outbreak, and early Easter holidays), but the labor market continued to perform strongly.

Figure 1.
Figure 1.

Savings by Non-Financial Corporations

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Deutsche Bundesbank, Destatis, Eurostat, Haver Analytics, Orbis, and IMF staff calculations.1/ includes dividends.
Figure 2.
Figure 2.

Investment in Human Capital

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Eurostat, OECD; Nedelkoska and Quintini (2018), “Automation, skills use and training,” and IMF staff estimates.1/ Includes public and private education spending. Calculated as the deviations from the fitted values estimated with the coefficients from cross-sectional regressions of education spending per student and per-capita income in U.S. dollar for 2012–14.2/ Participation rate of population aged 25–64 in education and training during the last four weeks.
Figure 3.
Figure 3.

Key Challenges to Entrepreneurship

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Destatis, Haver Analytics, OECD, World Bank, and IMF staff calculation.1/ The number of procedures to create a limited liability company (GmbH-Gesellschaft mit beschränkter Haftung-for Germany).2/ The share of individuals who send filled forms online.
Figure 4.
Figure 4.

Germany: Growth Developments

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Destatis, Haver Analytics, IFO Institute, INS, IMF World Economic Outlook, Markit, and IMF staff calculations.1/National Accounts Concepts.

2. Inflation and wage growth picked up somewhat. Headline and core inflation reached about 1.5 percent by end-2017 and picked up further in the first several months of 2018 (Figure 5). Nominal wage growth increased moderately in 2017 and early 2018. Staff analysis suggests that nominal wage growth in Germany has been consistent with subdued productivity growth and inflation expectations over the past few years, and that immigration has not had a significant impact (Annex VI).2

Figure 5.
Figure 5.

Germany: Prices and Labor Market

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Bundesbank, Federal Statistical Office, Federal Statistical Office’s 13th Coordinated Population Projection, Eurostat, Haver Analytics, and IMF staff calculations.

3. The fiscal position strengthened further in 2017, mostly reflecting cyclical effects. The general government surplus rose to 1.2 percent of GDP (from 1 percent of GDP in 2016), the highest level since reunification and about ¾ percentage point higher than initially planned in the 2017 Stability Program (Figure 7).3 The fiscal overperformance mainly reflected the surprise acceleration of GDP in 2017, leading to a lower expenditure-to-GDP ratio, while revenue-to-GDP performed largely as expected. Public investment increased by about 5 percent in nominal terms, or 0.1 percent of GDP. The fiscal stance, measured by the change in the structural primary balance, was broadly neutral in 2017, and the overall structural balance was flat at 1 percent of GDP. The public debt ratio decreased to 64.1 percent of GDP at end-2017, paving the way for it to reach the 60 percent of GDP benchmark this year.

Figure 6.
Figure 6.

Germany: Balance of Payments

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Bundesbank, DOTS, GDS, Haver Analytics, IMF World Economic Outlook, and IMF staff calculations.1/ The ULC-based REER is measured using ULC statistics for the manufacturing sector in Germany and 37 trading partners, using the OECD System of Unit Labor Cost Indicators.Note: EA5= Euro area economies (Greece, Ireland, Italy, Portugal, Spain) with high borrowing spreads during the 2010-11 sovereign debt crisis.
Figure 7.
Figure 7.

Germany: Fiscal Developments and Outlook

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Bloomberg Finance L.P., Federal Statistical Office, Ministry of Finance, and IMF staff calculations and projections.

4. Credit growth increased moderately. The overall private credit-to-GDP ratio remained broadly constant at around 100 percent of GDP—a historical low and below that of advanced economy peers. Credit to non-financial corporates (NFCs) showed a welcome pick-up in 2017, reflecting both stronger business investment and easy financial conditions. Mortgage lending also accelerated but, like credit to NFCs, it is still growing broadly in line with nominal GDP (Figure 8).

Figure 8.
Figure 8.

Germany: Credit Conditions and Asset Prices

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Bundesbank, ECB, Haver Analytics, and IMF staff calculations.
uA01fig01

Private Credit by Monetary and Financial Institutions

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: BIS and IMF staff calculations.

5. The current account (CA) surplus remained very high, despite narrowing to 8 percent of GDP from record highs in 2015–16. Recent data updates—mostly from revised foreign direct investment (FDI)-related earnings—reveal higher surpluses in 2015 and 2016 than previously estimated, by ¼ to ½ percentage point of GDP (Figure 6). In 2017, unfavorable terms of trade due to higher oil and raw material prices, as well as euro appreciation, pushed the trade balance down, despite its improvement in real terms. A one-off payment pushed the secondary income balance down. Overall, the CA surplus with euro area countries continued to rise and is now back at 2011 levels, but its composition has shifted from the high-debt countries to other euro area countries. The Net International Investment Position (NIIP) climbed to 60 percent of GDP at end-2017, with the rise relative to 2015 entirely explained by higher net portfolio investment (see Table 5 and Box 1). In the first quarter of 2018, the CA surplus rebounded to 8.5 percent of GDP, in part as the secondary income balance normalized. The real effective exchange rate appreciated by 1.4 percent in 2017 relative to 2016, and by a further 2 percent in the months up to May 2018, reflecting exchange rate movements against the dollar and other major trading partners.

Table 1.

Germany: Selected Economic Indicators, 2015–19

article image
article image
Sources: Deutsche Bundesbank, Federal Statistical Office, IMF staff estimates and projections.

Seasonally and working day adjusted (SWDA).

Contribution to GDP growth.

ILO definition, unless otherwise indicated.

National Accounts Concepts.

Deflated by national accounts deflator for private consumption; not SWDA.

Net lending/borrowing.

Excluding supplementary trade items.

Data refer to end of December.

Data reflect Germany’s contribution to M3 of the euro area.

Nominal effective exchange rate, all countries.

Real effective exchange rate, CPI based, all countries.

Table 2.

Germany: General Government Operations, 2015–23

(Percent of GDP)

article image
Sources: Bundesbank, Federal Statistical Office, Ministry of Finance, and IMF staff estimates and projections.
Table 3.

Germany: Medium Term Projections, 2015–23

article image
Sources: Federal Statistical Office, Bundesbank, and IMF staff estimates.
Table 4.

Germany: Balance of Payments, 2015–23

(Percent of GDP)

article image
Sources: Bundesbank, Federal Statistical Office, IMF Statistics Department, and IMF staff estimates.Note: Based on Balance of Payments Manual 6.
Table 5.

Germany: International Investment Position, 2009–17

(Percent of GDP)

article image
Sources: IMF Statistics Department and IMF staff calculations.Note: Based on Balance of Payments Manual 6.

6. Rising corporate net saving—alongside fiscal consolidation—is behind the rise in Germany’s external surplus. Household saving has remained high, but stable, over time, while government saving increased by 4 percentage points of GDP since 2001, and NFC net lending by about 5 percentage points of GDP from 2001 to 2015. NFC saving has trended up since the early 2000s, leading to a sustained decline in leverage from its peak in 2001 (Figure 1). Staff analysis suggests that, in the pre-crisis period, rising NFC saving reflected growing profitability amid wage moderation and declining debt service (Annex VII). Since the global financial crisis (GFC), declining dividend payout rates have become the most important driver of rising NFC saving, while the labor share reverted to its 2001 level and net profits stabilized as a share of GDP. In terms of saving rates, the increase is most obvious among small- and medium-sized firms, while family-owned businesses tend to have higher saving rates overall. Several factors may explain the rise in NFC saving, including corporate tax reforms in 2000 and 2008 which reduced incentives for debt financing, precautionary savings motives following a period of tight financial conditions during the GFC, or a need to build up cash buffers to finance R&D spending (especially given the dearth of venture capital—see Policy Discussions, Section D). The decline in interest rates may also have reduced pressure to pay out dividends at the same rate as in the past.

The Evolution of the Balance of Payment’s (BoP) Financial Account

Germany’s financial account balance has trended up since 2001, mirroring the current account surplus (Figure 6 and Table 4).1 Net portfolio investment (PI) has been its largest component since the GFC, while prior to that “other investment” (OI) flows were more important. These net flows, however, mask important developments in gross investments into and out of Germany.

uA01fig02

Net Acquisition of Financial Assets

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Deutsche Bundesbank, Haver Analytics and IMF staff calculations.
uA01fig03

Net Incurrence of Financial Liabilities

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Deutsche Bundesbank, Haver Analytics and IMF staff calculations.

The nature of cross-border PI flows has changed considerably over time. Before the GFC, the net PI balance was relatively small, but gross in- and outflows were notoriously large. German investors in particular stepped up holdings of euro area sovereign bonds through this period, while foreigners were investing both in German long-term government debt and private sector securities. Gross PI flows peaked in 2007, reflecting the pre-crisis environment of ample global liquidity and significant cross-border lending. Following a pause in 2008–09, outward PI recovered to pre-crisis levels. However, inward PI remained low and turned negative in recent years, as foreign investors sold German sovereign bonds to the Bundesbank in the context of the European Central Bank (ECB)’s Asset Purchase Program (APP). The implication is that net PI has turned large and positive, reflecting the reduced foreign investment in German sovereign bonds.

Quantitative easing by the ECB has also affected OI patterns. Up to 2009, OI outflows essentially followed German banks’ lending and accumulation of deposits abroad. This was sharply reversed in 2009, and hasn’t noticeably resumed since as German banks especially have reduced cross-border exposures. Instead, after the GFC, OI outflows were strongly driven by changes in the TARGET2 balance of the Bundesbank, which is recorded as a capital outflow in the BoP. In 2010–12, for example, shifts in market sentiment during the European debt crisis led to “safe-haven” investment in Germany. Liquidity provided by central banks elsewhere in the euro area partially ended up deposited in Germany (flight to safety), giving rise to new claims of the Bundesbank on the ECB. After 2014, the growing TARGET2 balance was instead related to the ECB’s APP: as foreign investors sold non-German bond holdings to a non-German central bank in the euro area, and deposited the proceeds in a German bank, the Bundesbank TARGET2 claims rise. Nevertheless, while changes in TARGET2 balances have a gross (OI) flow correspondence in the financial account, the net impact is lower as a liability of domestic banks towards foreign depositors is also created.

uA01fig04

TARGET2 Balance and the Financial Account

(Billions of Euros)

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Deutsche Bundesbank, Haver Analytics and IMF staff calculations.

Direct investment (DI) abroad and foreign DI in Germany have fluctuated around 3 and 2 percent of GDP, respectively (with some interim post-GFC decline in inward DI). German corporates have traditionally acquired equity (including through retained earnings) in Europe and in the US, and lent to controlled companies in lesser amounts. Inward investment originates mostly in the Euro Area, and reflects in part lending to parent (German) companies (reverse investment).

1 The balance of the capital account is close to zero as a share of GDP.2 The March 2012, March 2016, and December 2017 Bundesbank Monthly reports discuss the relation between unconventional monetary policies of the ECB, Target2 balances and the BoP in greater detail.

7. At the aggregate level, increased saving by the government and NFCs have curtailed household purchasing power. Disposable income—while growing in real and nominal terms—has declined by about 4 percentage points of GDP since 2010, reflecting lower capital income (on account of lower dividend payments and interest income) and, to a lesser extent, higher tax payments. As German households consume a relatively constant share of current income, private consumption as a share of GDP also dropped from about 55 percent on average between 1995 to 2005, to 51 percent at the end of 2017. Bringing back household consumption to its 2005 level in terms of GDP (55 percent) would mechanically decrease the current account by about 1.4 percentage points of GDP.

uA01fig05

Contribution to Cumulative Change in Household Disposable Income, since 2008

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Deutsche Bundesbank, Destatis, and IMF staff calculations.
uA01fig06

Household Consumption and Disposable Income

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Deutsche Bundesbank, Destatis, and IMF staff calculations.

8. Despite comfortable profits, business investment has remained low in Germany. A poor demographic outlook, relatively low productivity growth, and the lack of skilled labor seem to have been holding firms back.4 Business investment declined from around 13 percent of GDP in the 1990s to 11 percent of GDP in recent years. Although German companies have increased direct investment abroad since the mid-1990s, including to build supply chains, outward FDI has remained broadly stable over the last decade (at about 3 percent of GDP) (see also Box 1). Financing constraints do not seem to have been a factor.

uA01fig07

German Direct Investment Abroad 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Deutsche Bundesbank, Haver Analytics and IMF staff calculations.1/ Excludes investment by Monetary Financial Institutions

Solid Expansion in Near-Term; Looming Medium-Term Challenges

9. The near-term outlook is for continued solid expansion, but growth is expected to slow markedly over the medium term.

  • GDP growth in 2018 is projected to be somewhat lower than last year due to a disappointing first quarter. Following a soft patch, private consumption is expected to rebound on the back of the tightening labor market. Business investment is expected to remain robust, gradually making up for the 2015/2016 slowdown. Construction activity should continue to be supported by a large backlog of orders, but capacity limits and labor shortages are expected to dampen future growth.

  • Over the medium term, Germany’s unfavorable demographics and weak productivity growth are expected to weigh on output, with potential growth estimated at 1.3 percent. Staff’s medium-term projection is for growth to slow to potential and for the output gap to narrow, but remain positive, by 2023. The persistence of the positive output gap over the medium term reflects the asynchronous business cycles among euro area member states amid accommodative monetary conditions for the euro area as a whole.

10. Core inflation and nominal wage growth should gradually pick up. The positive output gap is expected to put upward pressure on prices, pushing both headline and core inflation to 2.5 percent by 2023. With unemployment below most estimates of natural rate, high job vacancy rates, and shortages of skilled workers in an increasing number of professions, wage growth is expected to accelerate steadily and exceed 3.5 percent in 2019 based on staff analysis of the wage-Phillips curve (Annex VI). Indeed, the latest wage bargaining rounds in the manufacturing, construction, and public sectors suggest significant acceleration in 2018 already.

11. Fiscal policy is expected to be moderately expansionary in the coming years, but fiscal space under the European fiscal rules would remain substantial. Based on the government’s 2018 Stability Program and the revised 2018 Federal budget—which reflect the new government’s fiscal commitments—staff forecasts that the overall general government balance would increase to 1½ percent of GDP this year and next, before declining to about ¾ percent of GDP over the medium term. In structural terms, the impact of the new government’s policies should be marginal in 2018: the structural primary balance would deteriorate by ¼ percentage point of GDP, reflecting higher spending on health and families, as well as a modest increase in public investment. However, fiscal measures of 1½ percent of 2017 GDP are foreseen over 2019–21. The public debt ratio is projected to decline to 45 percent of GDP by 2023 (Annex III).

12. A high CA surplus is expected through the medium term under current policies. In the short term, the rebound in global demand, partly driven by U.S. fiscal stimulus, will support German exports and the high trade surplus, despite increasing imports from higher energy prices. Over time, a gradual realignment of price competitiveness within the euro area—supported by the acceleration of wage growth and inflation in Germany—and continued strong domestic demand (helped by the moderate fiscal expansion and higher business investment) should drive a modest trade rebalancing. However, returns on the growing NIIP would keep the current account surplus large. In all, a modest ¾ percentage point of GDP decline in the current account surplus is expected between 2018 and 2023 under current policies. The recently imposed U.S. tariffs on steel and aluminum should have a minor adverse direct effect on exports, although an escalation in trade disputes would have more sizable implications (Annex II).

13. Risks to the outlook are tilted to the downside. Due to its very open and interconnected economy, Germany is particularly vulnerable to increased protectionism and rising anti-EU or anti-globalization sentiment (Annex II).

  • A significant rise in global protectionism or a hard Brexit would hurt Germany’s exports and FDI, possibly disrupt supply chains, and weigh on domestic investment and productivity.

  • A reassessment of sovereign risk in the euro area triggered by policy uncertainty or faltering reforms could lead to a renewed bout of financial stress, with adverse implications for investment, growth, and the banking system in Germany. In the longer term, failure to durably reverse rising anti-euro/EU and anti-globalization sentiment could adversely affect long-term growth, notably if prolonged uncertainty dampened the investment climate.

  • A stalled structural reform agenda and unresolved bank legacy and profitability problems may also rekindle stress in the euro area and weigh on exports, productivity, and investment in Germany.

  • The withdrawal of exceptional monetary stimulus in the US, Japan, and Europe may trigger sharp corrections in already stretched valuations across all asset classes, while legacy banking and fiscal issues in parts of Europe may reignite sovereign bond market tensions. These could, in turn, trigger financial turbulence in Germany and potentially important second round adverse outward spillovers because of the systemic and interconnected nature of Germany’s largest financial institutions.

  • Domestically, lack of progress in revamping bank business models and implementing restructuring plans could lead to financial distress in major banks. The new and untested framework for bank recovery and resolution may complicate the policy response.

Authorities’ Views

14. The authorities shared staff’s relatively favorable assessment of the near-term macroeconomic outlook, and stressed that potential growth is likely to slow over the medium term. They emphasized that private investment was picking up and that low interest rates would probably continue to support both housing market and the construction sector, although the latter would be constrained by labor shortages. The tightening labor market should lead to higher wage growth and inflation, but the authorities project a more gradual increase than staff, partly due to the continuing downward pressure on wages related to migration. In the medium to long term, there was agreement that the main challenge arises from Germany’s demographic profile. The authorities expect potential growth to drop after 2020 if immigration is not able to compensate for the decline in native working age population. The authorities also shared staff’s assessment of the risks to the outlook, seeing the main risks as coming from external factors.

Policy Discussions

A. An Opportunity to Address Challenges and Support Rebalancing

15. Germany’s key economic challenge is to raise its long-term growth potential, which would stimulate investment and help reduce the large CA surplus. Germany’s workforce is expected to begin shrinking in 2020 even after accounting for immigration. High domestic savings have helped prepare for future demographic costs and improved balance-sheets. However, this has occurred alongside low investment growth, which has weighed on the country’s productive capacity. Productivity growth has been lackluster, especially in the services sector. Moreover, high government and NFC saving have been a factor in the decline in disposable income and household consumption as a share of GDP, which has also contributed to the large CA surplus.

uA01fig08

Decomposition of Labor Productivity Growth

(Percent, 2002-2016 average)

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Source: OECD, and IMF staff calculations.

16. Germany’s external position remains substantially stronger than implied by medium-term fundamentals and desirable policy settings. The cyclically adjusted CA surplus stood at 8¼ percent of GDP in 2017, modestly lower than in 2016 and 3¼–6¼ percent of GDP above the interval assessed as being consistent with economic fundamentals and desirable policy settings of 2–4½ percent of GDP (the norm). The estimated norm is somewhat lower than in previous years, due to refinements to the Fund’s External Balance Assessment model and data updates.5 Part of the resulting CA gap (0.8 percentage point of GDP) is attributed to domestic policy distortions: 0.4 percentage point is due to domestic fiscal policy and 0.4 percentage point is due to the low credit-to-GDP ratio in Germany, which partly reflects relatively low investment (Annex VIII). The real effective exchange rate (REER) is estimated to remain undervalued by 10–20 percent, consistent with the large current account gap.

17. Recent wage increases are welcome and should support rebalancing. Higher wage growth would underpin stronger private consumption and imports. Further rises in wage and price inflation—reflecting Germany’s strong cyclical position—would help lift inflation in the euro area, facilitate the normalization of monetary policy, and contribute to external rebalancing. The authorities could usefully emphasize this in their public communications, while respecting the autonomy of the social partners.

18. Fiscal consolidation and public debt reduction have created substantial fiscal space under the European fiscal rules. Given long-term fiscal pressures deriving from an aging population, staff views the Stability and Growth Pact’s medium-term objective (MTO) as appropriate under current policies. Even after taking into account the new government’s fiscal plans, staff estimates that the general government fiscal buffer in relation to the MTO remains large, at about 1–1¼ percent of GDP in 2018–2020 and about ¼–¾ percent of GDP in 2021–2023. However, at the central government level, the structural balance would fall to about −¼ percent of GDP in 2019–2020 under staff’s baseline forecast, close to the −0.35 percent floor imposed by Germany’s national fiscal rule (“debt brake”), implying that fiscal space would primarily exist at the state and municipal government levels.6 This shift of fiscal space from the central to state and local governments is partly due to the reorganization of financial relations between the federal government and Länder agreed in 2016, under which a larger share of value-added tax (VAT) revenue and higher federal grants will be given to Länder starting in 2020.

Germany: General Government Operations 1/

article image

Based on the European System of Accounts (ESA).

General government balances include the priority measures in the coalition agreement, based on the preliminary implementation plan outlined in the revised 2018 federal budget, and staff assumes most measures stay in 2022 will continue in 2023. Staff also assumes that €10 billion digital infrastructure investment will be equally implemented during 2019-2022.

The 2023 output gap is assumed to remain at the same level as in 2022, as the authorities’ January 2018 projections do not include an estimate for the 2023 output gap.

The SGP’s MTO is currently set at −0.5 percent of GDP until 2019. It is assumed that it will remain at such level in 2020–23.

Compliance with the debt brake rule is assessed based on public accounting—different from ESA—but financial transactions are excluded from revenues and expenditures so as to ensure that the structural balance measure is as close as possible that of the Maastricht definition (based on ESA).

From 2020 onwards, state governments will be bound by a zero structural deficit ceiling, acceding to the national debt brake. Local governments and social security funds are subject to stringent borrowing constraints, but may run occasional deficits. The debt brake rule therefore does not impose a precise floor to the general government structural balance, but should imply that it remains close or above −0.35 percent of GDP over time.

Calculated as the difference between the projected structural balance and the SGP’s MTO. For 2023 the interval is defined by the differences to the debt brake floor (see footnote 5) and to the MTO.

Sources: Ministry of Finance, Bundesbank, Federal Statistical Office, and IMF staff estimates and projections.

19. More forceful policy action will be needed to decisively address Germany’s medium-term challenges and facilitate external rebalancing. Although the new government is taking some welcome measures to continue to address these challenges, the current cyclical upswing presents a golden opportunity for bolder action (Box 2). Policies aimed at boosting potential growth—by increasing productivity growth, labor supply and investment—would help offset the effects of aging on long-term living standards. A multi-pronged approach that involves the use of the entire fiscal space to support growth-enhancing policies alongside structural reforms to boost productivity growth and incentives for private investment is therefore needed. Concerted policy action that increases productivity growth and labor supply can improve expectations of future growth and provide greater incentives for domestic investment in Germany, which in turn would facilitate external rebalancing and have positive outward spillovers for Germany’s trading partners.7 Key priorities include: investing more in physical and human capital; boosting labor supply; supporting entrepreneurship; and structural reforms to increase productivity growth and improve incentives for domestic private investment. Many of these priority policy areas are under the purview of the state and municipal governments, where the fiscal space primarily exists.

Authorities’ Views

20. The authorities view the CA surplus as the result of private sector decisions and not of domestic policy distortions, but concurred with staff on the desirability of promoting higher domestic investment. They reiterated the importance of demographic factors in explaining Germany’s high savings rates, alongside differences in expected growth domestically and abroad and the economy’s export-oriented industrial structure. Like staff, they expect the CA surplus to remain large over the next few years, but to decline especially as the baby boomers retire. To reduce the current account surplus, the authorities agreed that policies should aim at raising domestic investment, but noted that the government has already implemented various measures in this direction in the previous legislature, and more is foreseen in the new coalition agreement. The authorities and staff agreed that trading partners policies will also affect Germany’s current account. The Bundesbank currently assesses the REER to be close to equilibrium, both based on price competitiveness and relative productivity indicators of the German economy.8

The New Government’s Budget Proposal

The new government’s budget proposal includes several welcome measures to support long-term growth and address poverty risk. A package of €46 billion (about 1½ percent of 2017 GDP) in additional spending and tax cuts, spread over the next four years, was announced in the new government’s coalition agreement. Spending measures include the expansion of the high-speed internet network (financed by auctioning 5G licenses); investment in all-day childcare and after-school programs; additional housing support and training for refugees; and support for education, vocational training, and R&D activities. The phasing out of the solidarity tax surcharges for low- and middle-income households, starting in 2021, will help trim the labor tax wedge. In addition, increases in targeted benefits—such as the supplementary allowance to combat child poverty and additional support for the long-term unemployed—should help reduce poverty risks. Tax revenue overperformance is to be allocated to addressing “bracket creep” in the tax system and further supporting digitalization.

uA01fig09

Composition of Priority Coalition Measures

(billion euros)

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Authorities.* Digital infrastructure has different funding sources.

The impact of the government’s new budget proposals on GDP, public indebtedness, and the current account is estimated to be moderate. Relying on usual multipliers for public investment, consumption tax and transfers (both targeted and non-targeted).1 The government’s fiscal package of about 1½ percent of 2017 GDP (an accumulative fiscal impulse of 1 percent of GDP) would boost GDP by about ½ percent over 4 years, would increase the public debt-to-GDP ratio by about 1¼ percent of GDP and decrease the current account by about ¼ percentage point of GDP. Normal implementation lags, especially for investment (almost half of the new measures), suggests that the bulk of the effect is expected in 2019–21.

Cumulative Effect of the Government Program (2018–2021)

article image
1 See “Das Public Kapital: How Much Would Higher German Public Investment Help Germany and the Euro Area?”, IMF Working Paper No. 14/227.

B. Investing in Physical and Human Capital

Germany’s ample fiscal space should be used to further increase investment in physical and human capital.

21. Recent increases in public investment are welcome, but further efforts are needed. Public investment has declined since the 1990s, driven by municipalities, leading to a stagnant public capital stock.9 Although cross-country comparisons of public investment are complicated by the range of modalities used by different countries to support investment in public goods, Germany’s government investment appears to be below that of other advanced economies even after accounting for investment grants and public-private partnerships (Annex VIII). Investment activity at the municipal level has recently picked up, supported by financial relief (through the Municipal Investment Promotion Program) and investment promotion measures (through Partnerschaft Deutschland (PD)—Germany’s public consulting company) taken by the federal government and the Länder.

22. Addressing capacity constraints and improving investment prioritization at the municipal level are essential. Despite the government’s measures, noted above, to support investment at the municipal level, regional disparities regarding both funding and planning capacities and lengthy administrative procedures remain major impediments to faster advancement of infrastructure projects. Staffing constraints continue to hinder investment planning at the municipal level and PD itself is reaching capacity constraints. Therefore, consideration should be given to prioritizing the provision of PD’s services to municipalities where public investment has been delayed the most, or to providing additional financial support for the hiring of external consultants on a competitive basis. To help prioritize investment, a comprehensive investment plan—covering all levels of government—should be prepared. Moreover, to accelerate investment in transport, the Federal Transport Agency should be operationalized without delay.

23. Boosting investment in human capital, including lifelong learning, is also key to raising long-term growth potential. Germany’s education is of high quality, yet still trails the best-performing countries (Figure 2). Notably, compulsory instruction time for primary education in Germany is significantly shorter than that in peer countries.10

  • There is scope for expanding education spending. The new government’s plans to provide full-day primary education to all students by 2025 through enhanced collaboration between the Federal government and the Länder is a welcome and important step.11 Further expanding full-day primary education and further enhancing the provision of high-quality early childcare and early childhood education would not only strengthen basic skills, but also enhance the integration of students with migrant backgrounds, support poverty reduction, and promote the labor participation of women.

  • Recent studies suggest that a large share of German jobs, notably those concentrated in middle-skill occupations with a high content of routine tasks, are vulnerable to skill-based technological change.12 However, the digital skills of German adults and participation rates in life-long learning trail peers. To better prepare for the future of work with new and changing skills, providing workers with lifelong learning opportunities in collaboration with employers will be crucial.

Authorities’ Views

24. The authorities agreed on the priorities for fiscal policy, but disagreed on fiscal space. Ministry of Finance officials argued that there is no space at the federal government level due to both the “black zero” (an informal fiscal guidepost aimed at no new debt at the Federal level) and Germany’s national fiscal rule. They reiterated that the “black zero” provided a very important anchor for fiscal policy and that spending increases on long-term growth-enhancing measures should be financed through a reduction of other public expenditures. Regarding public investment, the authorities stressed the issue of comparability, noting that the perimeter of the general government differs across countries. That said, they agreed that further increases in public investment are needed to lift Germany’s growth potential, and that bottlenecks at the municipal level need to be addressed. It is part of the new government’s priorities to tackle this issue. Regarding digital infrastructure, the government reaffirmed the view that public funds should not crowd out private investment. Regarding education, the authorities reiterated that education policy was the remit of the Länder in Germany, but saw scope for enhancing the quality of, and budget allocation for, education. They hoped that the 2017 constitutional changes that enabled the federal government to provide funding to financially weak municipalities could help improve the situation.

C. Increasing Labor Supply

Use of fiscal space and structural reforms should aim to boost the labor supply of women, older workers, and migrants.

25. Given the unfavorable demographic outlook, there is scope to use fiscal space to further boost labor supply. In 2017, 65 percent of women with children below the age of 7 worked part-time. Further expanding childcare and after-school programs would provide greater opportunities for women to pursue full-time employment.13 Reducing the labor tax wedge on low-income households and secondary earners would also improve incentives for greater labor force participation. Because income is taxed at the household level and healthcare coverage is provided cost-free for non-working spouses, the effective marginal tax rate for second earners is high, discouraging full-time female labor participation. In this context, the new government’s plan to equalize health insurance contributions between employees and employers and to reduce the unemployment insurance contribution by 0.3 percentage point are welcome steps to reducing the labor tax wedge.

26. Important progress is being made on refugee integration. The backlog of pending asylum applications has been reduced substantially and most refugees are now participating in language and culture classes. Some refugees have already entered the labor market. The new government has committed to continue funding refugee programs, enhancing opportunities for entry into the labor market and reducing poverty risks.

27. Pension and labor market reforms that make it more attractive to extend working lives would reduce poverty risks, support long-term growth, and help external rebalancing. Unfavorable demographics will soon put pressure on public finances. Public pension expenditure is expected to rise by 1.9 percentage point of GDP between 2016 and 2040 (compared with an average of 0.8 percentage point of GDP increase in the EU) and pension replacement rates are projected to decrease, increasing the risks of old-age poverty in the future. The coalition agreement includes measures to cap the pension contribution rate at 20 percent and set a floor on replacement rates (under the national definition) at 48 percent until 2025.14 This measure is expected not to have a large fiscal cost up to 2025, but would be burdensome if it were to stay in place afterwards. Reforms to encourage higher participation rates among older workers, and longer working lives overall (as life expectancy is rising), would be a more durable and growth-friendly way to support adequate replacement rates. Savings rates would likely fall, as there would be less need to save for retirement, helping to reduce the large current account surplus.

Authorities’ Views

28. The authorities agreed that tax reforms should provide incentives for labor force participation. They emphasized that the reduction in the solidarity surcharge and the unemployment contributions would reduce the tax wedge. But they noted that further measures, such as reducing bracket creep, were being contemplated. They reiterated their commitment to promote as rapid an integration of refugees in the labor market as possible, and to assess the effectiveness of current policies down the road.

29. The authorities noted that, to effectively prolong working lives, structural reforms should focus on incentives to work. The government explained its view that it would be politically challenging to further increase the statutory retirement age, which they deem as already high at 67, without implementing simultaneous labor market reforms aimed at fostering the hiring of older workers by firms. The government is exploring new avenues in this area, such as incentives for life-long learning.

D. Boosting Productivity Growth and Private Investment

Structural reforms should aim to enhance the environment for private investment and increase productivity growth. Priority areas include supporting entrepreneurship and venture capital, completing Germany’s digital transformation, advancing energy transition, and embracing competition-enhancing structural reforms.

30. Policies that foster entrepreneurship in Germany would enhance productivity growth and investment. Expanding venture capital would support entrepreneurial activity as well as investment in intangible assets (including R&D), where banks are traditionally less active, potentially reducing the need for firms to save and thereby facilitating external rebalancing. New business creation in Germany has been on a declining trend for a decade, which suggests that entrepreneurial activity—essential for technological diffusion and productivity growth—is limited (Figure 3). Although the German government provides substantial support for early-stage financing, the relatively small size of venture capital funds cannot sufficiently support start-ups at the growth stage. Thus, the government should further explore ways to encourage the provision of scale-up capital, including in the context of the EU-wide capital markets union. The government’s ongoing initiatives to simplify tax administration and plans to introduce tax incentives for R&D for small- and medium-size enterprises should also support entrepreneurship. Expanding e-government services, where Germany trails peers, would also help reduce administrative burdens for entrepreneurs.

31. Investment in digital infrastructure is essential to prepare for tomorrow’s challenges. The government’s monitoring report “DIGITAL Economy 2017” indicates that digitalization in the corporate sector is picking up pace, especially in small and medium enterprise sector. However, high-speed nation-wide internet connections and higher information and communication technology (ICT) capital per worker—where Germany is still lagging peers—are necessary if Germany is to keep its position as an innovation leader in tomorrow’s digital world. The new government’s plans to increase investment in digital infrastructure are therefore welcome and should be implemented without delay. Completing Germany’s digital transformation will require additional investment from the private sector and the government should ensure that incentives and regulations are appropriately supportive and that funding is available where needed.

32. Germany’s energy transformation is underway, and a clear strategy for reducing greenhouse gas emissions would help reduce uncertainty. Germany is on track to meet its renewable energy (RE) target. At the same time, the government has set ambitious goals to cut greenhouse gas emissions—some of which will be missed. To help reduce uncertainty about future energy costs and transition, a clear and credible strategy for meeting greenhouse gas emissions targets should be articulated. Elements of strategy could include measures to promote public transportation, support the use of electric vehicles, and phase out coal-fired power production. The creation of a commission to establish a process for phasing out coal is welcome.

33. Increased competition in network industries and professional services would boost productivity and stimulate private investment. Efficiency-boosting reforms in network industries and professional services—which are important inputs in a large number of activities—may have an important and positive impact on productivity, investment, and long-term growth.15 Since the last consultation, however, there has been limited progress in enhancing competition in the railways or postal services where the incumbents’ dominant positions are largely unchanged. In both areas, the regulator should make use of its powers to avoid discrimination against new entrants, and corrective regulatory measures should be taken were the status quo to persist.16 Moreover, staff continues to view professional services as overregulated in Germany, where exclusive rights, compulsory chamber membership, and regulation on prices and fees stifle competition. A National Action Plan to reform the regulatory environment for lawyers, patent attorneys, tax advisors and auditors was submitted to the EC in 2016, but progress has been very limited since then.17

Authorities’ Views

34. The authorities highlighted various ongoing initiatives that would support entrepreneurship and education. While acknowledging the importance of entrepreneurship and venture capital for innovation and investment, the authorities were less concerned about the declining trend of new business creation, indicating that it may only reflect strong labor market conditions (and therefore less need to pursue self-employment). They also mentioned that funding for early-stage startups was adequate, and that the funding environment for the growth-stage of new businesses had also improved, although large deals remained rare. The authorities agreed that there is a scope for reducing the administrative burden through simplifying procedures and providing more government services via electronic platforms.

35. The authorities emphasized progress achieved in implementing their digital agenda and in the transition to renewable energy.

  • While they acknowledged that cross-country comparisons suggested that Germany was lagging peers in terms of connectivity, download speed and ICT density, they argued that cross-country comparisons could be misleading as they may not appropriately measure the quality of services and the differences in product sophistication. The government reiterated its goal to make Germany a lead market for 5G application by 2025, noting that one of the main impediments to a faster and widespread adoption of digital technology was the lack of skilled labor. They plan to enhance the promotion of digitalization and ICT competences in small and medium-sized enterprises (SMEs), including through regional advisory competence centers.

  • The government stressed progress in implementing its energy policy, which has helped reduce uncertainty. For example, the 2017 RE Sources Act has substituted the old “feed-in” tariff system (which guaranteed a sale price for suppliers) with a competitive auction system that allows the production of electricity by wind, solar and biomass to be handled by the most competitive firms. This has helped contain the cost of electricity for consumers and allowed the government to retake control of the RE supply.

  • The authorities agreed that the pace of reforms in some professional services was slow, but argued that many of the existing regulations could be justified by legitimate concerns against potential deterioration of quality and consumer protection standards.

E. Housing Market: Preventing Financial Excesses

Urgently addressing data gaps and considering early activation of macroprudential tools would help safeguard financial stability.

36. Staff analysis suggests that house prices have risen faster than can be explained by demand and supply fundamentals in Germany’s major cities. House prices are rising moderately at the aggregate level, but have increased at double-digit rates in some hot spots where they appear overvalued. Housing demand is driven by rising household income, large immigration flows in recent years, and low interest rates (Figure 10). On the supply side, stringent zoning restrictions (including for environmental protection) and high and rising capacity utilization (including labor shortages) in the construction sector prevent a more agile response of supply to price developments. House prices are most overvalued in Munich, Hamburg, Hannover, and Frankfurt, and are estimated to be more than 20 percent above their fundament level on average in major German cities (Annex IX). The Bundesbank obtains similar overvaluation estimates for some German cities in its latest assessment.18 As recommended in the past, lowering the effective burden of tax on new construction and reexamining zoning restrictions, in particular where demand is not likely to abate, would help mitigate price pressures.

Figure 9.
Figure 9.

Germany: Recent Developments in the German Banking Sector

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: Bloomberg Finance L.P., ECB, IFS, S&P Global Market Intelligence, and IMF staff calculations.1/ Leverage ratio is defined as common equity net of intangibles as a percent of total assets net of intangibles.
Figure 10.
Figure 10.

Germany: Housing Market Developments

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Sources: bulwiengesa AG, Destatis, Federal Ministry of the Interior, Building and Community, vdpResearch, Local Real Estate Surveyor Comission, Haver Analytics, and IMF staff calculations.1/The scenarios refer to those described in the 12th and 13th Coordinated Population Projections, published respectively in 2009 and 2015.2/ Includes condominiums, family houses, and land for housing construction.
uA01fig10

Residential Property Prices in German Towns and Cities

(Index, 2010=100)

Citation: IMF Staff Country Reports 2018, 208; 10.5089/9781484366158.002.A001

Note: Bundesbank calculations based on price data provided by bulwiengesa AG.Sources: Deutsche Bundesbank, and IMF staff calculations.

37. New housing policies, aimed at improving affordability, are not expected to have a noticeable impact on prices. The government foresees spending €2 billion in renewed support for social housing in 2020–21, expanding the land available at a discount for social housing construction, and creating tax incentives to build on unused land. It also plans to allocate €2 billion to families with children acquiring a first home.19 Other measures are still being contemplated, including tax subsidies for rental housing, public loan guarantees and real estate tax exemptions to reduce equity requirements for owner-occupied houses, and strengthening rent controls. As these measures have counteracting effects on housing supply and demand, the overall impact on housing prices is likely to be small.

38. Mortgage growth at the aggregate level has been moderate so far. Housing loans have grown only marginally faster than GDP in recent years. German households are not highly leveraged (household debt stood at 53 percent of GDP at end-2017) and the overall debt-service-to-income ratio is low and declining (Table 7). Mortgage lending spreads have compressed due to high competition among banks, but no widespread deterioration of lending conditions has been observed. Mortgage credit is recourse and based on fixed interest rates.

Table 6.

Germany: Core Financial Soundness Indicators for Banks, 2012–17

(Percent)

article image
article image
Source: Deutsche Bundesbank. The authorities provide annual data only and disseminate them once a year.