Germany: 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Germany
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2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Germany

Abstract

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Germany

Context

1. Germany has experienced nearly a decade of solid growth and an unprecedented decline in unemployment. This strong performance followed a series of labor market reforms in the mid-2000s, a long period of balance sheet repair in the non-financial corporate sector, sustained improvement in public finances, and continued high household saving. Germany also became deeply integrated into global value chains, particularly in Eastern Europe. The result of these trends has been a rapid decline in public and private debt and the lowest unemployment rate since reunification.

2. The benefits of this strong economic performance have not been evenly shared, contributing to external imbalances. German wage growth has been meager for much of the past 20 years and has accelerated only recently. Over this period, income growth has been more pronounced at the top of the income distribution while purchasing power has stagnated at the bottom. In addition, a rising share of national income took the form of savings inside the corporate sector, particularly in family-owned and -managed firms, whose ownership is highly concentrated among wealthier households (see Selected Issued Paper “Wealth Inequality and Private Savings in Germany”). This depressed private consumption, as higher-income households have a high propensity to save, and, together with fiscal consolidation, fueled the rise in the current account surplus (see Box 1).

3. Germany faces significant medium-term challenges. The labor force is about to decline as the population ages; productivity growth is low; and investment growth has been weak until very recently. All of these factors will weigh on potential output. Moreover, Germany will need to adapt to technological change as digitalization and innovation become increasingly important drivers of value added. Regarding energy transition, Germany is on track to meet its renewable energy target. But building the necessary internal electricity transmission capacity remains a challenge. At the same time, there is still uncertainty about how the ambitious goals to cut greenhouse gas emissions will be met.

Outlook and Risks

Growth Slowdown Amid Sound Fundamentals

4. The economy slowed sharply in the second half of 2018, reflecting both temporary and structural factors. The slowdown reflected a mixture of special circumstances (e.g., disruptions in car production related to the rollout of new emission tests following the new Worldwide Harmonized Light Vehicle Test Procedure (WLTP), slower river transportation due to drought, etc.) and weak external demand, which hit Germany’s export-dependent economy particularly hard. Net exports contributed negatively to growth in 2018 as the large drop in exports in Q3 was only partially made up in Q4. Investment in equipment and construction remained robust while private consumption softened in the second half of the year despite strong labor market conditions. GDP growth bounced back in 2019 Q1, driven by strong domestic demand (vehicle purchases returned to trend and investment was robust). However, the latest high frequency indicators are mixed as foreign demand remains lackluster.

5. Wage growth continued to pick up, but underlying inflation remained subdued. Despite stalled output growth in 2018H2, employment continued to rise, bringing the unemployment rate to new record lows, and reported labor shortages are widespread. The tight labor market pushed wage growth above 3 percent in the second half of the year. Reflecting the still relatively strong cyclical position and increasingly binding capacity constraints, real wages also grew faster than productivity, resulting in an uptick in the labor share. As in other advanced economies, inflation pressures remained subdued despite rising wage growth: core inflation has been hovering around 1½ percent.

6. In 2018, Germany recorded its largest fiscal surplus since reunification, marking the fifth consecutive year of surplus. The general government surplus rose to 1.7 percent of GDP, from 1 percent of GDP in 2017, reflecting once again revenue overperformance and underspending due in part to the delay in forming the coalition government. Public investment increased by almost 8 percent in nominal terms, but only by 0.1 percentage point of GDP due to the low base. As a result, the fiscal stance (measured by the change in structural primary balance) was moderately contractionary, instead of expansionary as projected in the 2018 Article IV report. Public debt fell to 60.9 percent of GDP at end-2018.

Large External Imbalances Adjusting Slowly

7. The current account (CA) surplus has gradually come down but remains substantially stronger than implied by medium-term fundamentals and desirable policy settings.

  • The surplus fell by 0.7 ppt of GDP in 2018 to 7.3 percent of GDP, continuing a gradual downward trend from its 2015 peak of 8.5 percent of GDP. The underlying decline in net exports was broad-based across destinations, but more pronounced with respect to non-EU trading partners, reflecting slowing external demand and terms-of-trade worsening. Import growth was robust on the back of higher investment. In cyclically-adjusted terms, the current account surplus remains 3.6–5.6 percentage points higher than the value implied by fundamentals and desirable policies (staff assesses the current account norm at 2–4 percent of GDP for Germany).

  • Non-financial corporate (NFC) net lending (the difference between NFC saving and investment), responsible for most of the surge in Germany’s current account since 2011, came down substantially since its 2015 peak while government net lending increased (see paragraph 15 for additional details).

  • The Net International Investment Position (NIIP) climbed to 60.6 percent of GDP at end-2018, with the rise relative to 2015 entirely explained by higher net portfolio investment.

  • The real effective exchange rate remains 8–18 percent undervalued in 2018. It had appreciated by 2 percent in 2018 but depreciated by 1.3 percent in the months up to May 2019, reflecting exchange rate movements against the dollar and other major trading partners (see Annex I).

Financial Vulnerabilities on the Rise

8. Credit growth picked up moderately, supporting domestic demand. After a long period of corporate deleveraging and borrowing restraint by households, mortgage and NFC credit growth accelerated to a pace modestly faster than nominal GPD growth in 2018. For NFCs, this led to a slight rise in leverage after many years of decline (Figure 2). There is evidence that new credit to NFCs is increasingly channeled to relatively riskier firms1, and lending standards have been eased, as suggested by the Bank Lending Survey (Figure 14, top right panel).

Figure 1.
Figure 1.

Germany: Evolution of Unemployment and Stagnation of Lower Incomes

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Figure 2.
Figure 2.

Germany: Bank Credit to the Nonfinancial Sector

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: Deutsche Bundesbank, Haver Analytics, and IMF staff calculations.1/ Nonfinancial corporations’ total liabilities divided by shares and other equity.
Figure 3.
Figure 3.

Germany: Evolution and Distribution of Real Income

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: Eurostat, OECD, Thomson Reuters Worldscope; HFCS, IMF staff calculations.
Figure 4.
Figure 4.

Germany: Fiscal Positions at Länder Level

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Figure 5.
Figure 5.

Germany: Labor Productivity Growth

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: Destatis, Haver Analytics, OECD, and IMF staff calculations1/ Numbers in parentheses indicate the shares of individual sectors’ GVA in total economy GVA.2/ Trade, transportation, and hotels.3/ Information and communications.4/ Public service, education, and health.
Figure 6.
Figure 6.

Germany: Supply-Side Constraints

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: Destatis; European Commission, “Business and Consumer Surveys;” Haver Analytics; United Nations, “World Population Prospects: The 2017 Revision;” and IMF staff calculations.1/ The difference between the percentages of respondents giving positive and negative replies.2/ Estimated based on the ratio of nominal net capital stock to nominal GDP in 1991, which is extended with the growth rates of real capital stock of equipment and real GDP.
Figure 7.
Figure 7.

Germany: Residential and Commercial Real Estate Indicators

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: BulwienGesa AG, Deutsche Bundesbank, MSCI, and IMF staff calculations.1/ Defined as net operating income to properly assetvalue. Sample includes Australia, Canada, Denmark, Finland, France, Germany, Ireland, Japan, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, the UK, and the US.2/ Based on the classification proposed by the ESRB. The growth rate for 2009 is distorted due to the reclassification of property developers’ loans from housing and real estate activities to the construction sector.3/ Purchase, sale and management of commercial real estate, facility management enterprises.
Figure 8.
Figure 8.

German Banks’ Risk Provisioning and Tier 1 Capital Ratio

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Source: Duetsche Bundesbank1/ Including generalized specific loan loss provisions.2/ Assuming credit risk provisioning for each institution remains at the average for 1999–2010.
Figure 9.
Figure 9.

Germany: Change in LTV for New Mortgage Loans

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Source: Bundesbank.1/ The difference between the sum of the percentage of responses for tightened considerably and tightened somewhat minus the sum of the percentage of responses for eased considerably and eased somewhat.
Figure 10.
Figure 10.

Germany: Growth Developments

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: Destatis, Haver Analytics, IFO Institute, INS, IMF World Economic Outlook, Markit, and IMF staff calculations.1/ National Accounts Concepts.
Figure 11.
Figure 11.

Germany: Prices and Labor Market

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: Bundesbank, Federal Statistical Office, Federal Statistical Office’s 13th Coordinated Population Projection, Eurostat, Haver Analytics, and IMF staff calculations.
Figure 12.
Figure 12.

Germany: Balance of Payments

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.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 13.
Figure 13.

Germany: Fiscal Developments and Outlook

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: Federal Statistical Office, Ministry of Finance, and IMF staff calculations and projections.
Figure 14.
Figure 14.

Germany: Credit Conditions and Asset Prices

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: Bundesbank, Bloomberg Finance L.P, ECB, Haver Analytics, and IMF staff calculations.
Figure 15.
Figure 15.

Germany: Recent Developments in the German Banking Sector

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.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 16.
Figure 16.

Germany: Housing Market Developments

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.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.
Figure 17.
Figure 17.

Germany: Product Market Competition, Innovation, and Digitalization

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: Akamai’s State of the Internet 2017Q1 Report, Conference Board, Destatis, European Commission, OECD, and IMF staff calculations.1/ Includes new product development in the financial service industry, new architectural and engineering designs, brand equity, training, and organizational capital.2/ Includes software, databases, R&D, mineral exploration, artistic originals (copyrights and licenses).

9. The “low-for-long” interest rate environment is putting further pressure on the financial sector’s profitability. Yields on German government bonds have turned negative/scarcely positive across maturities and the yield curve has flattened. This reflects both a more dovish outlook for policy interest rates as well as the increasing scarcity of German government bonds (the euro area’s safe asset). With interest rates set to remain low for even longer, the profitability of banks and insurance companies—already challenged by high costs and slow progress with restructuring—is expected to come under renewed pressure.

Near-term Recovery with Risks Looming

10. The near-term outlook is for a gradual return of output to trend, but is subject to significant uncertainty. Staff’s baseline assumes that the weak external environment will weigh on exports but that domestic demand will strengthen. Private consumption growth is expected to recover, supported by continued strong labor market conditions and fiscal measures (e.g., income tax relief, family support). Given high capacity utilization and replacement needs, private non-residential investment is expected to expand, but at a slower pace than last year. Investment in construction, both residential and commercial real estate, is expected to continue to be strong. Despite the growth slowdown, staff assesses the output gap to be moderately positive in 2019, reflecting several years of above-potential growth alongside still-low potential growth (as a result of both slowing potential labor force growth and slowing contributions from capital accumulation). The positive output gap is expected to lead to modest upward pressure on core and headline inflation. Recent bargaining agreements suggest that wages will continue to grow at a solid pace in the coming quarters. With low interest rates, alongside the banking system’s large deposit base and ample liquidity, credit is expected to continue to expand to support economic growth.

11. Unfavorable demographics, low productivity growth, technological change, and the energy transition are expected to weigh on growth over the medium term. Growth is projected to decelerate to 1.1 percent by 2024 and the output gap is projected to gradually close. Both headline and core inflation should reach 2.2 percent by 2022. With the labor market expected to remain tight amid a declining labor force, wage growth should continue to accelerate.

12. The CA surplus is expected to continue narrowing but remain large over the medium term. The decline is expected to proceed at a slow pace as net exports continue to trend downward, underpinned by solid domestic demand and a gradual realignment of price competitiveness. In the medium term, the projected CA surplus would remain large, absent further policies to enhance investment and reduce excess saving. Consistent with the projected path for continued CA surpluses, the NIIP is expected to exceed 80 percent of GDP in the medium term.

13. Germany’s export-dependence and financial openness make it particularly vulnerable to external shocks. Risks are tilted to the downside, especially given the uncertain external environment (see Annex II).

  • A significant rise in global protectionism, a more pronounced China slowdown or a no-deal Brexit would hurt Germany’s exports and FDI, possibly disrupt supply chains, and weigh on domestic investment and productivity. Such disruptions could prove particularly harmful to the auto industry (see Box 2 on the impact of a US tariff on cars).

  • Tighter global financial conditions and a return of sovereign debt concerns in the euro area may trigger sharp corrections in already stretched valuations across asset classes. While German government bonds may benefit from safe-haven flows, other asset classes (real estate, equity markets) would likely be adversely affected.

  • Domestically, lack of progress in revamping bank business models could lead to financial distress in major banks, with potentially adverse external spillovers.

  • On the upside, wage growth could pick up faster than currently anticipated, investment could again surprise positively, and fiscal policy could be more expansionary than anticipated in the next year, with some positive external spillover.

  • In the longer term, risks revolve around structural challenges. Lack of progress in adapting to the technological and digital revolution could undermine Germany’s position as an innovation leader. Specifically, German automakers’ failure to shift to new technologies (e.g., hybrid and all electric models) could lead to an erosion of the global market share of German cars. A stalled structural reform agenda and unresolved bank legacy and profitability problems may also rekindle stress in the euro area and weigh on investment in Germany. Failure to durably reverse rising anti-euro/EU sentiment in Europe and anti-globalization forces worldwide could negatively affect growth.

Authorities’ Views

14. The authorities broadly shared staff’s assessment of the near-term macroeconomic outlook and risks. The predominant view is that the positive growth surprise in Q1 2019 should be seen as temporary. Manufacturing output stagnated in Q1. The authorities expect weakening foreign demand to continue to cloud the outlook, with recent international developments on trade policy interpreted as a sign that further escalation is likely. Recent estimates for growth in 2019 by the authorities are weaker than staff’s, implying a more pronounced slowdown in the rest of the year. The authorities also share staff’s assessment of risks and stressed that domestic demand could be affected by a prolonged exports slump given the very open nature of the German economy. Medium-term challenges for the automotive industry in a rapidly changing technological environment, and implications for the rest of the manufacturing sector were also seen as important.

Policy Discussions

Germany’s key economic challenge is to raise its long-term growth potential while rebalancing its economy. Projected demographic headwinds, low labor productivity growth, and a challenging energy transition call for raising investment in human and physical capital, promoting innovation and labor supply, and advancing structural reforms. After several years of stagnant real disposable income growth for low- and middle-income households, strong wage growth needs to continue to help the economy to rebalance. There is also scope to reduce the tax burden on labor income, which is particularly high in the lower-middle income brackets, to reduce disincentives to labor supply and boost household purchasing power. These multi-pronged policies would boost the country’s productive capacity while at the same time supporting rebalancing and helping to ensure that the benefits of higher growth are shared more evenly.

A. Addressing External Imbalances by Restoring Household Purchasing Power

15. Sizable and growing corporate net lending, together with fiscal consolidation, has been a key contributor to Germany’s rising current account surpluses. NFC net lending rose from -1.5 percent of GDP in 2001 to 3.8 percent in 2015 (the peak), contributing the bulk of the surge in the current account surplus since 2000. The increase in NFC net lending was driven by rising gross saving (notably by family-owned firms) as firms both reduced debt and increased holdings of cash and other liquid assets.2 In turn, the surge in gross saving was initially driven by rising profits, on the back of wage restraint and a falling labor share. Since 2008, however, it mostly reflected falling dividend payout ratios amid stable profitability. After peaking in 2015, the NFC net lending position has come down substantially, driven by lower profitability (due in part to higher wage growth), higher dividend payout ratios, and a modest pickup in investment. Over the past decade, government net lending has also risen markedly as a result of fiscal consolidation.

16. Household disposable income has stagnated for households in the lower half of the income distribution, depressing consumption. In tandem with rising corporate net lending, household disposable income—while growing in real and nominal terms—has declined relative to GDP by about 6.2 percentage points since 2005 (see Selected Issues Paper). The decline in the household disposable income ratio is concentrated in the lower half of the income distribution (Figure 3), where the propensity to consume is the highest. As a result, 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 household disposable income to GDP ratio back to its 2005 level (63 percent) through wage growth alone would require nominal wage growth to exceed annual nominal GDP growth by around 1.5 percentage points each year for over a decade.

uA01fig01

Household Consumption and Disposable Income

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

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

17. Widening top income inequality may also help explain high private savings and the rising current account surplus (see Box 1). Home and equity ownership rates in Germany are the lowest in the euro area, particularly among middle- and lower-income households. At the same time, the large net wealth of German firms is highly concentrated among the top of the wealth distribution due to the dominance of family-ownership and -control of Mittelstand firms. High corporate savings, therefore, partly reflect savings of wealthy German households accumulated within firms due to preferential tax treatment.3 Staff analysis shows that German firms owned (and managed) by a small number of families tend to save more than other firms, and more than similar private firms in the Euro area.4 As the marginal propensity to save is very high among wealthy households, the rise in corporate profits has contributed to higher top income inequality, increasing private savings and boosting the current account surplus.

uA01fig02

CA Balance and Top Income Inequality

(Percent)

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: World Inequality Database and Haver Analytics.

18. Policies that boost disposable incomes particularly among middle- and low-income households could help speed up external rebalancing, while also fostering more inclusive growth. Faster wage growth, which would be in line with the tight market conditions, would be the most direct way to boost disposable income. This would particularly benefit low- and middle-income households, who mainly rely on labor income to finance their consumption. Recent increases in wage growth are therefore welcome and the authorities should encourage robust wage growth in their public communications. Given the tightness of the labor market and the moderate level of the minimum wage, stronger increases in the minimum wage could also be contemplated at the next revision in 2021. Policies on the tax side can also be used to support the purchasing power of middle and lower-income earners (see below).

Authorities’ Views

19. The authorities emphasized that the current account surplus had been declining (as a share of GDP) since 2016 and is expected to fall further. At the same time, they view its relatively high level in the medium term as consistent with Germany’s demographic structure. Non-financial corporate savings are not expected to rise further as equity and liquidity buffers have reached comfortable levels. The authorities acknowledged that increased dispersion in household disposable income had contributed to the large current account surplus and pointed to the recent pick up in wage growth as a welcome development in this context. Additionally, recent fiscal measures that offer social contribution and income tax relief, and increased family benefits, should have a positive effect on lower incomes and support household consumption. The authorities agreed on the need to promote the economy’s long-run growth potential, especially by upgrading the digital infrastructure and fostering innovation.

20. The authorities acknowledge the relatively high concentration of wealth and divergence of household incomes but pointed to other aspects of the German economy that are relevant in this context. They pointed to latest survey data showing that the degree of wealth inequality has slightly declined, though it remains among the highest in the euro area. They viewed the concentration of business wealth as reflecting the stable ownership structure of the Mittelstand, which is often family-controlled, and is seen as the backbone of the German economy. Though wealth inequality is high, income redistribution is provided through the tax and benefit system.

B. Fiscal Policy to Boost Potential Growth and Support Rebalancing

21. Fiscal policy is set to turn expansionary in 2019, yet fiscal space will remain substantial in the medium term. The 2019 budget includes measures to increase family support and public investment, as well as income tax relief—in the form of a higher basic tax allowance and correction of bracket creep—worth 0.2 percent of GDP per year, resulting in a moderate fiscal expansion of about ⅔ percent of GDP. Looking farther ahead, staff projects that the structural surplus will decrease from 1.2 percent of GDP in 2018 to about ½ percent of GDP in 2021–22 on the basis of the package of fiscal measures agreed when the government coalition was formed last year. However, fiscal space in relation to the Stability and Growth Pact’s (SGP) medium-term objective (MTO) remains substantial (more than 1 percent of GDP over the medium term). In contrast to the European rules, which set limits on the general government structural deficit, Germany’s national rules (“debt brake”) set limits on the structural net borrowing for the central and state governments. Budget surpluses in recent years have allowed the central and many state governments to build up reserves. By financing expenditures with these reserves, constraints from national rules will not be binding at least for some time, so the relevant constraint for now is the MTO. The public debt ratio is expected to cross the 60 percent of GDP benchmark this year and will continue to decline rapidly over the projection period (see Annex III).

Germany: General Government Operations, 2018–24

(Percent of GDP)

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

Refers to 2023

Staff’s projections use the information of the latest available government medium term financial plan, adjusted for the differences in the IMF staff’s macroeconomic framework.

Th e current SGP’s MTO until 2023, and the same MTO is assumed to remain in 2024.

Calculated as the difference between the current staff projected structural balance and the SGP’s MTO.

Negative of the difference between the projected primary structural balance in each year and that of the year before.

22. Germany’s fiscal space should be used to support potential growth and rebalancing. Using fiscal tools and resources to invest in physical and human capital, incentivize innovation, and bolster labor supply would help Germany confront its long-term challenges and support external rebalancing by stimulating domestic demand in the short term.

  • There is scope to reform the tax system to make it more growth friendly. Germany’s labor taxation (including the tax wedge) is high and a high marginal tax rate takes effect at relatively low wage levels. Further tax relief for low-income households could boost their disposable income and support domestic demand. In addition, reducing the high effective marginal tax rate for second earners, for example by replacing the current income splitting system with a tax allowance or credit for couples, can promote full-time female labor force participation.5 Further expanding the provision of care for children under three years of age would also help women work longer hours. To compensate for revenue shortfalls, reforming property and inheritance taxes, could be considered. Such reforms would also help reduce excess saving and wealth concentration.

  • Incentivizing R&D would also help long-term growth. The government is currently proposing a new tax incentive for R&D activities. According to this proposal, a tax credit up to €500,000 per year will be provided for 25 percent of R&D costs up to €2 million starting in 2020. R&D expenditures are widely seen as a key driver of productivity growth, and research has shown that direct tax incentives targeting R&D inputs are more effective and efficient than “patent box” regimes that offer a reduced tax rate on qualified income. A generous R&D tax credit would support innovation and generate positive growth spillovers. The total envelope, currently estimated at about €1¼ billion, could be further expanded.

  • To address infrastructure gaps, particularly at the local government level, rebuilding planning capacity and enhancing coordination across levels of government will be critical. About two-thirds of public investment is executed by local governments. However, in the past, local governments prioritized fiscal consolidation at the expense of public investment (see Annex VI). More recently, budget surpluses have alleviated financial constraints in most localities. The ongoing reform of federal fiscal relations and financial support (such as the Municipal Investment Promotion Fund and Digital Infrastructure Fund), as well as technical support by Partnerschaft Deutschland have facilitated the execution of public investment at the municipal level. As a result, public investment growth accelerated in 2018 and the share of total government investment implemented by municipalities also picked up. However, capacity constraints and price pressures in the construction industry have emerged as new obstacles. Addressing these will require rebuilding planning capacity and stronger coordination across various government levels to ensure that larger and longer-term projects are implemented.

23. Fiscal policy should play its role if downside risks materialize. In case of a more protracted economic downturn, the government should let automatic stabilizers operate fully and, in addition, fully use its fiscal space. In the event of a severe economic downturn, depending on the size and nature of the shock to the economy, invoking the escape clause under both European and national fiscal rules could be appropriate to expand fiscal space, support the German economy, and contribute to a synchronized fiscal expansion.

24. In the face of changes in the international tax environment, Germany should preserve the competitive corporate tax system while not engaging in damaging tax competition. Germany has been a leader in implementing anti-tax avoidance measures. There are, however, adjustments to various provisions—notably regarding controlled foreign corporations—which could be beneficial. Looking ahead, the Franco-German proposal of minimum tax will benefit Germany, with internationally coordinated solutions particularly powerful. However, its modalities need to be developed further and implementation issues need to be resolved, some of which are specific to Germany (see Selected Issues Paper).

Authorities’ Views

25. The authorities argued that most of the space under the fiscal rules would be used; in the case of a severe downside scenario further fiscal stimulus would be considered. The authorities highlighted that their fiscal priorities, reflected in the government coalition agreement, are to boost productivity and growth potential through investment in infrastructure, education, and research. They also stressed that additional fiscal space would be limited, as their tax revenue projections for the coming years were much lower than staff’s. On public investment, Ministry of Finance officials noted that the improved fiscal position of all Länder and most municipalities in recent years is now bearing fruit as consolidation is giving way to higher investment. They added that the recent amendment to the Basic Law, allowing the federal government to provide financial assistance to Länder in key investment areas, would further boost public investment in education and infrastructure. However, capacity constraints and strong price increases in the construction sector were limiting the speed of the progress. Some Länder governments, however, viewed the national fiscal rule as restricting their investment over the long term. In the event of a severe downturn, the authorities confirmed that they would not be constrained by the fiscal rules and would provide stimulus to the economy depending on the nature of the slowdown.

26. The authorities stressed their commitment to preserving Germany’s competitive and socially equitable tax system. The government emphasized that several tax relief measures, including a higher basic tax allowance and compensation of bracket creep in 2019/2020 and the reduction in the solidarity surcharge from 2021, will boost disposable incomes particularly for low-and middle-income households. However, further reducing the labor tax wedge would be challenging given the increasing aging-related fiscal costs as well as government measures regarding the social security schemes. On corporate taxation, the authorities stressed that corporate tax reforms should ensure growth-friendly and fair conditions for all businesses, noting that the new R&D tax credit would help in this regard. At the current juncture, there are no plans to raise revenue by reforming property or inheritance taxes. However, work is underway on a revenue-neutral proposal to reform the immovable property tax regime by updating property valuations.

27. The authorities emphasized their commitment to seek collaborative solutions to international tax issues. They lamented harmful international tax competition and emphasized their commitment to improving anti-tax avoidance measures. They are seeking cooperation at the G20, OECD and EU level for the joint German-French minimum tax proposal, including fair and effective taxation of large digital companies.

C. Boosting Productivity Growth and Private Investment

28. As in other advanced countries, Germany’s labor productivity growth has been declining over the last two decades (Figure 5, left panel). The decline is broad based, including in the manufacturing sector (Figure 5, right panel). Within the manufacturing sector, productivity growth has been relatively high in the automotive sector, where robot density has also intensified.6 Productivity growth also tends to be higher among large firms compared to small- to medium-sized firms.

29. Supply-side constraints—both in labor and capital—seem to be increasingly binding. Reported labor shortages are widespread amid a declining working-age population (15–64 years old) (Figure 6, top panels). A new immigration law, which aims to attract skilled labor from outside of the EU, can provide some relief. However, more policy action is needed to prolong working lives and encourage labor force participation. Supply-side constraints are also evident in high capacity utilization rates amid a decline in of the stock of machinery and equipment in percent of GDP (Figure 6, bottom panels). The level of business investment in Germany is lower than that in peers—possibly reflecting concerns about future growth, red tape, and lack of skilled workers (see Annex VII).

30. Upgrading the digital infrastructure, pushing ahead with the e-Government project, and reducing uncertainties about energy transition are key to raising productivity and domestic investment while supporting external rebalancing.

  • Upgrade nationwide digital infrastructure. Germany has so far made little progress in expanding the coverage of high-speed fiber-optic internet at the national level, constraining productivity growth. SMEs remain slow adopters of digital technologies. For example, only 5 percent of SMEs in Germany use big-data analytics, compared to 10 percent in the EU as a whole. To accelerate the upgrade, the government is committed to allocating up to €12 billion to build a nationwide fiber-optic network by 2025. Regarding mobile communication, the ongoing auctioning of 5G licenses (2 and 3.6 GHz) and expected allocation of the 88MHz spectrum in 2025 are expected to improve coverage. Auction proceeds of €6.5 billion will be added to the Digital Infrastructure fund, which was created in 2018. In other areas, the government has implemented a welcome initiative to provide SMEs with consultancy services to advance their IT security, digital marketing, and digital processes. In August 2018, the government also created the Agency for Innovation in Cybersecurity to develop new technologies to defend Germany’s digital infrastructure from cyberattacks.

  • Push ahead with e-Government. Cumbersome procedures to start a business and high compliance costs are among the key challenges to entrepreneurship. The government should further streamline regulations, while fully implementing the National e-Government Strategy. Once implemented, the e-Government platform will provide public services at the federal and local government levels on one interface, substantially reducing administrative burdens.

  • Reduce uncertainties about energy transition. Although Germany has made admirable progress in some aspects of its energy transition, uncertainty about the strategy for completing the transition seems to be adversely affecting business sentiment. Under current policies, Germany is unlikely to meet its 2020 target on reducing greenhouse gas output. A carbon tax could be a useful part of a comprehensive strategy, which the government is preparing.7 Concerning electricity from renewables, Germany is on track to reach its 2020 renewable energy target. Yet, the rising share of renewables in electricity production in the absence of sufficient internal transmission capacity is creating challenges for network management. To overcome this issue, the Grid Expansion Acceleration Act was adopted in April 2019, simplifying the procedure for grid expansion projects. The government has also introduced competitive auctions for renewable energy aiming to help stabilize costs.

31. The government should also continue its support to promote innovation, enhance competition, and expand the quality and quantity of labor supply.

  • Promote innovation. With a range of government initiatives, venture capital investment has been rising over the last few years, returning to the pre-GFC level. Investment in start-ups by non-venture capital companies, or investment in the form of venture debt has also been on a rise. However, the relatively small size of venture capital funds continues to hinder the capital-intensive scale-up stage. The government should continue its efforts to encourage scale-up of funds, including through promoting fund-of-funds to attract institutional investors and encouraging cross-border investment in the context of the EU-wide Capital Markets Union. Introduction of generous incentives for R&D would also help entrepreneurship and innovation.8

  • Increase competition in business services and regulated professions. Liberalizing these sectors can reduce the cost of doing business using these business services as inputs. In 2019, the government plans to undertake a review of regulations in professional services, with the goal of reforming the Professional Law in this area. Other professions, such as accountants, architects, and engineers are also in need of reform. Competition in the railway sector is increasing in freight and regional passenger trains, but the market share of new entrants for long distance passenger train services remains low due to high track-access charges. To promote further competition, the government plans to evaluate the Railway Regulation Act.

  • Expand quality and quantity of labor supply. Increasing investment in education and life-long learning can help ensure that Germany’s labor force is equipped with the necessary skills in the face of rapid technological change, as well as extend work lives. Addressing teacher shortages—in vocational education and training, and primary education—is therefore urgent. At 71 percent, Germany’s old-age employment rate is relatively high. Yet, pension reforms to explicitly link the statutory retirement age with life expectancy can further increase old-age labor force participation by extending working years as life expectancy increases. According to the EC, adjusting the pensionable age by two-thirds of the increase in life expectancy would maintain the current ratio of 1:2 regarding the average time spent in retirement versus time spent working, without reducing pension levels.9 Refugee integration is gaining momentum, with the employment rate of refugees from the top eight countries reaching about 33 percent in November 2018, up by nearly 8 ppt from a year earlier.10 Continuing support to refugees to improve German language proficiency and gain experience in German labor market norms, as well as making selected qualifications transferrable would further accelerate integration.

Authorities’ Views

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

  • Regarding the digital infrastructure, the government has set out a clear strategy and allocated financial resources to support a nationwide fiber-based gigabit network. Investment-friendly regulation, in accordance with the European Electronic Communications Code, to incentivize private investments is to be implemented by end-2020. The authorities highlighted severe capacity constraints in the construction sector as a key challenge to implementation. The government is preparing a master plan to expand mobile coverage and deploy 5G.

  • Important government initiatives have been taken to accelerate energy transition. Among others, the government published the Electricity Grid Action Plan in August 2018, laying out strategy to expand the power grid by optimizing the capacity utilization of the existing grids while expanding the grids. The government has also introduced measures to promote green tech and reduce the cost of renewable energy. The forthcoming National Energy and Climate Plan for 2021–30 will include concrete measures to attain the 2030 target on reducing greenhouse gas output, while steps to phase out of coal-fired power generation by 2038 are under preparation. A carbon tax is under discussion in the government.

33. The authorities also highlighted ongoing efforts to support innovation and venture capital. Government initiatives are guided by the “High-Tech Strategy 2025,” which lists six priority areas (digital economy, sustainable economy and energy, innovative work environment, healthy living, intelligent mobility, and civil security). To support innovation, especially of SMEs, the government is drafting a bill on R&D tax credits. With a number of government initiatives, inter alia jointly with the European Investment Fund and KfW Capital, venture capital investment has been rising to pre-GFC levels, and the size of funds has also been growing. To further support venture capital, the government plans to continue its co-investment strategy to crowd in private investment, especially by institutional investors.

D. Shoring up Financial-Sector Profitability while Preventing Buildup of Financial Risks

34. The continued “low-for-long” environment is exacerbating the profitability challenges of German banks and life insurance companies.

  • Low profitability continues to weigh on the banking sector, eroding banks’ ability to generate capital organically and putting them at risk in the event of adverse earnings shocks. Large German banks continue to underperform European peers in market valuation, reflecting high operating costs, outdated IT systems, provisions for compliance violations, and in some cases legacy costs from exposure to the shipping industry. Leverage remains very high, particularly at the German global systemically important bank (G-SIB) and some Landesbanken. For small and medium-sized banks, the low interest rate environment has continued to weigh on profitability as they lag peers in developing alternative sources of income. The full adoption of Basel III— especially the introduction of an output floor for internal risk models—is expected to substantially increase German banks’ minimum capital requirement.

  • As of mid-2018, most German life insures’ solvency ratios were well above the 100 percent threshold set by supervisors, although around two-thirds of them relied on transitional measures and the dispersion was large. The prolonged low interest rate environment is forcing life insurers to shift away from guaranteed-return products, yet such products are expected to remain dominant in the next decade. At the same time, diversification of insurers’ investment portfolios is proceeding only slowly, suggesting that the low interest rate environment will continue to weigh on profitability for some time.

35. Supervisors should continue monitoring interest rate risk and press for faster progress in implementing restructuring plans in both banking and insurance sectors. To boost profitability, more decisive cost cuts—for example, by reducing branches and promoting digitization—are necessary for both banks and insurers. For large banks, restructuring plans are in place but need faster implementation. Savings and cooperative banks should continue to develop fee-based income and pursue further consolidation. Life insurers should continue to reduce the share of guaranteed products while diversifying investment, for example in infrastructure projects or foreign assets.

36. Real estate prices continue to rise rapidly while aggregate credit growth remains in check.

  • House prices in major cities have continued to rise rapidly, moving further into overvaluation territory. Staff analysis suggests that house prices were overvalued in Germany’s main cities, from 10–15 percent in Stuttgart and Dusseldorf to 25–30 percent in Hannover, Frankfurt and Hamburg and more than 40 percent in Munich in 2017.11 The government has stepped up efforts to increase housing supply, including by allocating €2 billion to build 100,000 new social housing units during 2020–21, selling federally-owned properties to local authorities at reduced prices to build affordable housing, and providing a special depreciation allowance for new rental housing construction. The impact on house prices, however, is expected to be limited.

  • Commercial real estate (CRE) prices have risen even faster than house prices (Figure 7, top right panel) with a moderate decline in the yield on CRE investment (Figure 7, bottom left panel). Price increases have been particularly large in the office sub-segment and banks’ exposure to the sector has risen over the last three years, despite the sizable share of equity-based and foreign-financed investment.

  • These rapid price increases have not yet been accompanied by strong increases in credit growth at the aggregate level. Credit growth accelerated to a pace slightly exceeding nominal GDP growth, but the credit-to-GDP ratio remains low from a historical perspective and compared with other advanced economies. Bank lending to CRE-related activities also appears relatively small compared to the EU average, yet the impact of a sharp decline in CRE prices on bank balance sheets could still be important as defaults on CRE tend to be higher than those on residential real estate.12

37. Macro-financial vulnerabilities are mounting nonetheless. Low default rates have led to a decline in banks’ loan loss provisioning (Figure 8, left panel). According to the Bundesbank’s analysis, German banks’ average tier 1 capital ratio would be lower by around 2 percentage points if they used historical level of risk provisioning (Figure 8, right panel). At the same time, banks that rely on internal models to calculate regulatory capital have reduced risk weights and there is evidence of “search for yield” behavior. These trends, alongside rising real estate prices and weak bank profitability, point to a rise in macro-financial vulnerabilities.

38. Activation of the counter-cyclical capital buffer (CCyB) is welcome. Given the build-up of macro-financial vulnerabilities, a tightening of macroprudential policies is appropriate to enhance resilience in the banking system. In May, the Financial Stability Committee recommended to raise the CCyB by 0.25 percent and banks have 12 months from the beginning of Q3 2019 to meet the new requirement. The relatively small increase in the CCyB should have limited impact on credit supply which is only now recovering after nearly two decades of deleveraging.

39. Additional macroprudential action is needed to guard against imbalances in the real estate sector.

  • Urgently address data gaps. The Bank Lending Survey suggests that LTV ratios for new mortgage loans have been relatively stable on an aggregate basis (Figure 9), yet lack of granular loan information hinders a full assessment of potential financial stability risks in specific market segments. It is essential that these data gaps be addressed.

  • Consider prompt activation of the existing borrower-based measures. Absent granular data alongside the prolonged rise in house prices, the authorities should consider implementing an LTV cap and amortization requirements on mortgages.

  • Expand the macroprudential toolkit. Germany currently lacks income-based instruments for residential and CRE lending or other borrower-based instruments for CRE lending.13 The authorities should consider introducing income-based instruments, such as a debt-to-income or debt-service-to-income cap. In addition, appropriate instruments for CRE should also be considered, taking into account diverse financing structures. As the government is currently reviewing the effectiveness of existing instruments, this is a right time to consider expanding the toolkit.

40. In line with the 2016 FSAP recommendations, the authorities are strengthening AML/CFT supervision, including for banks with cross-border operations. BaFin (the AML/CFT supervisor for all German financial institutions) has appointed a “Special Representatives” to sit on-site in one of the major banks to carry out audit functions. The representative reports directly to BaFin and may be granted additional powers to take remedial actions within the bank, as deemed appropriate. Within BaFin, specialized units have been set up to focus on the supervision of high-risks banks (i.e. major banks with cross-border operations) which are subject to continuous AML/CFT monitoring. Regarding cross-border operations, BaFin assesses, together with the external auditors, implementation of group-wide policies by foreign branches and subsidiaries. Progress in this area should continue, taking into account recently identified AML/CFT weaknesses across the Europe, including by considering further integration of AML/CFT supervision at the European Union level.

Authorities’ Views

41. The authorities shared the view that risks to financial stability are building up, yet did not see acute systemic risks. The prolonged favorable economic conditions and low-for-long interest rate environment have increased the risk of underestimating credit risk, which is one of the reasons why the German Financial Stability Committee has recently recommended the activation of the CCyB from the third quarter of 2019. Based on the indicators and information available at this point in time, the authorities saw no substantial increase in risks to financial stability stemming from the flow of new housing loans which would require an activation of sector-specific demand-side macroprudential policy tools, such as the LTV cap and amortization requirement. The authorities are to review their macroprudential toolkit, and the need to introduce household income-based instruments would be considered in this context. Appropriate borrower-based instruments for CRE loans would need to reflect diverse CRE financing structures. The authorities agreed on the urgency of closing data gaps. However, the currently ongoing ad hoc survey on real estate lending and corporate credit underwriting standards was expected to provide some valuable information on possible financial risks in specific segments of the economy.

42. The authorities broadly shared the view that banks and life insurance companies need to accelerate their restructuring to boost profitability. Given the limited scope for higher revenue under the low interest rate environment and intense competition, the authorities saw room for restructuring and consolidation within the banking sector. At the same time, smaller banks needed to consider increasing their fee and commission income. The German supervisory authorities shared the view that the low interest rate environment presents challenges to the life insurance sector but took comfort in the long transitional period (through 2031) for the full adoption of Solvency II. They were of the view that the needed reduction in guaranteed products was proceeding slowly due to the large stock and long maturity of such products. They also highlighted the importance of diversifying insurers’ investment portfolios—for example, in infrastructure projects. The authorities indicated that efforts are underway to transpose the 5th EU Money Laundering Directive into national law and prepare for the AML/CFT comprehensive assessment of Germany by the Financial Action Task Force (FATF) in 2020, which may entail additional revisions to the AML/CFT legal framework. The authorities welcome the advancement of AML/CFT supervisory colleges at the EU level but see challenges in setting up a more centralized European supervisory framework for AML/CFT.

E. Tackling the Supply-Side of Corruption

43. Germany has taken strong anti-bribery enforcement actions. The 2018 report of the OECD Working Group on Bribery in International Business Transactions (OECD WGB)14 recognized Germany as one of the highest enforcers of the OECD’s Anti-Bribery Convention, having sanctioned 328 individuals and 18 companies in a total of 67 foreign bribery cases since 1999. Authorities have been able to detect instances of foreign bribery through a range of sources, and in particular through information provided by tax authorities. Investigative authorities have applied a broad range of investigative tools and techniques, including mutual legal assistance, coordinated investigations with tax authorities and joint investigative teams in multijurisdictional cases. In addition, the authorities have taken a pragmatic approach to enforcement actions by using alternative offences and a range of proceedings, including conditional resolutions with natural persons. In addition, the OECD WGB commended Germany for the creation of a Federal Debarment Register with mandatory debarment from public procurement.

44. The OECD WGB encouraged the authorities to continue with these efforts and recommended strengthening enforcement actions against legal persons involved in foreign bribery cases. The OECD WGB expressed concerns about insufficient and inconsistent enforcement actions taken against legal persons, and encouraged efforts to take more effective, proportionate and dissuasive sanctions against legal persons, including by going forward with the 2018 Coalition Agreement Commitment to tie punitive fines more closely to the turnover of a legal person. It also recommended that the authorities review their overall approach in holding companies liable, including the principle of prosecutorial discretion of legal persons, the introduction of clear guidance for self-reporting by companies and the possibility to introduce a system of conditional resolution for legal persons. The OECD WGB also recognized the need to improve compilation of statistics at either the Federal level or across regions to better monitor enforcement. Finally, the OECD WGB emphasized the need to clarify the criteria for using non-trial resolution tools and, in line with data protection rules, make their main elements public. A more comprehensive framework for whistleblower protection should also be developed. Fund staff agrees with these recommendations and urges the authorities to move forward in implementing them. The text above was prepared based on a summary of the OECD WGB’s Phase 4 Report of Germany in June 2018.15

Authorities’ Views

45. The authorities welcomed the IMF’s initiative to address supply side issues of corruption. They noted that they had volunteered to be part of this assessment. Germany will be presenting its Phase 4 two-year written follow-up report on progress in implementing the WGB’s recommendations at the WGB Plenary in June 2020. The authorities will continue to strengthen their enforcement actions in relation to foreign bribery cases.

Staff Appraisal

46. Germany’s economic performance has been strong over the last decade, but its benefits have been unevenly shared. The sharp decline in unemployment has been an important success. However, as wage growth lagged behind, lower incomes stagnated, and a rising share of national income took the form of savings inside the corporate sector. These trends, together with fiscal consolidation after 2011, led to a sharp rise in the current account surplus.

47. More recently, Germany’s large imbalances started to slowly unwind, but further strong wage growth is key for the economy to continue to rebalance. With the tight labor market, wage growth picked up, and the labor share in national income began to recover. The introduction of the national minimum wage in 2015 also bolstered wages for unskilled workers. The current account surplus has fallen below its 2015 peak but remains well above the level consistent with fundamentals in the medium-term. Faster wage growth, which would be consistent with the very tight labor market, would help accelerate real exchange rate appreciation and speed up external rebalancing, while also ensuring that the benefits of growth are widely shared.

48. The short-term outlook is for a gradual return of growth to trend, but risks are on the downside. Real GDP growth slowed sharply in the second half of 2018, reflecting a mixture of weak external demand and special circumstances, but the underlying momentum of domestic demand is still robust, driven by low unemployment, solid wage increases and investment, and supportive fiscal policy. As a result, growth is expected to return to trend by the end of 2019. However, risks are significant, including further escalation of trade tensions, a more pronounced China slowdown, a disorderly Brexit, and renewed stress in the euro area.

49. Unfavorable demographics, weak productivity growth, and the challenges of the energy transition will continue to weigh on long-term growth potential. As in other advanced countries, Germany’s labor productivity growth has been declining over the last two decades. On the energy front, Germany is on track to meet its renewable energy target. At the same time, there is still uncertainty about how the ambitious goals to cut greenhouse gas emissions will be met.

50. Remaining space under the fiscal rules should be used to strengthen the economy’s growth potential. Including all of this year’s budget measures as well as additional measures in the coalition agreement, Germany’s fiscal position is expected to remain well within the limits imposed by the national and European fiscal rules, while the public debt ratio will continue to decline rapidly. These budgetary resources should be deployed from 2020 onwards to strengthen the economy by promoting innovation, expanding labor supply to counter population aging, and continuing to fill infrastructure gaps.

51. There is scope to reform the tax system to make it more growth friendly and inclusive, while incentivizing targeted business investment. Additional tax relief for low-income households would, alongside continued wage growth, boost their disposable income and consumption, supporting rebalancing. In addition, reducing the high effective marginal tax rate for secondary earners could help promote full-time female labor force participation. Further expanding childcare and after-school programs would also be important in this regard. Budgetary room for these plans, if needed, could be created by reforming property and inheritance taxes. The government’s new proposal of tax credits for R&D is welcome, but the total envelope could be usefully expanded. In the face of changes in the global international tax environment, Germany should maintain its position of leadership in implementing anti-tax avoidance measures and preserve the competitive corporate tax system while not engaging in damaging tax competition.

52. Continuing to address infrastructure gaps, particularly at the local government level, will require rebuilding planning capacity and better coordination across levels of government. In the past, local governments (Länder and municipalities) prioritized fiscal consolidation at the expense of investment. More recently, budget surpluses have alleviated financial constraints in most localities, but capacity constraints and price pressures in the construction industry have emerged as new obstacles. Stronger coordination across various government levels would help ensure that larger and longer-term projects get under way. Local governments should work to rebuild planning capacity.

53. Further policy action is needed to address medium-term challenges and lift long-term growth potential. Initiatives to upgrade the digital infrastructure should be strengthened, and the “National E-Government Strategy” should be implemented rapidly. There is scope for further scaling up venture capital by attracting institutional investors and encouraging cross-border investment in the context of the EU-wide Capital Markets Union. A clearer strategy for curbing greenhouse gas emissions would help reduce uncertainty about the energy transition. The introduction of a carbon tax could be part of the solution.

54. It is imperative that banks and life insurance companies accelerate their restructuring to boost profitability and resilience. The banking sector would benefit from further consolidation, cost-cutting, and continued development of fee-based income. In the life insurance sector, low interest rates challenge the sector’s resilience, and the replacement of conventional guaranteed return products with other types of products needs to proceed faster. In this context, supervisors should continue monitoring interest rate risk and progress in implementing restructuring plans in both banking and insurance sectors.

55. As macro-financial vulnerabilities are building up, the recent activation of the countercyclical capital buffer is welcome and additional action should be considered. Additional actions to enhance resilience in the banking system and guard against potential imbalances in the real estate market could include:

  • Urgently addressing data gaps to enable a fuller assessment of possible financial stability risks. The ongoing one-off bank survey on real estate lending and corporate credit underwriting standards is a step in the right direction, but regular collection of granular data is needed for effective macroprudential policy-making.

  • Early implementation of the existing borrower-based measures (cap on the loan-to-value ratio and amortization requirements) on residential mortgage lending to prevent the buildup of vulnerabilities in the residential real estate sector.

  • Expanding the toolkit by introducing income-based instruments (e.g., cap on debt-service-to-income, cap on debt-to-income) residential loans and appropriate borrower-based measures for CRE loans.

56. It is recommended that the next Article IV consultation take place on the regular 12-month cycle.

Corporate Saving, Top Income and Wealth Inequality, and External Imbalances1

The surging German CA surplus over the last two decades was accompanied by a sharp rise in top income inequality. The correlation coefficient between the CA surplus and the share of national income accruing to the top 10 percent of the income distribution is 0.95 over 1992–2016. As the CA increased by 9 percent of GDP, the top income share climbed by 6 percentage points, with the sharpest increase in both series occurring in the early-mid 2000. Since 2009, the top income share appears to have flattened, while corporate savings rose rapidly, further boosting the current account surplus. These retained earnings and other types of capital income, however, are not properly captured as income of ultimate shareholders and thus the measured top income share since 2009. If business ownership is highly concentrated at the top of the income distribution, then appropriate attribution of corporate savings to their ultimate shareholders would lead to a continued rise in the top income share after 2009, which does not appear in the data.

uA01fig03

CA Balance and Top Income Inequality

(Percent)

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: World Inequality Database and Haver Analytics.

Rising corporate profits—increasingly saved in firms owned by the wealthiest households— therefore supported the rise in top income inequality. Business ownership is indeed highly concentrated among the wealthiest households in Germany. The 10 percent wealthiest households own 60 percent of the aggregate net wealth in the economy – the highest level in the euro area, and most of the wealth at the top of the distribution is business wealth. Thus, the increase in corporate profits and retained earnings in recent years in Germany has likely disproportionately boosted incomes and net worth of the richest households. Indeed, as capital income is unevenly distributed in every country, we find a strong relationship between rising NFC saving/profits and rising top income inequality over the medium-long term across a panel of advanced economies over the last two decades. This relationship is particularly strong in countries with high wealth inequality, such as Germany. Indeed, the rise in corporate saving, coupled with the high wealth inequality, can explain about half of the rise in top income inequality over the period 2000–2015 in Germany.

uA01fig04

Top 10 Wealth Share – Decomposition

(Percent)

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: Household Finance and Consumption Survey (HFCS) 2017, Bloomberg,Federal Reserve Bank of St. Louis
uA01fig05

Correlation Between Corporate Saving and Top Income Inequality

(10 year changes)

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: World Inequality Database, OECD National Accounts Statistics.

As wealthier households tend to have a higher propensity to save, widening income inequality boosted aggregate saving and depressed aggregate consumption, resulting in a rising current account surplus. Survey data show that the lower/median income households in Germany tend to have a propensity to consume close to one. The persistent decline/stagnation of lower incomes and rising top incomes therefore contributed to the compression in the aggregate consumption to GDP ratio, with the mirror image being a rise in the aggregate saving rate and current account surplus (see text chart in paragraph 16). Finally, persistent, concentrated increases in private saving among top income households exacerbates wealth inequality over time. The interaction between wealth inequality and corporate saving therefore goes both ways and is mutually reinforcing.

uA01fig06

Real Disposable Household Income

(Percent, cumulative change since 2000)

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: DIWSOEP.
1 For more details, see Selected Issues Paper “Wealth inequality and private savings in Germany”.

The Impact of Potential US Auto Tariffs on Germany

Germany was one of the major car and car parts exporters to the United States in 2017, along with Canada, Mexico, and Japan. Five European countries, including Germany, the UK, Italy, Sweden, and the Slovak Republic, were among the top 10 exporters, which together accounted for 99 percent of the car exports to the US. These export values, however, embodied the value-added created not only by the exporting countries but also by other countries in their supply chains. About ⅔ of the value of German car exports is domestically generated while ⅓ of the value can be attributable to other countries in its supply chain.

uA01fig07

Top-10 Car Exporters to United States (2017), Breakdown by Source of Value Added

(Billions of US Dollars)

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Source: EORA database. UNComtrade. and IMF staff calculations

The estimated trade-channel impact on Germany of a 25 percent US tariff on autos and auto parts is around 0.15 percent of GDP when GVCs are fully considered.1 Network analysis that aims to estimate the trade-channel impact of such a trade shock through GVC linkages suggests that the imposition of US tariffs on autos and auto parts would affect a broader group of countries than gross export data indicates.2 The analysis finds that, within Europe, Germany, Sweden, and Slovakia would be most adversely affected by the US tariff shock (figure below left panel). For Germany, half of the impact is due to the direct effect of lower car exports to the US and half is due to lower exports of intermediate goods used in car production in third countries. The latter reflects Germany’s strong GVC linkages (figure below right panel).3 Output losses can be significantly larger for all countries once confidence effects and financial channels are taken into account (see October 2018 WEO).

uA01fig08

Estimated Trade-Channel Impact of Tariffs on U.S. Car Imports

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: EORA database, UNComtrade, and IMF staff calculations.
uA01fig09

Impact of Tariffs on US Car Imports

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 213; 10.5089/9781498324625.002.A001

Sources: EORA database, UNComtrade, and IMF staff calculations.
1 The impact does not take into account confidence effects, retaliation, or trade diversion. 2 GVC data are from the Eora global supply chain database, 3 See IMF (2019) “Trade Tensions, Global Value Chains and Spillovers: Insights for Europe”, Departmental Paper.
Table 1.

Germany: Selected Economic Indicators, 2016–20

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

Contribution to GDP growth.

ILO definition.

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, 2016–24

(Percent of GDP)

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

Germany: Medium Term Projections, 2016–24

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

Germany: Balance of Payments, 2016–24

(Percent of GDP)

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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, 2010–18

(Percent of GDP)

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Sources: Deutsche Bundesbank, IMF Statistics Department, and IMF staff calculations. Note: Based on Balance of Payments Manual 6.
Table 6.

Germany: Core Financial Soundness Indicators for Banks, 2013–18

(Percent)

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