Blog Carsten Brzeski

Germany: Something's cooking

While most commentators and politicians in Germany still focus on ECB bashing, the need for new structural reforms in the Eurozone’s largest economy is gradually receiving more attention.

Currently in Germany, most attention in the public debate on economic issues is still on the ECB. Whether it is wide-spread criticism on the ECB’s QE and zero interest rates or the recently announced gradual abolishment of the 500 euro bill, the ECB currently seems to be the Germans’ most favourite scapegoat. Under the surface of this ECB bashing and the often-felt impression of German superiority when it comes to economic recipes against the euro crisis, however, homemade problems are arising. Homemade problems that currently are not widely discussed in the German media and the political arena: the lack of new structural reforms.

In fact, the German economy’s current strength is still mainly the result of economic reforms from more than ten years ago, combined with extremely favourable external circumstances like low interest rates, low inflation and a weak euro exchange rate. Therefore, it does not really come as a surprise that international institutions like the OECD have frequently called upon the German government to implement new reforms, particularly in the labour market, the tax system and the pension system. Last week, ECB President Draghi also hinted at the lack of new reforms in Germany. Now, a new IMF Working Paper (WP/16/96 “Structural reform in Germany”) presents more evidence that delaying or even entirely missing out on new reforms would be a big missed opportunity. The paper investigates the economic impact of i) a reduction in the social security tax in the low-wage sector, ii) a publicly financed expansion of full-day child care and full-day schooling, and iii) the further deregulation of the professional services sector. According to the authors of the paper, particularly the first two reforms would have a significant positive impact on growth and employment and, even though they would cost money at the beginning, would eventually be positive for public finances. Similar to earlier IMF research on public investments in infrastructure, the working paper presents new measures and reforms that, particularly in a low interest rate environment, look like a free lunch. A win-win situation, both for public finances and the economy. Germans should love it.

There is another interesting and delicate twist to this IMF Working Paper: it actually is the English version of a German academic paper commissioned by the German ministry of economic affairs published last November. Last year, the ministry had started an initiative investigating possible future reforms. For those not too familiar with every detail of German politics, the ministry of economic reforms is headed by Vice-Chancellor Gabriel from Merkel’s junior coalition partner. This makes the paper even more delicate as it is another illustration that the shots on Germany’s economic policies are not called at the ministry of economic affairs but rather at the ministry of finance (headed by Wolfgang Schaeuble) and Chancellor Merkel herself. Having the same paper published at the IMF (Gabriel’s main economic advisor is a former IMF official) could be a smart move to gain clout and revive a debate that did not have sufficient support within the government. Or it is just a nice ‘House of Cards’ move to press another button and wait what will happen.

All in all, even though the German economy looks extremely solid and strong from the outside and the government’s opposition to any new stimulus sounds convincing, close attention to what is happening beneath the surface shows that something is cooking.