A bit of supply side policy to cure Germany's ills?

 

Friedrich Merz’s economic cure for Germany, the sick man of Europe

The CDU leader’s prescription is tax cuts, slashing benefits for refugees and less bureaucracy — but economists say Agenda 30 doesn’t add up

Friedrich Merz, the CDU leader, has promised to turn Germany’s economic prospects around with an Agenda 2030

David Crossland

, Berlin

Sunday January 12 2025, 6.35pm, The Times

The last time a German government enacted “get on your bike” economic reforms was more than 20 years ago when Chancellor Gerhard Schröder, now vilified for his friendship with Vladimir Putin, cajoled his Social Democrats into accepting his Agenda 2010 package of radical benefit cuts.

The agenda cost him his job because SPD voters never forgave him for it, but it worked, hauling Europe’s largest economy out of recession and temporarily restoring its “Vorsprung durch Technik” prowess in Europe and the world.

Angela Merkel reaped the rewards, taking credit for solid economic growth that endured for most of her 16 years in power. With tax revenues pouring in, she put reforms on hold, keeping the ageing population happy with pension increases while blue-chips like VW and Siemens raked in profits from surging sales to China and cheap Russian energy.

• Angela Merkel exclusive: Donald Trump, Vladimir Putin and me

Those days are over. The title of sick man of Europe is back again for the first time since 2003, when it spurred Schröder into action.

In the past two years, Germany’s performance has been the worst among the G7 top economies, with a contraction in GDP in 2023 and zero growth in 2024. It is expected to remain at the bottom of the ranking in 2025 with 0.8 per cent growth, according to the International Monetary Fund.

Surging costs, paralysing bureaucracy and years of underinvestment have made a mockery of clichés about Teutonic efficiency and the trains running on time.

The word “agenda” in a campaign manifest remains a red rag to the left but the CDU leader, Friedrich Merz, the contender most likely to become chancellor in the February 23 election, has embraced it, promising to turn Germany around with an Agenda 2030.

Formally agreed in Hamburg at a weekend conference of CDU leaders, the 12-page plan pledges to restore Germany to annual growth of at least 2 per cent with a four-year series of tax cuts for low and middle-income households and for companies. The top tax rate on corporate earnings is to be slashed from 40 per cent to 25 per cent. The CDU has remained vague on how it plans to fund the relief and is pinning its hopes on rising growth to do the job.

Merz, centre, in Hamburg. The CDU leader has promised to turn Germany around with an Agenda 2030

MARCUS BRANDT/GETTY IMAGES

In an attempt to clip the wings of the hard-right AfD, which is in second place at 21 per cent according to the latest poll, the agenda includes cuts in benefits for refugees, as well as for the long-term unemployed. Anyone refusing reasonable offers of work will risk a complete loss of state support, Merz told a news conference on Saturday.

“We’ve got to restore our economic performance. The objective state of our economy is much worse than 20 years ago because we’re losing competitiveness on a large scale,” Merz said.

Germany’s manufacturing sector remained the core of its prosperity and would suffer “irreparable damage” without fundamental change. “We don’t have much time to correct this,” said Merz, whose CDU/CSU bloc is polling at 30 per cent.

Agenda 2030 will introduce tax breaks for overtime and for pensioners who want to top up their income in an attempt to get Germans to work more; recent OECD data showed that Germans put in significantly fewer working hours per year than the EU average or UK workers.

Merz said immigration had led to an “objective overburdening of the capacities of our country”

MARCUS BRANDT/GETTY IMAGES

Merz also plans to spur investment through “deep cutbacks” in German and EU bureaucracy. Planning approval for building projects is to be sped up and start-up companies are to be spared much of Germany’s notorious red tape. There are plans for a digital affairs ministry to help cut bureaucracy.

The agenda also aims to reverse the planned EU ban on the sale of new petrol and diesel cars from 2035.

Merz said immigration had led to an “objective overburdening of the capacities of our country” after more than three million people from non-EU countries had entered Germany in the past four years.

The message was similar, but less blunt, to that of his rival Alice Weidel, whose AfD has been endorsed by Elon Musk as Germany’s “last spark of hope”.

Alice Weidel, co-leader of the AfD, has radical plans for Germany’s green policy, including tearing down wind turbines

KAY NIETFELD/REUTERS

“Cut social benefits for people without residence entitlement and carry out deportation on a large scale,” she told a party conference in Riesa where she was anointed as its candidate for chancellor. “I must honestly tell you, if that’s supposed to be called remigration, then it’s called remigration,” she told delegates to applause.

She described the 10,000 protesters who had delayed the start of the conference by two hours as “red painted Nazis”, echoing her remarks last week in an online conversation with Musk that Adolf Hitler was a communist.

She also had a radical plan on green policy, promising: “We will tear down all wind turbines, down with these windmills of shame!”

Economists are questioning how Merz plans to fund the tax cuts and other measures given that they will cost an estimated €89 billion.

Marcel Fratzscher, the president of the German Institute for Economic Research, said: “Economic growth of 2 per cent is illusory. The combination of lower taxes, higher investment and less debt is a contradiction in terms and like squaring the circle.”

France is ahead of us (just) in the shaky fiscal position stakes:

 

• Ambrose Evans-Pritchard

France is playing with fire: an IMF bailout is no longer unthinkable

The collapse of the European project’s twin-anchor threatens dramatic consequences for the Continent

Ambrose Evans-Pritchard

Related Topics

• France, 
• Global economy, 
• IMF

27 November 2024 7:00am GMT

239

Emmanuel Macron’s ‘grand bargain’ with Berlin has failed Credit: Sarah Meyssonier/Pool/EPA-EFE/Shutterstock

France is pushing its luck. The country has long enjoyed an “exorbitant privilege” within the EU, able to borrow at rock-bottom German rates because it is deemed to be the twin-anchor of the European project.

Markets assume that the EU institutions will always coddle France whatever it does. We may soon find out whether this is a political narrative beyond its sell-by date.

There is a high likelihood that the Barnier government will collapse over the next month without passing a budget, unable to rein in runaway fiscal deficits that subvert the cohesion of monetary union.

“The governability of France is being called into question more than I have ever seen in my lifetime,” said Moritz Kraemer, ex-head of sovereign ratings at Standard & Poor’s.

The risk spread of 10-year French bonds over German Bunds spiked to 83 points on Tuesday, the highest since the eurozone bond crisis in 2012, though that metric does not fully capture the underlying gravity of events.

“The markets are waiting for a credible response but nobody can see where it is going to come from and there doesn’t seem to be any sense of urgency,” said Mr Kraemer, now chief economist at the German Landesbank LBBW.

“The French are playing with fire. Nobody in the markets still thinks that France is still part of the eurozone core. These spreads are a loud and clear warning,” he said.

His words have weight. S&P will decide on Friday whether to downgrade French debt yet further, after cutting the rating to AA- in May.

France is not at any imminent risk of a Greek default crisis, any more than Britain was at risk during the Truss mini-storm. But it is moving into the grey zone.

Mr Kraemer said the European Central Bank may ultimately be forced to intervene, invoking its untested “spread protection tool” (TPI) to buy French debt on the open market. “This could only go on for a couple of months; then there would have to be a proper adjustment,” he said.

This would require combined action by the International Monetary Fund and EU’s bail-out fund (ESM), together imposing the IMF’s usual medicine of spending cuts, tax rises, and harsh reform – if they could even handle a big beast with €3.3 trillion (£2.8 trillion) of public debt.

“It would be really brutal upfront austerity. The politics would be absolutely toxic because the ECB’s president is a former French finance minister,” he said.

Any use of the rescue machinery would require the assent of the German Bundestag, the Dutch Tweede Kamer and the northern creditor states. It is hard to imagine a more explosive political showdown.

The chances that the current French parliament would agree to draconian terms is close to zero. Two prickly animals hold the balance of power: the Left-wing Popular Front, and the Right-wing National Rally. Both defend France’s sacred – and unaffordable – welfare model.

The EU’s Mercosur trade treaty with Latin America adds another stick of political dynamite to the mix. If this treaty is imposed on France against its vehement protest – as seems likely – it risks an emotional rupture between the French people and the EU power structure.

For now there seems to be a widespread assumption that the ECB will suppress French bond yields as it did for Italy over the years. As cynics say, isn’t that why Emmanuel Macron pushed so hard to secure the top job for France’s Christine Lagarde?

But the institution can no longer mop up Club Med debt with no questions asked under the cover of quantitative easing. Post-Covid inflation has made this patently illegal. Any attempt to do so at scale would lead to a knife-fight within the governing council.

The French government understands the risks as the budget deficit hits 6.1pc of GDP this year and heads for structurally higher levels through the 2020s. “If we don’t act, the mechanical dynamic of public spending could push it to 7pc in 2025,” said Laurent Saint-Martin, the budget minister.

Premier Michel Barnier wants fiscal tightening of €60bn – in reality nearer €45bn – in mixed cuts and taxes, warning of a debt trap as interest service costs spiral higher. “Retrenchment is unavoidable, otherwise we are heading straight into a financial crisis,” he said last month.

Yet he cannot even count on the parties of his own loose coalition. His finance minister – a Macron loyalist – has publicly rebuked him for trying to raise taxes. Other Macronistes are acting as if they are in opposition. Party discipline has disintegrated.

The National Assembly has become a seething hotbed of self-promoting potentates pursuing their own power plays. It is an unedifying spectacle.

The government survives on the sufferance of National Rally’s Marine Le Pen, poetic justice after an election manipulated to deprive her 11m voters of genuine franchise.

As Henry Samuel reports from our Paris bureau, Le Pen is threatening to plant the “kiss of death” on the hapless coalition by joining the Left in a vote of no confidence triggered by attempts to force through the budget by decree power.

She has imposed a “red line” over the cost of living. The real reason is that 73pc of her party’s supporters want rid of Mr Barnier, one of the last great gentlemen of modern politics.

Most of Marine Le Pen’s party want rid of Michel Barnier, the last great gentleman of French politics Credit: Dimitar Dilkoff/AFP via Getty Images

Professor Thomas Mayer, ex-chief economist at Deutsche Bank and author of Europe’s Unfinished Currency, said the political foundations of monetary union are coming apart. “The eurozone core is melting down. Markets can see that public finances are out of control and that France is moving into the Italian camp,” he said.

The German economic establishment is splitting into two camps as it watches the soap opera unfold. “The orthodox view is that Germany must stick to sound finances even if it becomes the sole anchor of the euro. At least we will still have a halfway respectable currency,” he said.

“The second view you are hearing more and more is that if others don’t bother, why should we? To hell with it, let’s just get rid of our debt-brake, and if the euro goes down the drain, that’s just too bad. The coalition imploded over this,” said Prof Mayer, now director of the Flossbach von Storch Research Institute.

“What you are seeing in the bond markets is that investors are beginning to doubt whether the German debt-brake will continue,” he said. Danish yields are now 20 points below German yields even though the krone is pegged to the euro. This is unprecedented.

Prof Mayer said the EU had turned into a bureaucratic leviathan that posed an increasing threat to Germany’s fundamental interests.

“Our government is going to have to confront the European Commission head on. It is imposing more and more directives on everything. It is impinging on personal freedoms, on production, on supply chains. It’s simply horrific,” he said.

“I don’t know how long Scandinavians will go along with it, or the Netherlands: they can all see the writing on the wall,” he said.

One thing is absolutely clear: President Macron’s “grand bargain” with Berlin has failed. He came to power in 2017 pledging to restore fiscal probity and make France fit for the euro. This would supposedly unlock German assent for a “Hamiltonian” leap forward: joint debt issuance and a muscular EU treasury with borrowing powers.

“It is dead in the water. There is no realistic constellation of political parties in Germany that would agree to it,” said Mr Kraemer.

France will probably muddle through and avert a full-blown financial crisis for now. But the larger damage is done.

There will be no fiscal union after all. Without that the euro is a chronically unstable construction on borrowed time.

The bit in the middle has what I was talking about with Germany keeping policy tight

 

German coalition collapses

Political turmoil couldn’t have come at a worse time. Emily Hohler reports

Scholz has “finally lanced the boil”

German chancellor Olaf Scholz has “just pulled the plug on his coalition and lost his parliamentary majority”, with polls implying that his Social Democrat party will be defeated in the snap election called for 23 February, says Guy Chazan in the Financial Times. The current government will be put to a confidence vote on 16 December, which it is expected to lose. 

Despite Scholz’s low approval ratings and the wish of some in the SPD that he be replaced by the popular defence minister Boris Pistorius as SPD leader, party leaders have “rallied round” and most expect Scholz to be the name on next year’s ballot. His standing among some colleagues has “paradoxically improved” since the government’s collapse – he has been hailed as a hero who “finally lanced the boil, ending a dysfunctional government riven by ideological conflict”. Last week, Scholz fired finance minister Christian Lindner, leader of the pro-business Free Democrats (FDP), for refusing to suspend the debt brake to allow more funding for Ukraine, effectively ejecting the party from the coalition.

Back to 2006

Donald Trump’s victory couldn’t have come at a worse time, says The Times. His plans to impose more tariffs on imported European goods are likely to be “particularly catastrophic for Germany” since America is its largest trading partner. Trump has suggested tariffs may be between 10% and 20%, possibly much higher for cars, Germany’s main export. The EU may respond in kind. The German Economic Institute estimates that a trade war could cost Germany €120bn-€180bn over Trump’s four-year term. Then there’s a possible Putin victory in Ukraine, “with all that this implies for the survival of the EU”, says Ambrose Evans-Pritchard in The Telegraph.

Last year, the US had a $170bn trade deficit with the EU; Germany accounted for half of that. This “touches on a deeper problem”. The country has relied on a current-account surplus of 6%-8% of GDP for much of the past 20 years, the result of a “tax and regulatory structure, allied to fiscal ideology, that suppresses internal consumption and wages to the benefit of the exporting elites”. A large surplus would normally partially self-correct via the exchange rate, but Germany “jammed the adjustment mechanism by launching the euro”, leading Washington to accuse Berlin of “gaming monetary union to lock in a stealth devaluation”.

Germany’s “original sin” was a collective refusal by elites to embrace modern technologies, says Wolfgang Munchau in The Times. As time went on, leaders “continued to double down”, with a heavy dependence on a few industries such as cars and chemicals and increasing reliance on Russia for gas and China for exports. The “neo-mercantalists in the government” turned a “bad bet by a single industry” – the car industry’s refusal to embrace the rise of EVs – into a “bad bet for the whole country”. Industrial production has fallen back to 2006 levels this year; the economy as a whole has seen virtually no growth since 2018. Unless Germany repeals its constitutional debt brake and starts to generate some domestic demand, it will “sink into atrophy”, says Evans-Pritchard. “The last chicken has come home to roost.”

If Reeves thinks we have it bad she should consider Lindner's position:

 

Germany faces a rude economic awakening

A rude awakening awaits Europe’s former economic powerhouse

Jeremy Warner25 August 2024 • 9:00am

176

Anyone would think we’d been swept away into Lewis Carroll’s Alice Through the Looking Glass. Normally when the economic news is good, the incumbent government likes to boast about it, and contrariwise, to play the news down when it’s poor.

That’s logic, as Tweedledee might have said.

But with Rachel Reeves and her newly installed team at the Treasury, it is the other way around. Positive economic news is treated grudgingly, while the negative is mercilessly played up.

This is the worst economic inheritance since the Second World War, the new Chancellor repeatedly insists in preparing us for tax rises – and she will simply not have it any other way.

Nobody would deny that there are big challenges facing the UK economy, particularly when it comes to the public finances, where the national debt has swollen to nearly 100pc of GDP and there is little sign of the deficit being put on a sustainable footing.

But just look at Germany and things don’t seem quite so bad. Admittedly, the public finances in Germany are in rude health relative to Britain, but the wider economy is struggling as rarely before.

While the UK recorded growth of 0.7pc in the first quarter, Germany barely managed to lift itself out of recession, with growth of just 0.2pc. What’s more, the economy contracted anew in the second quarter even as the UK managed a respectable 0.6pc growth.

The contrast is even more striking when it comes to the more forward-looking data, such as the S&P Global Flash PMI composite output index, a measure of current private sector activity, and the GfK consumer confidence index, one of the longest-running measures of consumer sentiment.

The S&P composite reading for Germany slumped to 48.5 in August, against a relatively healthy 53.4 for the UK, with anything below 50 representing contraction and anything above expansion. Much the same story is told by the GfK consumer confidence data.

Germany is stuck in the doldrums, while the UK economy continues to defy the Government’s doom-mongering with what for the moment is steady growth.

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Two quarters of expansion do not, sadly, a summer make. It would be most unwise to think that the current juxtaposition between British and German levels of economic activity has established a lasting trend.

Even so, the UK might seem structurally to be rather better placed to navigate the constantly shifting sands of today’s world economy than Germany, which is stuck in a rut and lacks the flexibility to get itself out.

Many of the problems that afflict the German economy – poor levels of business investment, stifling red tape and bureaucracy, Nimbyism, an increasingly workshy labour force sustained by overly generous welfare, dilapidated infrastructure and an ageing demographic – are quite similar to those of the UK.

But the causes are different, and they are more entrenched. Germany is finding it difficult to adapt to a fast-changing world and, unable to change itself, is in danger of being left behind.

The key reason for German stagnation is depressed levels of business and housing investment, which because of Germany’s strengths in manufacturing have traditionally been a much larger element of GDP than in the UK.

You might expect poor business investment to in part be compensated for, given the recent rise in real wages, by growth in consumer demand. That’s what’s happened in the UK. But we’ve not seen it in Germany, with its cultural propensity to save rather than spend.

As for the fall-off in traditionally high levels of business investment, this is partly explained, according to Clemens Fuest, head of Germany’s Ifo Institute for Economic Research, by increasingly crushing levels of red tape and bureaucracy.

“It’s like requiring all citizens to report on their daily movements as a way of deterring shoplifting”, explains Prof Fuest. “Measured bureaucracy has become as bad as that, and for business investment, the effect is devastating”.

Similarly with housebuilding and construction, where rent controls and planning restrictions have seriously undermined supply.

In Berlin, voters have responded to housing shortages and rising rents by threatening larger landlords with expropriation; predictably, the effect has been to further deter new housebuilding.

With rising protectionism, what used to be one of Germany’s most admirable economic qualities – its propensity to export – has meanwhile become a key vulnerability.

This has in turn encouraged German firms already struggling to compete because of high labour costs to invest directly in overseas markets rather than at home.

The enforced switch from petrol and diesel engines, where German engineering has for decades reigned supreme, to electric vehicles, piles on the agony.

Germany’s Mittelstand of medium-sized family owned businesses, many of them heavily geared to the internal combustion engine – again once considered one of Germany’s key economic strengths – is in danger of being left high and dry.

To cap it all, Germany has found itself badly caught out by its heavy reliance on previously cheap Russian energy supplies.

With war in Ukraine, these have all but disappeared. It almost beggars belief that in the midst of such a crisis, Berlin should further shoot itself in the foot by closing its remaining nuclear power stations.

Relative strength in the public finances theoretically offers Germany a lifeline. Where Reeves finds herself condemned to “tough decisions” over tax and spend, Germany has all the fiscal room it needs to supercharge its economy with stimulus.

But Berlin also finds itself hemmed in by its own self-imposed debt brake rules, and in any case it’s not clear that Keynesian style stimulus works in a country which is structurally a world apart from Britain and also has a very different economic tradition.

Tax cuts tend to be saved rather than consumed, and there is already an unspent €80bn (£68bn) backlog of infrastructure projects held up in the works by byzantine logistical and planning constraints.

Germany’s problems are as much down to deficiencies in supply as demand.

Wander around any of Germany’s major cities, or stroll through its rolling countryside and picture postcard villages, and you wouldn’t believe that this is a country living on borrowed time.

Yet beneath the apparent prosperity lies a sea of trouble where millions are locked in part-time work by generous welfare entitlements that give little incentive to seek full-time employment, and where seemingly every problem is met with a “so ist das Leben” (that’s life) shrug of the shoulders.

Reeves would no doubt gladly swap her own challenges for those of her German counterpart, Christian Lindner, but economic stagnation is not a happy place to be, even when sugared by Germany-style work/life balance.

Germany will eventually bounce back – it always does. But there is a rude, and politically destabilising, awakening to go through before it does.

At least in Britain, we are already fully aware of the mediocrity of our circumstances. Germany still has that moment of self-realisation to come.