FINANCIAL NEWS 

Germany’s Golden Opportunity

BERLIN – The German economy appears unstoppable. Output is expected to grow by more than 2% this year, and wages by 3%, with the current-account surplus set to reach a towering 8.4% of GDP. Unemployment has been halved over the last decade, and now stands at an all-time low. German exporters remain highly innovative and competitive. And the government is recording a sizeable budget surplus. While the rest of Europe remains mired in crisis and self-doubt, Germany’s future seems bright and secure. But appearances can be deceiving.

In fact, today’s rosy macroeconomic data tell only part of the story. Since the euro was established in 1999, Germany’s productivity growth has been no more than average among European countries, real wages have declined for half the workforce, and annual GDP growth has averaged a disappointing 1.2%.

A key reason for this lackluster performance is Germany’s notoriously paltry investment rate, which is among the lowest in the OECD. The result is deteriorating infrastructure, including roads, bridges, and schools. This, together with an inadequate regulatory and business environment, has raised concerns among companies; since 1999, the largest German multinationals have doubled their employee headcounts abroad, while cutting jobs at home.

In their 2013 coalition agreement, the Christian Democratic Union and the Social Democrats set a goal of raising public and private investment by 3% of GDP, or €90 billion ($100.8 billion) annually, to reach the OECD average. Although this is not a particularly ambitious objective – after all, Germany’s current-account surplus at the time amounted to 7.8% GDP – achieving it is vital to the country’s continued prosperity.

Last August, the German government appointed a 21-member committee of experts (including the three authors) from business, labor unions, finance, and academia to determine how to achieve the target. Last month, the committee presented its ten-point action plan, which, despite disagreement on taxes and private financing of public investment, reflects an unusually broad consensus.

For starters, the action plan calls for limiting the impact on public investment of the pressure to consolidate the government budget. The plan does not challenge the constitutional debt brake that forbids the federal government from running structural deficits above 0.35% of GDP. But it does recommend a legally binding commitment to keep investment levels at least as high as the rate of depreciation of state assets, and to use unexpected budget surpluses, first and foremost, for increased public investment.

In order to support local investment, the expert committee proposes creating a “national investment pact” to enable municipalities to increase investment by at least €15 billion over the next three years. And it recommends establishing a public advisory institution to help municipalities realize their investment projects, of which there is currently a €118 billion backlog.

The most controversial issue, within the committee and in Germany, relates to financing infrastructure via public-private partnerships, a seemingly promising solution that nonetheless has proved to be far from a panacea. To strike an effective balance, the action plan proposes two publicly owned investment funds – one raising money from institutional investors, and the other from individuals. The public projects financed by the funds would provide sufficient efficiency gains to attract private financing.

As for purely private-sector investment, the committee recommends a focus on developing the sectors that will dominate tomorrow’s economy. As it stands, Germany is strong in traditional industrial sectors, but has fallen behind its competitors in Asia and the United States in terms of investment in research and development. To catch up, R&D spending should be raised from less than 3% to at least 3.5% of GDP.

Nowhere is the need to overcome financing bottlenecks more apparent than with Germany’s Energiewende (energy transition). To succeed, more than €30 billion, or 1% of GDP, will have to be invested annually in network infrastructure, renewable-energy generation, combined heat and power systems, and storage technologies in the coming decades. While some of these funds will come from public budgets, the vast majority will have to be provided by the private sector.

Moreover, bringing Germany’s digital infrastructure, especially its broadband networks, up to international standards will require significant investment, which an improved regulatory framework could help to encourage. Regulatory reform is also needed to strengthen support for startup companies – an area in which Germany is notoriously weak, reflected in the difficulties such companies face in obtaining venture capital.

A substantial increase in private investment is necessary not just for Germany; it is critical to Europe’s recovery from its ongoing crisis. Given Germany’s relative economic strength, it has a special responsibility to help foster investment throughout Europe, including by promoting European-level reforms of transport and energy, supporting incentives for innovation, and backing digital modernization.

The expert committee supports EU Commission President Jean-Claude Juncker’s plan to channel some €300 billion of private-sector money toward infrastructure, and proposes that if the scheme is successful, it should be transformed into a permanent European investment mechanism. This would require more funding in the long run for the European Fund for Strategic Investments, to which the German government should contribute directly.

Germany’s combination of strong growth, low unemployment, favorable financing conditions, and large budget surpluses present it with a golden opportunity. With increased investment in infrastructure, not to mention a competitive education system and more investment-friendly business conditions, it can place its economy on a stronger footing for the future, and help pull Europe out of its malaise. We now have a plan; all that is needed is the will to implement it.