On Sunday, Germans will vote for a new Bundestag which will subsequently elect a new Chancellor. After 16 years, it is undoubtedly the end of an era, certainly for me as a German. The last time Germany had a Chancellor that was not Angela Merkel, I was still not allowed to drive a car or participate in federal elections. Going into the elections, polls see the SPD candidate Olaf Scholz with a surprisingly comfortable margin ahead of the CDU’s Armin Laschet, who seems to have failed to convince voters that he has what it takes to follow in Ms Merkel’s shoes. In any case, it seems highly likely that the frontrunner will need to enter into intense coalition talks most likely with the free-market liberals and the Greens which make for uneasy bedfellows.

Looking back over the past 16 years, Merkel’s chancellorship can be read as a series of crises that required leadership on the domestic as well as the EU level,  starting with the financial crisis of 2008-2009 which eventually led to the eurozone sovereign debt crisis of in the early 2010s. Shortly thereafter, the migrant crisis came to a head in 2015. Merkel’s final term brought more turmoil on the international stage in the form of Brexit, the Trump presidency in the US and finally the Covid-19 pandemic.

In terms of the domestic economic policy agenda Merkel’s term seems less impressive. Coming off the back of the Hartz IV labour market reforms that were implemented in 2002-2003, Germany’s transformation from the ‘sick man of the euro’[1] to one of the eurozone’s growth engines and the world’s most successful exporting nations has been well documented. However, this apparent success has been achieved through lowering domestic wages as well as an obsession with balanced budgets. German fixation on budget surpluses was famously enshrined in its constitution through the debt brake, prohibiting a structural deficit in excess of 0.35% except in times of natural disasters (including pandemics) or acute economic crises.

However, the challenges of the future require investments of the scale that would clash with the limitations imposed by such stringent rules. The three most pressing issues that the new Government needs to deal with are: demographic change, digitalisation, and decarbonisation.

Germany has one of the fastest ageing populations among EU states and the federal contributions to pensions already account for a quarter of the national budgets, a share that could rise to over 55% by 2060. A serious reform of the pension system was not part of the election campaigns but is something that will need to be tackled sooner rather than later. On digitalisation, Germany has fallen far behind its peers. Whether it’s broadband speed and coverage, digital payments, or public digital services, German insistence on processes, bureaucracy and an excessive focus on data privacy have all been a hinderance in the development of a digital economy of the 21st century. Lastly, decarbonisation will be a challenge on a number of fronts. Under Merkel, Germany first initiated and then halfway through deserted its ‘Energiewende’ – the move towards renewable energies. The result is that Germany still relies heavily on coal and will continue to do so for some time as its nuclear reactors are taken off the grid in the coming years. Meanwhile, German car manufacturing, the traditional pillar stone of Germany’s economy, has started to come to terms with the end of the internal combustion engine. German car manufacturers have started to offer fully electric vehicles in their fleet and have started to focus on future mobility themes. However, the future of thousands of highly specialised firms along the supply chains remains in danger.

These challenges, especially digitalisation and decarbonisation, cannot be tackled simply through reforms and legislature – large investment programmes will be necessary to transform the physical and digital infrastructure of the country. Proposals have been made as to how this could be made possible without touching the constitutional debt brake.[2] A welcome side-effect of a more profligate Germany would be the reduction of structural imbalances within the EU. Following the pandemic, all countries have some way to go to recover to their levels of potential output. Germany, however, has more fiscal space than most EU countries. How to use this most effectively, is one of the many difficult questions awaiting the winner of Sunday’s election.

1: https://www.economist.com/special/1999/06/03/the-sick-man-of-the-euro
2: https://newforum.org/finance/eine-neue-deutsche-finanzpolitik/

For more information please contact:

Kay Daniel Neufeld  Email:kneufeld@cebr.com Phone: 020 7324 2841