German Government Approves Record Economic Stimulus Package

The economic heart of the European Union (EU) is pounding again. Yesterday, senior members from the three ruling parties in Germany—the senior Christian Democratic Union (CDU), sister party the Christian Social Union (CSU), and the junior Social Democratic Party (SPD)—agreed on a second economic stimulus plan for the ailing economy. The "Pact for Safeguarding Employment and Stability in Germany" comes only two months after an initial 32-billion-euro (US$42.5-billion) package and promises a raft of tax cuts, increases in state benefits, and aid for troubled businesses. Chancellor Angela Merkel (CDU), her deputy Frank-Walter Steinmeier (SPD), and CSU leader Horst Seehofer will present the draft agreement to the press today. The government is keen to push it through parliament swiftly; ideally, the agreement will come into effect on 1 July and will run until late 2010.

Good for Germany?

Peter Struck, the leader of the SPD faction in the Bundestag (lower house of parliament), described yesterday as a "good day for Germany" following the announcement of the plan to invest an estimated 50 billion euro into the economy. The plan is the most expensive devised by a German government since 1945. Merkel in particular was lambasted for the first stimulus plan and ensuing inter-governmental tensions about tax cuts. Recently, the tide has turned again and the parliamentary factions of the CDU-CSU and the SPD paved the way for yesterday's agreement (see Germany: 6 January 2008: German Ruling Parties Resolve Row over Economic Stimulus Plan).

It can be argued that big problems require big solutions. However, the threat of a major recession has not deterred those that prefer a more conservative take on state expenditure. The criticism of the plan from opposition parties was to have been expected. Guido Westerwelle, for instance, the leader of Merkel's favourite opposition party, the Free Democratic Party (FDP) has warned that the package will only ease the burden on individual German households by a mere 10-15 euro per month. However, the government leaders may be more worried about the remarks of some middle-and senior-ranking politicians from their own fold. The CDU's in-house expert on budgetary matters, Steffen Kampeter, lambasted the "spending spree" of the government and estimated that the agreement will lead to 60 billion euro net in new borrowing; this is 20 billion euro higher than the previous record set by then-finance minister Theo Waigel back in 1996. The Maastricht Treaty budget deficit limit of 3% of nominal GDP roughly equates to 75 billion euro of annual public-sector borrowing at present.

Worries about sky-high public debt rates have prompted other commentators to call for controversial solutions. An increase in the retirement age to 67 and higher charging of pensioners have been suggested. Others warn that the measures will only start to have an effect from late 2009 onwards, which could be too late for both the cabinet and the economy.

Other than the debt issue, opponents of the draft text have criticised its tameness. Several business representatives argue that it might be big on debt but it is weak on alleviating the burden for employers and employees. The chairman of the German Chamber of Industry and Commerce (DIHK), Martin Wansleben, has called for significant changes to the corporate tax rate, notably as regards the calculation of losses. Hanns-Eberhard Schleyer, the general secretary of the German Crafts and Trade Federation (ZDH), has echoed Wansleben's criticism and requested a simplification of the schemes offered by the German development bank (KfW) as well as reform of education and training along the lines of what the German government decided at the education summit in October 2008. The president of the Federal Union of the German Wholesale and Exports (BGA), Anton Börner, is pushing the cabinet for the abolition of the solidarity tax and for a friendlier stance on temporary work contracts; ideally, the latter should benefit from more government support during the next 5-10 years.

In economic terms, the bulk of the impact will not be seen until late 2009. This pertains particularly to the planned additional spending on transport infrastructure and schools, given the usual lead times, although there are proposals to speed up tender procedures. Extra benefits and tax cuts for consumers and small businesses will take effect in July, but the prospect of their arrival should support consumer spending during the first half of 2009. The fiscal cost of the package will be considerable, although it should be considered how much higher tax revenue shortfalls and required spending on social matters would become in the absence of such state support. The risk of the recession lasting well into 2010 in that event would not be small.

Outlook and Implications

Germany is heading for a recession this year. Every party agrees on this, yet policy-makers disagree strongly over the right solution to the problem. The German government is often—and rightly—regarded as conservative when it comes to public debt. Yet, needs must and the forthcoming general election on 27 September has forced the hand of even the staunchest defenders of EU regulations on public debt.

Economically, this second economic stimulus package is more unified and at the same time of a much greater magnitude than the first set of measures announced late last year. The timing of its planned introduction (July) can be criticised, and those measures targeted directly at businesses in particular are required sooner. However, it should not be forgotten that private consumption is still relatively resilient right now thanks to the boost to purchasing power from rapidly falling inflation. The expected spike in unemployment—which will last well into 2010—suggests that tax relief and consumer incentive measures may actually be well timed to support consumption during the second half of the year. Furthermore, with psychology playing such an important role in this crisis, which was triggered by the financial sector, the announcement of the package alone may have a considerable reassuring effect on overall domestic demand during the first half of 2009. Overall, given the depth of the downturn right now, the package will hardly be able to prevent a contraction in GDP of around 2% in 2009, but it will safeguard and speed up the recovery in 2010. The drawback of the package is the likelihood that Germany will return to fiscal deficits near or even above 3% of GDP during 2009-11, and the fact that a balanced budget (as in 2007) will not be seen again until 2013 at the very earliest.