Modest Recovery in Store for Germany
IMF Survey online
March 30, 2010
- Moderate recovery expected, with growth of 1.2 percent of GDP in 2010
- More restructuring needed in banking sector
- Labor, service sector reforms could unleash growth potential, boost domestic demand
The IMF is forecasting growth in Europe’s largest economy of 1.2 percent of GDP this year, followed by 1.7 percent in 2011.
Reflecting Germany’s role as the world’s second largest exporter, the pickup in global trade is the main factor behind the recovery, although fiscal stimulus continues to provide support to the economy.
In this interview, the IMF’s mission chief for Germany Juha Kähkönen and Deputy Division Chief Helge Berger discuss risks to the recovery, why few jobs were lost in Germany during the crisis, and whether Germany needs to recalibrate its growth model.
IMF Survey online: What are the IMF’s expectations for a German recovery?
Kähkönen: The recovery in Germany is well underway, but we think it will be moderate and fragile. Last year, GDP dropped by 5 percent. For this year, we project a growth of 1.2 percent. Our expectations for 2011 are slightly higher, at 1.7 percent.
The recovery is supported by several factors, but the pickup in global trade is probably the most important factor. As you know, Germany’s economy is open and very export-oriented. The pull from Asia and, to a lesser extent, the United States has a direct and positive impact on the economy.
But policy support also matters. Fiscal policy in particular has supported demand. The government allowed automatic stabilizers to work in full and also implemented other stimulus measures, including a very popular car scrapping program last year. A short-term work program known as Kurzarbeit also helped limit the depth of the recession and will continue to provide substantial support for the economy in 2010.
IMF Survey online: What are the main risks to the outlook?
Kähkönen: There is a chance that the upswing will be stronger than currently foreseen, but the risks are predominantly on the downside. We see two main risks.
First, the demand for exports could be lower than expected. If growth in Germany’s partner countries, especially within Europe and, in particular, Southern Europe, were to fall short of expectations, this will be felt directly in Germany.
Second, we cannot exclude the possibility of a credit crunch. If there are further loan losses in the financial sector, this could constrain the lending capacity of banks, which in turn will impact growth.
IMF Survey online: In light of these risks, is Germany’s fiscal policy adequate?
Kähkönen: The government’s fiscal strategy, in our view, strikes the right balance between supporting the economy in the short term and planning to consolidate government finances once the recovery has taken hold.
The fiscal stimulus in Germany this year is among the largest in the Group of Seven economies (G-7). We think this is appropriate, given how fragile the recovery is. If the recovery turns out to be weaker or takes longer to materialize than we currently expect, the government might want to consider additional fiscal support.
But once private sector demand has become self-sustaining, as we project will happen in 2011, fiscal support should be withdrawn and consolidation started. Like other members of the European Union, the government must live to the requirements of the European Stability and Growth Pact, which stipulates that the general government deficit should be reduced to 3 percent of GDP―in Germany’s case, by 2013. On top of that, a new constitutional rule requires the structural federal government deficit be near zero by 2016. The government is firmly committed to meeting these targets.
We strongly support the medium-term commitment to sustainability—not only because it will be important for meeting the fiscal rules and preparing for the fiscal challenges of Germany’s aging population, but also because it is crucial for anchoring fiscal consolidation in the whole euro area. As has happened in the past, Germany’s fiscal actions could set an example for the rest of Europe.
To achieve these medium-term goals, the government needs to put in place concrete measures, starting in 2011. In our view, such measures should focus on reducing expenditure―international experience shows that consolidating expenditure is most effective when it comes to achieving a lasting reduction in government deficits. But revenue measures might also be needed. If that’s the case, we would propose broadening the value-added tax and income tax base, rather than simply increasing tax rates.
IMF Survey online: The labor market has held up remarkably well in Germany compared to other advanced economies. How much of that can be ascribed to the Kurzarbeit program?
Berger: Unemployment figures barely moved during the recession, which is quite remarkable. Some observers even talk of an employment miracle. Things can change, though. And while employment has held steadily, hourly work numbers have decreased quite substantially.
What we see is to a large extent the impact of past labor market reforms, which made labor markets more flexible. Today, collective bargaining agreements often include clauses that allow companies to adjust the amount of time worked, something which was used quite extensively during the recession.
But the Kurzarbeit program―essentially a government subsidy for short-time work―also played a very important role. At its peak, the program supported work time reductions for 1.5 million employees, a figure that amounts to about 3.5 percent of the total labor force. This is really quite an astonishing number.
The scheme is effective because it encouraged burden sharing between employers and employees and prevented unemployment. Research shows that prolonged unemployment does lasting damage to peoples’ skills sets. Thus, keeping people in the work force rather than laying them off is a major benefit of this program.
As we enter the recovery, the program should be adjusted so it does not hold back change in the labor market. The Kurzarbeit program was and is particularly popular in the export sector, which is still under considerable pressure. We don’t think that export growth will return to its pre-crisis exuberance and so more jobs will need to be created elsewhere in the economy, for instance in the service sector.
IMF Survey online: There are still lingering problems in the banking sector. What steps does the government need to take, both in terms of resolving left-over problems from the crisis, and in terms of laying the foundation for stronger banks in the future?
Berger: It’s fair to say that the German banking sector on the whole is healthier than it was during the early phase of the crisis. The improvement is due to the brighter economic outlook, substantial policy efforts, and government-backed restructuring.
But serious weaknesses remain, particularly in the larger public banks known as Landesbanken. These banks accumulated substantial losses during the crisis. Their problems come down to the fact that they lack a viable business model. Most of the banks are structurally unprofitable and tend to be excessive risk-takers, something which became clear during the crisis, when they were a drain on the public finances and a source of financial instability.
Some of the Landesbanken are already being restructured, but there is a strong need for more fundamental consolidation in the sector. The surviving banks should have effective governance, something most of them lack today. They should be privatized, with viable business models that are able to face the test of markets.
On a broader level, the government has taken a number of initiatives to improve the financial stability framework, based on lessons learned during the crisis.
First, the government is planning to consolidate all prudential banking supervision into Germany’s national central bank, the Bundesbank. This will help eliminate coordination and accountability issues under the current setup where these responsibilities are split between the Bundesbank and BAFin, the national financial sector supervisor. This will improve information flows, which is crucial, especially in a crisis environment, and decision making, which should become swifter and more efficient.
Second, we think there is scope to maximize efficiency gains if the Bundesbank’s prudential mandate is widened further to include the insurance sector. Traditionally, insurance and banking services are highly integrated markets in Germany, and regulation and oversight from a single source would clearly make sense.
Third, the government is planning to introduce a permanent resolution regime for systemically important banks. Temporary mechanisms were put in place during the crisis but a more permanent solution needs to be found. We think it might also make sense to extend the new permanent framework to include non-systemic banks. Whether a bank can have an impact on the entire financial system or not can change at a minute’s notice during a crisis, so including all banks would be helpful.
Finally, we would like to see more progress in the area of deposit insurance. Deposit insurance is highly fragmented in Germany, where different parts of the banking sector run their own schemes. This approach showed its weaknesses during the crisis. As an example, commercial banks, which also run their own deposit insurance scheme, needed government guaranties of 6.7 billion euros to cover losses during the crisis. For these reasons, a more unified fund for deposit insurance spanning the entire banking system would be a great improvement.
IMF Survey online: There is a lot of debate right now about the need for new growth models, in Europe and elsewhere. Germany has been criticized for relying too much on export-driven growth. What are your views?
Berger: There’s certainly a need to strengthen Germany’s growth potential and to repair the damage from the crisis to potential growth. But this is easier said than done. There are important reservoirs of growth in Germany’s labor and services markets. Employment protection is still fairly high in the country and the service sector clearly holds a large untapped growth potential. Simultaneous reforms in both areas promise sizable growth and employment gains in the medium term.
Reforms in these areas would not only unleash domestic growth potential in Germany, they would also reduce the country’s reliance on exports―a double growth dividend. On top of that, such reforms would also help reduce trade imbalances within Europe and globally.
What will not work is an attempt to achieve a rebalancing of growth by weakening Germany’s competitiveness―for example, through excessive wage growth. Such a strategy would only serve to hurt domestic German growth and would damage Europe’s competitiveness as well.
IMF Survey online: So in a nutshell, what are the IMF’s main recommendations for Germany?
Kähkönen: The main challenge for the government is to protect and nurture the fragile recovery while getting ready to roll back the support measures that were put in place during the crisis. This will require policy action in three main areas. First, we recommend short-term fiscal support combined with fiscal consolidation as soon as the recovery has taken hold. Second, the government should finalize the restructuring of the Landesbanken and lay the groundwork for a healthy and crisis-safe financial sector. And, finally, further reforms of the labor markets and the service sector would allow the economy to adjust to the post-crisis world and would promote greater domestic demand.
