Policy-Makers Should Take Advantage of Economic Tailwinds in Europe and Germany

Europe is currently doing well economically, and Germany even more so. The next German government should take advantage of these economic tailwinds to push through reforms – especially given the major challenges it is currently facing, such as demographic change, climate protection, migration, digitalisation and the further development of the EU. These were the main points highlighted by Professor Christoph M. Schmidt, chair of the German Council of Economic Experts and president of the RWI – Leibniz Institute for Economic Research, in his presentation of the council’s Annual Report 2017/2018 at the Centre for European Economic Research (ZEW), Mannheim. On 28 November 2017, Professor Schmidt gave the audience an outline of the council’s recently published annual report as part of the lecture series First-Hand Information on Economic Policy and shed light on the policy areas which the council considers necessary to be readjusted by the German government and the EU.

The German economy is running at full steam. “We have behind us a long period of continued upswing,” Christoph Schmidt told an audience of around 170 guests, which featured high-profile figures from the realms of economics, science and civil society, at ZEW. “All signs are pointing towards a positive future; this holds especially true for Europe. According to the estimates of the German Council of Economic Experts, German gross domestic product (GDP) is likely to grow by two per cent in 2017 and 2.2 per cent in 2018. Furthermore, the council expects GDP in the euro area to grow by 2.3 per cent in 2017 and by 2.1 per cent in 2018.

According to Schmidt, German growth is supported by a solid basis. The stable employment situation has contributed to a steady development in household incomes, resulting in an equally stable expenditure behaviour of private consumers. This has been accompanied by an increase in exports and imports, which was in turn driven by an economic upturn across all Eurozone countries. “We are seeing rising employment rates in all Member States,” emphasised Schmidt. Even Spain, one of the countries that have been most severely hit by the financial crisis, is on a path to economic recovery. “Italy has, however, turned into a cause for concern within the euro area,” conceded Professor Schmidt, pointing towards Italy’s high levels of public debt and the desolate state of its banking sector.

“Our economy is running at full capacity”

In Germany, by contrast, only price competitiveness has experienced a slight decrease in the past years as wage growth has come to exceed productivity growth. At this point, Christoph Schmidt’s speech took a different turn: “However – our economy is running at full capacity, which means that it will become increasingly difficult to fully exploit existing growth opportunities.” The five council members have thus come to the conclusion that it is crucial to undertake reforms which boost the potential growth of the German economy as soon as possible – especially since the current account surplus provides an ideal opportunity to implement such reforms.

According to Schmidt, a major share of the fiscal surplus stems from tax revenues that have accumulated as a result of bracket creep and the solidarity surcharge that is still being levied. Nevertheless, the German government should refrain from adopting a procyclical fiscal policy in an economy that is already running at full capacity. “Implementing tax reforms while avoiding strong fiscal stimuli,” announced Schmidt, “this will be the great challenge the German government will have to meet.” This is, however, only one of many pressing problems German policy-makers will have to tackle, as became evident over the course of his speech.

Since the coalition talks for the so-called Jamaica coalition have recently failed, the opportunity to provide urgently needed impulses for an energy transition have, at least for now, been squandered. “The basic concept and the objectives of the energy transition must remain unchanged,” warned Schmidt. The instruments used for its implementation should, however, be adapted, for instance, by urging all sectors to contribute to environmental protection and linking the three sectors mobility, electricity and heat generation with regard to CO2 pricing. At the same time, the digitalisation in the world of work requires structural changes. In this respect, the council recommends that a digitalisation commission be introduced “in order to identify both regulations hindering innovation and needs for reform, as well as to enhance innovative capabilities.”

Back to the principle of subsidiarity in Europe

With regard to the persisting expansionary monetary policy of the European Central Bank (ECB), council chairman Schmidt called on the ECB to regularly publish forecasts that could prepare for the phasing out of the current ECB policy. Schmidt also emphasised the importance of the European Stability Mechanism (ESM), an indispensable tool for European crisis management, whose role should be extended. In general, members of the European Union should ask themselves which policy areas require collective action to support the further development of Europe and which areas should fall under the responsibility of the Member States. “This brings us back to the principle of subsidiarity,” concludes Schmidt. While the idea to extend the ESM’s role in the EU has great potential, other proposals such as the introduction of a common European unemployment insurance and a more integrated fiscal policy at the EU level would be less desirable.

At the end of the speech, ZEW President Professor Achim Wambach opened the debate between Christoph Schmidt and the audience, which contributed with a number of questions: Wouldn’t it make more sense if future tax reforms were targeted directly at medium and low incomes instead of focusing on the bracket creep? What consequences would the introduction of a basic income have on the economy? And will we have to resort to bilateral free trade agreements if multilateral negotiations fail? As has been shown by this discussion, the assessments of the German Council of Economic Experts provides some food for thought on further economic policy issues.

The lecture series “First-Hand Information on Economic Policy”is supported by the ZEW Sponsors’ Association for Science and Practice.