Business Cycles, Growth, Economic Structure Economic Policy Public Finances and Financial Economics

10 Statements – Investment for More Growth. An Agenda for Germany’s Future

Germany has been swept away on a wave of euphoria – the public perception is that its economy is thriving and its future is promising. A study by DIW Berlin (document in German, a shorter English version of the study will be published in August) refutes this perception, arguing that, in recent years, Germany has not only made fundamental economic policy mistakes but has also failed to set a course for the future. Above all, this is reflected in a massive investment shortfall. DIW Berlin’s study proposes an agenda for investment which focuses on three key areas – education, transport, and energy – and aims to make Germany into an attractive business location and foster growth and gainful employment. The core tenets of the study are summarized below in 10 statements.

1.   At first glance, Germany’s economy appears to be very strong – but a more long-term perspective exposes the country’s weaknesses.

While some countries in the European monetary union were forced deep into recession by the global economic crisis, in comparison with most other euro countries, the German economy is currently flourishing. Unemployment has fallen to its lowest level since reunification and economic performance has grown by over eight percent since 2009. Public finances have been consolidated and generated a surplus in 2012.

However, in comparison with the rest of the euro area, since 1999, economic growth in Germany has been slow. In the same period, real wages stagnated and average real consumption expenditure in the rest of the euro area rose much more sharply than in Germany. Even more importantly, Germany’s potential growth is low, which means very limited prospects for growth in employment and wage income over the next few years.

2. One of Germany’s biggest weaknesses is a lack of investment – the annual investment shortfall is three percent of GDP or around 75 billion euros.

By international standards, Germany has a very low investment rate, which is continuing to fall. In 1999, it was approximately 20 percent and today the rate is only just under 17 percent. Since 1999, Germany has generated an average annual investment shortfall of three percent, which corresponds to over 40 percent of the country’s GDP. However, due to its specialization in research-intensive sectors and knowledge-intensive services, Germany has comparatively high demands when it comes to the production environment, human capital, conservation of resources, and mobility.

Investment in Germany is presently too limited to secure long-term, healthy, and sustainable economic – and thus also income – growth. This applies to both public and private investment.

3. Since 2000, Germany’s net public assets have been completely consumed, leaving nothing for future generations.

The government’s net assets have plummeted from 20 percent of GDP in 1999 to a total of zero this year. This is a result of both a shrinking public infrastructure and growing public debt. The lack of net assets has weakened Germany’s position as a location for foreign investment and deprives future generations of important growth opportunities.

4. Due to losses of 400 billion euros on its investments abroad since 1999, Germany has missed significant growth opportunities.

Germany has a high private savings rate. These high levels of savings have, for the most part, not been invested in Germany but abroad. However, these investments have not yielded the expected returns. Since 1999, German investors have lost approximately 400 billion euros due to bad investments abroad, which corresponds to around 16 percent of GDP. From 2006 to 2012 alone, losses were as high as approximately 600 billion euros, which is 22 percent of the country’s GDP. If these had been domestic investments, German annual economic growth per capita could have been up to one percent higher.

5.  Germany currently has exceptionally favorable financing conditions for private and public investment.

This is unlikely to change dramatically in the coming years. Germany is profiting from the sustained uncertainty on the European financial markets; in the search for comparatively secure investment opportunities, capital is increasingly flowing into Germany. Furthermore, the favorable real economic conditions – gauged, for example, by the state of the labor market – have relieved public finances. In the medium term, public budgets are expected to record increasing surpluses; in 2017 alone, the surplus reached just under 28 billion euros, which corresponds to approximately one percent of German GDP. These surpluses are expected to be mainly of a structural nature, i.e., not driven by economic developments. Accordingly, the debt ratio is expected to decrease substantially. Finance policy-makers should exploit the favorable cash flow situation and prepare the ground for better potential growth in the future.

6. The energy transition needs investment – around 31 to 38 billion euros per annum until 2020.

Significant investment is required for the energy transition (the shift to a sustainable economy by means of renewable energy, energy efficiency, and sustainable development). Investment is needed in renewable energy systems for electricity and heat supply and in the infrastructure, particularly for power grids. Furthermore, substantial investment is also required to increase energy efficiency through thermal insulation of buildings, for instance. Without this investment, the energy transition policy targets will remain unachievable. The basis for the requisite investment, which should come primarily from the private economy, consists of stable framework conditions in all of the afore-mentioned areas.

7. The transport infrastructure needs investment – there is an annual deficit of almost 10 billion euros.

In recent years, investment in the maintenance and quality assurance of the transport infrastructure has been largely neglected. Calculations for the past few years indicate an investment shortfall of almost four billion euros for the maintenance of Germany’s transport routes alone. Based on the assumption that the investment shortfall for maintaining the transport infrastructure will be no less than this in the coming years, and also taking into consideration the investment backlog accumulated due to years of neglect, annual investment needs, financed primarily by public funds, are likely to be at least 6.5 billion euros. There are also additional investment requirements, which are difficult to predict, for vehicles as well as one-off network and capacity upgrades. More public investment will not only greatly improve the domestic manufacturing conditions but will also increase the attractiveness of Germany as a business location which will, in turn, act as a catalyst for private investment.

8. Education needs investment – Germany spends almost one percent of GDP less on education than other industrialized countries.

Expenditure in the education sector does not fall under investment in the national accounts but rather under public spending. Nonetheless, the sector is vital for the economy and, as such, is one of the most important areas of investment. From a macroeconomic perspective, investment in this area is particularly profitable. However, with spending on education of approximately 5.3 percent of GDP, Germany’s investment in this area is below the EU21 average and also significantly lower than the OECD33 average of 6.2 percent. Germany’s investment backlog is especially large in early childhood education where the prospects of returns to education are particularly good and thus investment exceptionally profitable.

9.   Higher investment means stronger growth and higher wages.

The analysis by DIW Berlin indicates that bridging the investment gap could, in the medium term, result in significantly stronger economic growth in Germany. Potential growth for 2017 could be 0.6 percentage points higher, i.e., approximately 1.6 percent instead of one percent of GDP. The growth-promoting effect of an increase in investment activity in Germany would also create the foundations for sustainable wage growth. If the investment gap in Germany is closed, real wages would also grow.

10. Now is the best time for investment.

It is high time for Germany to tackle this investment weakness and bridge the investment gap as soon as possible. It is crucial that the ground is prepared for this now as it takes time for such investment to bear fruit. Furthermore, Germany and, above all, Europe, are still mired in crisis with very weak economies. Increased private and public investment now would not only bolster Germany’s economic growth but would also provide significant impetus for growth in Europe. At the moment, this would be the most effective way for Germany to help its neighbors.

Furthermore, a key argument in favor of addressing this investment backlog immediately is that financing conditions for the German government and also for companies and households have never before been so favorable. In the long term, such a strategy is not only possible from a fiscal point of view but also conducive to a sustainable fiscal consolidation policy.

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