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| Chancellor of Germany, Angela Merkel |
German citizens put health care second only to the economy and jobs as a priority for government, ahead of education, the environment and crime in a poll carried out for the Economist Intelligence Unit before last Sunday's election. Despite Germany’s relatively strong performance on various health indicators, just 38 per cent of Germans felt positive about the care they would receive if ill, far fewer than the other countries surveyed. After a deadlocked result four years ago, German voters remain split but there is a prospect of some change.
The EIU surveyed over 1,500 citizens in Germany, the US, UK and India, amid a year of debate on health reform. In the aftermath of the polls, Elga Bartsch, a Morgan Stanley executive director whose main research focus is the monetary policy of the European Central Bank, says that with 334 seats out of 625 of the new German Bundestag, the centre-right black-yellow coalition has a strong political mandate and, by German standards, a relatively broad majority in the lower house of parliament, the Bundestag.
Bartsch says the position of the centre-right coalition is somewhat weaker in the upper house of parliament, the Bundesrat, representing the governments of the regional states. In the Bundesrat, the centre-right is currently the largest group, but it lacks an outright majority of the votes. So far, the black-yellow coalition does not have to contend with the opposition parties, the SPD - - the party of social democrats - - the Left - - which developed from the East German communist party - - and Greens, having a blocking majority as was the case towards the end of the Helmut Kohl era. She says the ability to push legislation through the upper house rests on the fact that those states, where only one coalition party is part of the federal government, are neutral in any debate and abstain from voting.
How the majority in the upper house develops going forward depends also on the outcome of coalition talks in several regional states, which went to the polls from late August. Four states - - Thuringia, Saarland, Brandenburg and Schleswig-Holstein - - still need to agree on a coalition. In all cases, there are several possibilities. Typically, a choice is between a Grand Coalition between the SPD and the CDU (which after the change in government at the national level is probably less enticing and has already been ruled out in Schleswig-Holstein) and a left-leaning coalition between the Social Democrats, the Left Party and the Greens. As a third alternative, a so-called Jamaica coalition between the CDU, the Free Democrats and the Greens is being discussed, e.g., in Saarland. Only Schleswig-Holstein, where the votes are still being counted, might just have been able to turn the corner towards a CDU/FDP coalition. Finally, the largest German state, North-Rhine Westphalia, will go to the polls in a regional election next summer.
Good news for medium-term growth and near-term sentiment
Elga Bartsch says the election outcome probably does not warrant MS to change in its German macro forecasts. The US investment bank expects the sharp contraction in GDP of 5% this year to be followed by GDP growth around the long-term trend of 1.5% next year. But, on balance, the change in government makes the bank more positive about Germany's medium-term growth prospects, and forecasts may be revised once the coalition agreement takes shape and the timeline for the income tax cuts promised in the election campaigns becomes clear. In the near term, however, the change in government will likely boost investor and business sentiment in Germany as a CDU/FDP coalition is perceived to be more market-friendly and MS would expect some visible gains in the next ZEW (Germany's Centre for European Economic Research) investor sentiment and the Ifo (Ifo Institute for Economic Research at the University of Munich) business climate surveys. Eventually, it should, however, also boost investment spending and hence job growth in Europe's largest economy.
Tremendous policy challenges lie ahead
The MS economist says in light of the positive factors, it is vital not to lose sight of the challenges that still lie ahead. The recession has likely done considerable damage to the economy, much of which still has to manifest itself - - among other things in the labour market - - in fiscal balances and possibly in bank lending. Notwithstanding the vigorous initial bounce-back, the recovery eventually will likely be a tepid one, MS expects. As a result, unemployment is set to rise further. In addition, the timid recovery implies that the cyclical improvement in public finances will remain smaller than it usually would in an upswing and, like many other governments, the new German government is likely to look at various options, including privatisations. As both parties have promised significant tax cuts in their election campaigns, creating the budgetary room for such manoeuvres will be challenging.
Would the real Angela Merkel please stand up?
Bartsch says, during her first national election campaign four years ago, Angela Merkel pushed for a pro-market election platform. However, after this bold reform platform nearly lost Mrs. Merkel the 2005 election and forced her into an uncomfortable Grand Coalition with the Social Democrats, she altered her tone. One of the key questions that political pundits have been debating ever since is whether this shift largely reflected the necessity of keeping the Grand Coalition together or whether it also reflected a change in her personal convictions. Having the opportunity to team up with the Free Democrats, who share a large part of her original radical reform platform, the evidence will be available soon. The sense is, though, that having to manoeuvre Germany through the deepest recession in post-war history and through major financial market turmoil might also have changed her own perspective. The only question is by how much. In general, the political spectrum has shifted towards the left in Germany. Over the last four years, Chancellor Merkel's Grand Coalition reversed some of the hard-fought-for labour market reforms implemented by the Red-Green Schroeder government (e.g., by introducing minimum wages in several sectors, by extending unemployment benefits for older workers, and by bulking up short-shift subsidies sharply). In addition, top income taxes were hiked (instead of lowered as the CDU/CSU election platform had envisaged) with the introduction of a so-called ‘Reichensteuer', which introduced a new top income tax bracket at 45% to appease the Social Democrats, who had to swallow a three-point VAT hike, which especially hit those on lower incomes and hence with higher spending propensities.
Mending Europe's largest economy
Bartsch says the tasks facing the new German government are tremendous. It has to manage the exit from the massive fiscal stimulus and financial rescue packages carefully. It has to ensure that the post-crisis economy is a more resilient and more balanced one. It has to address the long-standing issue of an ageing German society where generational inequality is on the rise and where younger generations are now burdened with an even higher debt level. Importantly, it has to facilitate the necessary structural change needed to combat climate change and to stay competitive in a rapidly changing global economic landscape. As a very open economy, it has to resist protectionist pressures at home and abroad. At the heart of many of these issues is whether the still highly regulated German labour market is flexible enough to generate enough new jobs to make up for the job losses in declining industries.
MS says election platforms go in the right direction, but not far enough
Regarding taxes, both parties have committed to income tax cuts in the run-up to the election and will now be under pressure to deliver on this key election promise. In addition, the Free Democrats aim to remove some of the restrictions introduced as part of the 2008 corporate tax reform, notably the new limits introduced on the tax-deductibility of interest payments, on carrying losses forward after a take-over and on offshoring, thus reducing the effective corporate tax burden. Both aim to raise the tax credit for families and to lower the lowest tax band from the current 14% to 12% or even 10%.
In light of the newly introduced debt brake, under which the German constitution limits federal government borrowing to 0.35% of GDP by 2016 and governs state borrowing completely from 2020 onwards, the new government has its work cut out if it wants to reduce the budget deficit and cut taxes at the same time. This will likely mean some serious spending cuts. Some of these cuts could come in the area of social benefits. Some could come in health care, where the FDP is proposing a basic private insurance, with subsidies for those who cannot meet the costs. However, the CDU/CSU is essentially aiming to maintain the status quo, having abandoned its more radical health care reform ideas. Some of the savings could come in the area of pension benefits, where the CDU/CSU is committed to the planned gradual increase in the pension age to 67. The FDP is even proposing to do away with the fixed pension age altogether and to allow individuals to decide when they want to retire based on actuarially fair discount factors. While the proposals of the Free Democrats on pension reform are far reaching, it remains to be seen whether, if it could indeed be implemented, it would be sufficient to address the pension time bomb caused by an ageing society with generous entitlements to pension benefits, healthcare and long-term care.
Elga Bartsch says with regard to labour market policies, one of the key questions is whether the new sector-specific minimum wages that have been introduced by the Grand Coalition can be watered down or even completely dismantled. The latter looks unlikely, given that the CDU/CSU still seems to support sector-specific minimum wages. But as the FDP is seeking to abolish them altogether, this will likely be a topic of debate in the coalition talks.
However, Merkel said on Monday, that while she does not support a national minimum wage, she does not want to change the system in existing sectors where minimum levels apply.
The FDP is very much in favour of allowing companies to negotiate tailor-made deals with their workforce. Bartsch says the ability of individual companies and their workers (represented by trade unions) to hammer out company-specific agreements on working hours and pay was instrumental in the successful corporate restructuring process. It would thus be important not only to turn back the clock on minimum wages, which more than anything else act as a barrier to competition, but also to allow for more flexibility in company-specific negotiations.
Both parties are committed to building new power stations (notably modern coal plants) and to capturing and storing carbon dioxide (CO2). Running existing nuclear power stations longer is acceptable to the CDU/CSU and the FDP, even though they would probably shy away from building new nuclear power stations.
