Tristan PERRIER, CFA, Strategy and Economic Research at Amundi
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The polls predict a clear victory for Angela Merkel’s CDU/CSU but several government coalition scenarios are possible. The parties that could form a coalition (CDU/CSU, SPD, FDP and/or Greens), while sharing many essential views, do diverge significantly on a number of fiscal and European topics.
Regarding the budget, these parties are in favour of tax cuts, but they differ as to how much and who should benefit. Their public spending priorities are also different (infrastructures, social areas and/or defence). Importantly, the CDU/CSU wants to strengthen public infrastructures more by lifting administrative obstacles than by spending more at the federal level.
On Europe, there is almost consensus on certain subjects (a tough approach on Brexit, strengthening cooperation in defence, accepting a limited amount of risk sharing). However, the SPD and the Greens are more favourable than the CDU/CSU to new initiatives bringing more federalism, while the FDP is more reluctant.
Despite these differences, Germany’s attitude concerning Europe is not likely to change dramatically under a government coalition dominated by the CDU/CSU. The future government should agree to some prudent advances, but will remain very cautious when it comes to risk sharing. Should the eurozone crisis rear its head again, however, the composition of the government coalition may affect how Germany reacts.
The implementation of some of the campaign promises will generate a moderate fiscal stimulus in Germany, but we believe that GDP growth will be a little less strong in 2018 than in 2017 (a return to trend rather than a decrease).
Today’s strong economic performance means that new domestic economic policy decisions are less urgent in Germany than in the Eurozone’s other large countries. However, the government will still have to respond to the many medium-term challenges. These include, among others, the lack of significant competitiveness –enhancing reforms since the last decade, the necessary rebalancing of an economy that relies excessively on external demand and the major socio-economic themes of population ageing, integration of recent migrants and, possibly, the rise in social inequalities. The progress of the AfD party is a sign that the German political stability that has prevailed in recent decades, itself a cornerstone of the solidity of European construction, now appears to be slightly less unshakable.
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14 September 2017
14 Septembre 2017
Background, timing and electoral system
Germany is currently ruled by a coalition led by Angela Merkel’s centre-right CDU/CSU with the socialist party SPD as a junior partner. Angela Merkel has been Chancellor since 2005 and is currently serving her third term. She governed in coalition with the SPD between 2005 and 2009, and then with the pro free market FDP between 2009 and 2013.
On 24 September, German voters will go to the polls to elect a new parliament, for a four-year term. In principle, a government must be formed within a month of the elections, after which the Chancellor is nominated.
Although Germany’s electoral system is complex, it ensures quasi-proportional representation. Each voter gets two votes, the first to vote for their local constituency representative (299 representatives) who wins by a simple majority, and the second to vote for a party list within their state (299 representatives also). “Compensation seats” are added (which means that the total can surpass 598) to ensure full representation proportional to the number of “second votes” received by each party that clears a 5% threshold of the national vote or that wins three constituencies.
Because of this proportionality, a coalition is almost inevitable. Since the creation of the Federal Republic of Germany in 1949, only once, in 1957, has a party won an absolute majority.
The CDU/CSU currently holds 41.5% of seats, the SPD holds 25.7%, Die Linke (far left) 8.6% and the Greens 8.4%. The two other main parties, the liberal FDP and anti-immigrant and eurosceptic AfD, are not represented as they did not reach the required 5% threshold during the 2013 election.
Probable CDU/CSU win, but several government coalition scenarios are possible.
The CDU/CSU leads in the polls with a substantial 35% to 40% of voting intentions. The SPD is second with less than 25% (it was level with the CDU/CSU briefly at the start of the year, but has fallen since). The FDP, Die Linke and AfD are slightly below 10% each, while the Greens are between 7% and 9%. The debate on 3 September (the only televised debate between Angela Merkel and SPD leader Martin Schulz) does not seem to have benefited the two largest parties.
A win by the CDU/CSU is therefore very probable, meaning Angela Merkel will be Chancellor for a fourth term. However, there is uncertainty concerning the party or parties that would team up with it to form a governing coalition:
CDU/CSU, FDP, SPD and the Greens: similar views on many essential topics, but also notable differences regarding Europe and economic policy.
Generally speaking, the economic programmes of the parties likely to play key roles in the next government (CDU/CSU, SPD, Greens, FDP) give greater scope to fiscal measures (expenditure and taxes, see the box below) than to structural reforms to improve competitiveness. Due to strong recent economic performance, this latter theme is less of a pressing concern in Germany than in France, Spain and Italy.
The four parties want to introduce tax cuts, but they differ in terms of how much and who should benefit: planned cuts promised by the CDU/CSU and, even more so, the FDP, are larger and more widespread, whereas the SPD and Greens want to concentrate the cuts on low earners while increasing taxes on the wealthy.
All four parties also plan increases in expenditures, but with different priorities (infrastructure for SPD, FDP and Greens, defence for CDU/CSU and FDP, social spending for SPD, Greens and, to a lesser extent, CDU/CSU). Many amounts are not detailed (see box). Importantly, in order to boost infrastructure, the CDU/CSU gives the priority to the reduction of bureaucratic obstacles over committing substantial new federal spending (recall than in Germany many infrastructure decisions are taken at the level of federated states).
On Europe, the four mainstream parties do insist on their support for European construction and the euro, while diverging on the acceptable strategies to strengthen solidarity between member states.
What to expect after the election? Very prudent new steps in European construction, modest budget stimulus, need to design answers to the many long-term challenges.
Going by the scenarios that are most likely (with the CDU/CSU as the main partner in the governing coalition), there is little reason to expect major changes in Germany’s attitude towards Europe. Germany is likely to advance very prudently, favouring 1/ an increase in resources available for certain cooperation programmes (defence, infrastructure), 2/ a somewhat less strict attitude on fiscal matters concerning southern countries, a development underpinned by the recovery of the region as a whole, which helps to narrow deficits, 3/ a strengthening of European institutions as long as Germany maintains a right of veto for any decision involving the sharing of risks.
Germany could thus accept to move forward in some of the directions proposed by France (notably a eurozone budget and Ministry of finance) while limiting their scope in terms of amounts, financing sources and prerogatives. It will in any case remain very vigilant when it comes to moral hazard and incentives: strengthened institutions will have to promote reform and fiscal discipline, not make it easier for countries that would want to derogate. Moreover, certain institutions could be strengthened on the back of others (notably, the decision to turn the ESM into a European monetary fund could involve this body taking over the budgetary supervision role of the Commission, which is considered too political). Finally, regarding the Banking Union, it is very unlikely that Germany could accept common deposit insurance without strict limitations on banks’ abilities to invest in their country’s sovereign bonds. In any case, France’s domestic economic policy (realisation of the reforms promised by the French government and France’s compliance with its fiscal commitments) will remain a determining factor for Germany’s appetite for new initiatives.
However, we note that, in the event of a CDU/FDP coalition, Germany’s desire to maintain the eurozone’s integrity at any cost could be a little less forthright (or at least could be perceived as such by the markets) if a new crisis similar to the Greek episode in the summer of 2015 were to arise. However, this risk should not be exaggerated, even if the FDP were to persist in seeking to design a path for certain countries to exit the eurozone. This party would only be the “junior” partner in a CDU-dominated coalition.
With regard to Germany’s own economy, the application of the CDU/CSU programme (potentially modified slightly to take account of certain demands by the SPD, FDP or Greens, depending on the coalition formed) will produce some fiscal stimulus (roughly 0.3% of GDP over two years for a tax reduction of around €20bn, in addition to higher infrastructure expenditure, the amount of which is very uncertain). Since fiscal stimulus has already been at play since 2016 because of expenditure required to deal with the inflow of refugees, it is not certain that this new stimulus would really accelerate growth. In the very unlikely scenario of a coalition with the SPD as the senior party, we can expect greater fiscal stimulus (possibly offset by negative confidence effects).
Based on good recent economic data, we have revised up our 2017 growth forecast to 2%. For 2018, we expect a slight deceleration to 1.7%, which is still a robust level of expansion based on resilient public and private consumption, investment and construction (1.7% corresponds to the potential growth rate towards which the economy should now converge in a context of full employment and an output gap of virtually zero).
There is nevertheless significant upward risk to this forecast (if very low unemployment gives way to wage increases that in turn lead to a reduction in Germany’s very high current account surplus, identified by the European Commission as a macroeconomic imbalance). The main downside risks are an overly rapid rise in the euro or a growth shock somewhere else in the world to mention only economic risks.
Over the long term, the main economic challenges that the government will have to address are 1/ the lack of significant structural reform to increase competitiveness since the end of the last decade, while the eurozone’s other three main countries, France, Italy and Spain, have implemented major reforms and could make further progress. The perception of a country resting on its laurels and of a government that has focused primarily on crisis management (eurozone and refugee crisis) are indeed themes that seem to be of increasing concern to German economists, while international organisations are calling on Germany to implement other reforms; 2/ the question of boosting domestic demand, as the country still appears excessively reliant on external trade, a theme that relates to the very large current surplus, the necessary efforts to boost wages and, possibly, infrastructure development (see EC recommendations in the Box below); 3/ major socio-economic themes relating to rapid population ageing, the integration of the recent immigration wave and, possibly, the issue of rising inequalities and growing number of “working poor”, even though whether this problem is more acute in Germany than in comparable countries is highly debated while the SPD has apparently failed to efficiently use this theme in its campaign.
In many respects, German economic problems are less urgent than those of France or Italy. However, the rise in protest and eurosceptic sentiment embodied by the AfD party can be a sign that German political stability, which for years has been a cornerstone of the solidity of the entire European construction process, may become slightly less unshakable in coming years. While the factors causing this rise in protest sentiment are many and complex, they require, among other answers, new economic decisions.
2017 EC recommendations to Germany:
1. Use fiscal policy to support domestic demand and achieve a sustained upward trend in investment. Accelerate public investment at all levels of government, especially in education, research and innovation, and address capacity and planning constraints for infrastructure investments. Further improve the efficiency and investment-friendliness of the tax system. Stimulate competition in business services and regulated professions.
2. Reduce disincentives to work for second earners and facilitate transitions to standard employment. Reduce the high tax wedge for low-wage earners. Create conditions to promote higher real wage growth, respecting the role of the social partners.