How can Friedrich Merz turn Germany’s economy around? | DW Business

Key Concepts:

• Government effectiveness and public perception
• Bureaucracy and red tape reduction
• Investment and economic growth
• Unit labor costs and manufacturing decline
• Consensus-based governance and reform implementation
• Demographic challenges and immigration policy
• Consumer confidence and government messaging
• Cyclical vs. structural economic issues

1. Government Effectiveness and Public Perception

• The German government is perceived as having good plans but struggling to implement them effectively.
• Public bickering within the coalition government obscures progress and undermines business and consumer confidence.
• The government needs to present results rather than focusing on internal disagreements.
• The Chancellor, Meltz, is criticized for acting like a CEO, not consulting enough with coalition partners and his own party.
• "Matt is not consulting enough with his coalition partner and with people within his own political camp."
• The government is continuing the tradition of "having lots of words, lots of noise and in creating the impression that there is not enough action."

2. Bureaucracy and Red Tape Reduction

• Excessive bureaucracy is a long-standing issue hindering investment and economic growth in Germany.
• Deregulation is a difficult, long-term process due to various interest groups and the involvement of 16 federal states with their own bureaucracies.
• A "top-down priority" is needed to overcome bureaucratic resistance and protectionist lobbies.
• "If you leave deregulation to the bureaucrats, then it's very likely that the bureaucrats and the protectionist lobbies as usually cooperate and the result is not much deregulation."
• A "bonfire of regulations" is necessary to improve German economic performance.

3. Investment and Economic Growth

• Massive private sector investment drive is underway, with the government planning to invest up to a trillion in the economy.
• The initial signs of increased spending are visible in bulk orders, particularly for military equipment, engineering, and architecture.
• These investments are expected to improve infrastructure and logistics, but the impact will take time to materialize.
• Private sector investment is currently being held back due to a lack of confidence.

4. Unit Labor Costs and Manufacturing Decline

• Germany's unit labor costs are significantly higher than the industrialized country average (22% above) and the Euro area average (15% above).
• This contributes to the decline in manufacturing output, which is down approximately 12% since 2018.
• However, the decline in value added by manufacturing is less pronounced than the decline in physical output due to after-sales services.
• Better infrastructure and logistics are needed to offset the labor cost disadvantage.

5. Consensus-Based Governance and Reform Implementation

• Germany's consensus-based system can slow down reform implementation, but changes are more likely to be effective once a consensus is reached.
• The current government is trying to build a consensus between the political center-right and center-left.
• The lack of a widespread perception that fundamental change is needed hinders the acceptance of potentially unpopular reforms.
• "Germany indeed works by consensus and in history that has often been an advantage because that means if there is a consensus for change, the change actually happens."

6. Demographic Challenges and Immigration Policy

• The aging population is a drag on growth, with qualified workers retiring and creating gaps in the labor market.
• Immigration is already helping to address this issue, with net employment gains primarily due to foreign-born individuals.
• A "rational immigration policy" is needed, focusing on attracting qualified immigrants with faster procedures and recognizing their qualifications.
• The government is providing tax incentives for people to work beyond retirement age.

7. Consumer Confidence and Government Messaging

• German consumers are pessimistic and worried about jobs and incomes.
• The government's message is not positive, contributing to a lack of consumer confidence.
• Increased spending on defense and infrastructure can help boost the economy and improve consumer sentiment.
• The government needs to "get its act together," reduce public bickering, and present results to improve consumer confidence.

8. Cyclical vs. Structural Economic Issues

• The recent underperformance of the German economy is largely cyclical, influenced by factors such as:
  • China's economic slowdown
  • Trump's tariffs
  • The Putin shock and energy price increases in 2022
• However, structural issues would likely limit Germany's growth to around 0.5% per year even without these cyclical factors.
• With more serious structural reforms, Germany could achieve a growth rate closer to 1%.

9. Political Considerations and Unpopular Decisions

• The two major parties in the coalition have lost votes to the right-wing AFD and are afraid of losing more.
• This makes them cautious about implementing unpopular reforms, such as benefit cuts or pension entitlement adjustments.
• However, taking these unpopular decisions now could lead to better economic performance in the future, potentially improving the parties' prospects in the next election.
• "Politically, it's better to now take a few somewhat unpopular decisions for instance on benefit cuts for instance on pruning um pension entitlements in order to then be have a better economic performance in the years thereafter."

10. Conclusion

Germany faces a combination of cyclical and structural economic challenges. While external factors have contributed to recent underperformance, long-standing issues such as bureaucracy, high labor costs, and demographic shifts are hindering long-term growth. The government needs to improve its effectiveness, reduce internal conflict, and implement structural reforms to boost investment, productivity, and consumer confidence. A rational immigration policy and strategic investments in infrastructure and defense are also crucial. While some progress is being made, more decisive action and a clear, unified message are needed to address Germany's economic malaise and secure its future prosperity.