Germany’s Real Challenges are Aging, Underinvestment, and Too Much Red Tape

IMF News, March 27, 2024

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Germany was the only G7 economy to shrink last year and is set to be the group’s slowest-growing economy again this year, according to the IMF’s latest projections.
Wholesale gas prices, after soaring in 2022, have fallen back to 2018 levels.
Germany’s terms-of-trade has returned to the same level as before the energy shock.
Germany’s trade surplus reached 4.3 percent of GDP last year and is likely to increase further this year.
Concerns about widespread deindustrialization are overstated: energy-intensive chemicals, metals, and paper industries have contracted but account for 4 percent of the economy.
Auto production rose by 11 percent last year.
Germany’s electric vehicle exports increased by 60 percent in 2023.
Two German manufacturers for which data are available, Volkswagen and BMW, alone account for over 10 percent of global electric vehicle sales.
Manufacturing value-added has remained steady even as industrial production has fallen because manufacturers shifted into higher value-added products and used fewer intermediate inputs.

Temporary factors that have depressed demand and activity:
- Consumer retrenchment when inflation surged.
- European Central Bank interest-rate increases that depressed housing construction and other interest-sensitive sectors.
- Post-pandemic global demand rebalancing away from manufactured goods toward services, which was unfavorable for Germany’s manufacturing-intensive economy.
The IMF expects these temporary headwinds to gradually fade over the next year or two.

Germany faces a fundamental structural headwind of sluggish productivity growth and an accelerating population aging.
Over the next five years, as the migrant wave ends and baby boomers retire, the growth rate of Germany’s labor force will drop by more than in any other G7 country.
Consequences of aging:
- Downward pressure on GDP per person due to fewer workers per retiree.
- Higher social security contributions and lower pensions absent reforms.
- Increased demand for healthcare services, drawing workers away from other industries.
- Potential labor shortages that could deter investment.
Potential labor-supply responses:
- Greater immigration (prospects uncertain).
- Increasing labor supply by making it easier for women to extend working hours:
- There are 2.3 million fewer women working than men.
- Women are five times more likely to work part-time.
- Policies to expand access to reliable childcare and reduce taxes for secondary earners in married couples could help close these gaps.

Productivity has been dragged down by inadequate investment in public infrastructure.
Public investment declined in the 1990s and, since then, has barely been enough to offset depreciation, putting Germany near the bottom of advanced economies in public investment.
Money budgeted for investment is routinely underspent, often because of staff shortages in municipalities.
Options to boost public investment and productivity:
- Expand municipalities’ planning capacity through consulting services programs like Partnerschaft Deutschland.
- Increase financing for public investment by reforming other expenditures, mobilizing more revenue, or adjusting the debt brake limits on federal borrowing.
- The debt brake could be eased by around 1 percent of GDP while still allowing public debt to decline as a share of GDP.

Cutting red tape is vital to raise investment and new business formation:
- It takes about five to six years to get permission to build an onshore wind farm.
- It takes 120 days to obtain a business license, more than double the OECD average.
Digitalizing government services could speed up processes:
- Germany lags other EU countries in offering online services to businesses, including registration and tax filing.
- Only 43 percent of government services pre-fill personal data on online forms compared with the EU average of 68 percent.

Implement ambitious reforms to address aging, underinvestment, and excessive red tape.
Boost labor supply through:
- Policies to attract and integrate migrants.
- Measures to increase female labor-force participation and working hours (expand reliable childcare; reduce taxes for secondary earners).
Raise productivity by:
- Increasing and more effectively using public investment (expand municipal planning capacity; mobilize financing; consider easing the debt brake by around 1 percent of GDP).
- Cutting regulatory burdens that delay projects and business entry.
- Accelerating digitalization of government services to reduce administrative delays and improve business-facing processes.

Kevin Fletcher, Harri Kemp, and Galen Sher; March 27, 2024 — IMF NEWS.