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The economic legacy of Chancellor Angela Merkel

The economic legacy of Chancellor Angela Merkel

On September 26, 2021, when Germany casts ballots to elect a new federal parliament, Angela Dorothea Merkel will have been chancellor for precisely 16 years and 16 days. And she may well remain head of government for a few more weeks, perhaps even months, since forming any new government (probably based on a coalition of three political groups) is likely to take time. But in any case, this is the right moment to look back at her 16 years of leadership and what they meant for Germany’s economy. The overall record is mixed – with some assets and some liabilities left on the balance sheet.

Positive legacy: Steady growth, more employment and stable public finances

The obvious thing to do is to look at the German growth performance since 2005, when Ms. Merkel entered the chancellery, and compare its expansion to the rest of the world (as represented by the OECD or EU average) and the main rivals: China and the United States). 

Figure 1 presents the figures for gross domestic product (GDP) per capita. One can see that the German economy grew quite remarkably during the first three years of the Merkel era, was hit comparatively hard by the deep recession in 2009 but managed to rebound extraordinarily after that. Since 2011, the economy grew modestly but steadily for almost 10 years before taking a second hit due to the coronavirus crisis.

Of course, GDP numbers are not the direct result of a leader’s performance. It is entrepreneurs and workers that create value-added. But a head of government can frustrate or encourage this impetus. When Ms. Merkel took office, Germany was commonly regarded as “the sick man of Europe.”

The country’s economic growth averaged a modest 1.2 percent per year from 1998 to 2005, while unemployment rates rose to an alarming 11.1 percent in 2005. This debacle prompted Ms. Merkel’s predecessor, the Social Democrat Gerhard Schroeder (1998-2005), to launch a series of reforms aiming to reduce the sclerosis of the German labor market and the often-unconditional generosity of its welfare systems. The reforms’ overall objective was to increase the competitiveness of the German economy – in particular, its export sector. Significantly, the program included corporate tax breaks.

As figure 2 shows, the economy’s most remarkable performance during Angela Merkel’s chancellorship occurred in the labor market. From having the highest unemployment rates compared to EU or OECD averages and the U.S. or China until 2007, Germany now has the lowest numbers in that category.

Arguably, this is the most spectacular economic success of Chancellor Merkel’s 16 years in office. However, it was also due to other factors: the bold reforms of her social-democrat predecessor (who, as a consequence, lost the 2005 elections), and the established German system of social partnership between employers and employees that leads to nonpoliticized, pragmatic contracts and agreements which gives protecting employment priority over “class-struggle” rituals. Other factors, such as the undervaluation of the euro, increased demand from China for German mechanical engineering and the changing demographics, also played important roles. In any case, at present, the German labor market is at a stage where finding a job has become much less of a problem than finding a skilled and willing job seeker.

More than the primarily export-driven increase in GDP, the overall increase in employment has also helped public finances become healthier. As more people were integrated into the German economy as net taxpayers and contributors to social security systems, public debt shrank from 2010 – even without any serious attempt by the government at reducing public expenditure.

As figure 3 illustrates, the reduction of public debt per GDP by 22 percentage points between 2010 and 2019 was no minor achievement during Chancellor Merkel’s term. But it was not necessarily her achievement. In fact, it was the German taxpayers and the European Central Bank (ECB) who both helped public spending grow with the rate of GDP (at lower costs of interest for public debt) and thus sustain a very high rate of public expenditures to GDP of around 42 percent.

Still, one may want to compare Germany’s budget situation to similar countries like France, which started at almost the same debt-to-GDP ratio (67 percent) when Ms. Merkel took office in 2005, but in 2021 hovers around 100 percent. In contrast, Germany’s public debt may this year come back to the level where Ms. Merkel started.

Overall, three factors helped the chancellor and her four governments (three with the Social Democrats, one with the more market-friendly Free Democrats) to run on generous but relatively stable budgets.  

 

  • The extreme reduction of interest rates: in 2005, costs of public borrowing accounted for 2.8 percent of German GDP – in 2019, it was at 0.8 percent, and it has kept falling since new public debt can even be financed at negative interest. 
  • The debt-brake: this constitutional amendment agreed in 2009 and effective since 2011, has undoubtedly helped to temper politicians’ usual proclivity to spend all the money they can put their hands on. Wolfgang Schauble, Ms. Merkel’s faithful and longest-serving finance minister, stood, more than the chancellor, by this principle of a balanced budget. He certainly had an eye on fellow eurozone members who may have subscribed to the “fiscal compact” (a balanced-budget commitment) in 2012, but many of whom could hardly care less … until today.
  • Continuously high taxation: there was only one time during Chancellor Merkel’s 16-year watch in which she effectively lowered taxes for business. In 2008, business income tax was reduced from 38 to 30 percent. Since then, Germany has fallen back to having one of the most burdening tax regimes worldwide – not only for companies but also for self-employed entrepreneurs and employees. 

This last aspect of fiscal solidity also creates a lasting liability in Angela Merkel’s economic account, to which we now turn.

 

Negative legacy: Too much ineffective state interference, erratic government leadership

Germany’s position as Europe’s “economic powerhouse” may have improved at least when compared to its past position as the “sick man of Europe” at the beginning of the century. However, as a global player, the country is not even near  pole position after Ms. Merkel’s 16 years in office. A look at global competitiveness indices reveals that there is much work left undone. In the last IMD World competitiveness report, Germany ranks 15 out of 64 countries analyzed. When the chancellor took office in the dire economic circumstances of 2005, Germany ranked 23 out of 60 countries. This is but mild progress, mostly attributable to favorable circumstances outside the government’s control (see above). 

Perhaps most worryingly, not much of the increased GDP per capita (see figure 1) has remained with those who worked hard to own it. OECD figures show that out of 1 euro labor cost of an average employee, hardly more than 50 cents are left as net income after the deduction of income tax plus employee and employer social security contributions.

The actual economic miracle turns out to be that Germany could still increase employment by around 5 million people during the last 16 years of Chancellor Merkel’s government under the regime of such extreme labor taxation. Part of the explanation is that German entrepreneurs are used to high labor costs and have found ways to improve productivity, innovate in critical areas, and export to the world for decades. The cheap euro also has helped. 

Whether such conditions will remain is highly dubious today. The legacy of Angela Merkel and her various cabinets is not promising on multiple accounts.  

Digitalization. In terms of capacity and readiness to adopt and explore digital technologies as drivers for productivity and innovation in business or government, Germany is constantly lagging. In 2015, some steps toward e-government were taken – with the aim to complete them in 2032! And when the coronavirus forced schools to go digital, many struggled to establish reliable data connections, comply with data security regulations or even create email accounts for teachers.

Energy policy. The Merkel governments never had a clear and consistent view on energy policy. Modern coal power plants were first subsidized and then forced to earlier closure. Nuclear power utilization was first prolonged and, after the Fukushima accident in 2011, hastily forced to an early phaseout. Renewable energy is subsidized at an enormous cost – even where it makes little sense. Bureaucratic hurdles and public protest have forestalled energy grids. This has made Germany one of the most expensive places for energy consumption in private households and industries. However, the country has not become a model for effective CO2 reduction or for effectively coordinating its decisions with European neighbors.

Europe. Many accounts of Chancellor Merkel’s legacy as a “European leader” refer to how she mastered many crises on the European stage. During the multiyear euro crisis which started in 2009 she spent many nights negotiating and managed to keep the eurozone together – in ways that went against the principled opinion of her own finance minister and the advice of many, if not most, German economists. With last year’s agreement on a 750 billion euro “NextGenerationEU” package to raise on capital markets for loans and grants, increasing the union’s outstanding debt by a multiple of around 15 and constituting the largest-ever euro-denominated issuance of debt at the supranational level, the Merkel government allowed for a dramatic change of EU fiscal governance. For better or worse, the old image of the chancellor as the thrifty “Swabian housewife” insisting on balanced budgets no longer applies.

Structural reforms. That catchword used to be the primary demand that not only Germany but also the “Troika” of International Monetary Fund, EU Commission and the ECB would throw at countries in need of EU (and German) monetary assistance. However, many of the reforms necessary to increase the economy’s competitiveness and the sustainability of the state-organized social security systems have not been undertaken in Germany itself – also during the 16 years of Angela Merkel’s supervision. As analyzed here before, Germany’s social security systems are in urgent need of reform. As aging takes its relentless toll, private and public pensions that rely almost exclusively on a “pay-as-you-go” scheme, with the current pensions of the retired paid from the current premiums of the not yet retired, are doomed to fail on their old promises. Future German governments and voters will have to make tough decisions.

Chancellor Merkel will leave those difficult choices to her successors. She always preferred solving immediate problems in a pragmatic way to addressing lingering issues with a visionary plan. Harald Martenstein, a Berlin columnist, once quipped about Ms. Merkel: “What she really wanted is hard to say. But she achieved quite a lot of it.”

Michael Wohlgemuth is the Director of Open Europe Berlin.

The views expressed on austriancenter.com are not necessarily those of the Austrian Economics Center.

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