A Look under the Hood of the Precoalition Deal in Germany

January 16, 2018 10:00 AM
Photo Credit: 
REUTERS/Fabrizio Bensch

Three and a half months after German voters dealt a setback to Chancellor Angela Merkel’s Christian Democrats (CDU), its Bavarian sister party, the Christian Social Union (CSU), and their coalition partners, the Social Democrats (SPD), the three parties have concluded a preliminary deal that could lead to a formal coalition agreement. The result, a 27-page statement of policy objectives, is fundamentally an exercise in continuity. What else can you expect from parties that have collaborated in government for the last four years, in a country that views itself (and its government) as having mostly done well?

Yet, the agreement will disappoint many. The left, including many SPD members, will bemoan that the SPD leadership caved on two of its signature proposals—raising the top income tax rate and ditching the private leg of Germany’s dual public/private health care system—while forging an uneasy compromise with the CSU on refugee policy. Some of Germany’s European neighbors will not be happy about the intention to renew the government’s commitment to a balanced budget—in excess of the standard of fiscal probity dictated by EU fiscal rules and the German Constitution. And economists in Germany, at the European Commission, and the International Monetary Fund will criticize the absence of ambitious market-oriented reforms, such as a liberalization of professional services, or a reform that would restore the sustainability of the pension system.

Looking under the hood, however, there is more to like than to dislike in this preliminary agreement.

First, while there are no bold reforms, there is plenty of good incremental stuff—some of it bordering on bold. Since Germany has a budget surplus, a balanced budget target is consistent with lower taxes and higher expenditures. The agreement gets the structure of these elements broadly right, by vowing to raise spending on education, child care, and infrastructure and to eliminate a tax known as a “solidarity surcharge,” introduced in 1991 to finance German reunification, for the lower 90 percent of income earners over the next four years. There is also a multibillion euro initiative to build a fiber-optic digital network throughout the country by 2025, to be financed outside the budget. The constitution is supposed to get tweaked to allow greater federal government funding in school infrastructure. And there are commitments to lower indirect labor costs, currently among the highest in the Organization for Economic Cooperation and Development, to create a legal right to—and to fund—full-time child care until the end of elementary school and to expand the earnings brackets benefiting from reduced social contributions. These initiatives could reduce obstacles to growth in Germany by improving infrastructure (including digital infrastructure) and labor supply, particularly of women and low-income earners.

Second, the section on Europe, while low on specifics, signals a willingness to engage in serious reform. Compared with the previous coalition agreement, the new agreement features a commitment to Europe right at the start—with big, credible words expressing Germany’s gratitude and commitment to Europe, international trade, multilateralism, and the historic partnership with France. Beyond these words, the parties commit to “strengthen the EU financially…including specific resources for economic stabilization, social convergence, and support of structural reform in the Eurozone, which could be the basis for a future investment budget for the Eurozone” and to seek eurozone and EU reforms to improve “fiscal control, economic coordination, and the fight against tax fraud and aggressive avoidance.” There is also supposed to be an initiative, together with France, to create a common corporate tax base and introduce a common minimum corporate tax rate in Europe—a longstanding objective particularly of the SPD, which is shared by the Macron government. Last but not least, the European Stability Mechanism (ESM) is supposed to be developed into a European Monetary Fund under parliamentary control, anchored in EU law. The European Commission has strongly pushed for the latter.

This is a good start. But it now faces two challenges.

The first is political. Coalition negotiations cannot proceed unless a special party conference of the SPD endorses the preliminary statement on January 21. Assuming this happens, the result of the coalition negotiations—which could extend into the spring—must be ratified by the SPD’s 400,000-plus members. The impression among many SPD members that the party caved on some of its core demands may overshadow the fact that much of the nitty-gritty of the policy statement agreed between the parties bears the SPD’s signature (as did the 2013 coalition agreement). Hence, none of these two steps can be taken for granted. Failure in either step would likely trigger new elections.

The second is substantive. While some areas of the preliminary statement are extraordinarily specific— such as refugee policy or the right of employees to part-time work—many other areas are not, including eurozone reform. Any attempt at specifics may lay bare divisions between the parties that are either impossible to bridge or could force them to retreat into generalities (which would give a lot of discretionary power to the future minister of finance).

In this regard, one can perhaps draw comfort from one short paragraph towards the end of the section on Europe, which describes the guiding principle for negotiating partners on European reform: reconciling “solidarity” with good incentives. As a group of French and German economists, including my PIIE colleague Nicolas Véron and myself, argued in the fall—and as we show in a more detailed recent report —this principle could help develop a framework for euro area reform that both works and addresses the priorities and concerns of participating countries.