Germany’s economic challenges
A priority for the new government will be to address issues that are hampering the German economy. The International Monetary Fund has highlighted that Germany’s low GDP growth reflects low labour productivity, poor public infrastructure, the low female participation rate in the labour market, the aging population, and excessive bureaucracy.2
Merz, a pro-European, supports a reduction in business tax rates and market deregulation to boost private investment and increase the competitiveness of German companies. He also advocates the need to reduce bureaucracy, increase public investment and improve the efficiency of the public administration, for example by broadening the provision of online services. In addition, the CDU leader favours boosting military spending in line with the 2% of GDP NATO target and using nuclear energy to lower energy costs for German businesses and households.
In contrast, Merz was critical of the increases in social spending approved by the outgoing government and of the EU decision to focus entirely on electric mobility by imposing a ban on the production of internal combustion engine vehicles by 2035 instead of examining other technologies to reduce emissions.
Some of Merz's positions, particularly on social spending, tax cuts and nuclear energy, contrast with the policies implemented by the SPD-led government. It is therefore likely that negotiations to form a new government coalition will be lengthy and that the CDU will have to soften some of its positions.
Furthermore, it is desirable that the new government considers a reform of the debt brake to allow greater fiscal flexibility. In the past, Merz has supported a strict implementation of the debt brake. However, he has recently indicated that he is open to reforming it contingent on the additional resources financing pro-growth programs and social welfare spending remaining under control. According to IMF estimates, a change to the debt brake that increases the federal deficit limit by one percentage point of GDP would keep the German debt/GDP ratio on a decreasing trajectory.3
Reforming the debt brake rule implies changing an article of German Basic Law. This requires a qualified majority of two-thirds in both the Bundestag and the Bundesrat, Germany’s upper house of Parliament. According to polls, this threshold can be reached with an agreement between the CDU, the SPD and the Greens. Although it is not necessary for the Greens to join the government coalition, negotiating a debt brake reform would make it more likely that some of their demands will influence the new government’s policies, thereby further softening Merz’s stance.
Conclusions
The collapse of the coalition between the SPD, Greens and FDP will likely lead to a change of government after the snap elections on 23 February. The leader of the centre-right CDU party Friedrich Merz is the favourite to become the next chancellor and aims to implement a pro-growth and pro-business agenda including lower taxes, deregulation, less bureaucracy, and more infrastructure investments. Even though a new government coalition, most likely with the SPD, will be needed to gain the Bundestag's confidence, it seems likely that during the next legislature German fiscal policy will be more expansionary than it has historically been.
