Is Germany’s ‘colossal’ recovery plan a role model for other coronavirus-hit economies?

A waiter prepares coffee at Café Einstein in Berlin on May 15, 2020, as coronavirus lockdown measures were eased and cafés and restaurants were allowed to reopen.
A waiter prepares coffee at Café Einstein in Berlin on May 15, 2020, as coronavirus lockdown measures were eased and cafés and restaurants were allowed to reopen. © Tobias Schwarz, AFP

Germany became the first European country to announce a post-coronavirus economic stimulus package last week, allocating €130 billion that follows an initial roll-out of emergency measures to save the economy from the fallout of the pandemic. The ambitious plan could inspire other eurozone nations also desperate for a reboot.

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Berlin surged ahead of its EU brethren on June 3 by unveiling Europe’s first comprehensive stimulus programme designed to resuscitate its ailing economy, which like many, has been battered by the Covid-19 pandemic. Chancellor Angela Merkel said the initial emergency measures introduced to limit the fallout would give way to a programme set to cost Germany €130 billion ($146 billion) and would aim to shorten the duration – and soften the blow – of the coming recession.

"It is a plan of colossal magnitude, equivalent to 4 percent of German GDP," said Alexandre Baradez, head of market analysis for the financial firm IG France, in an interview with FRANCE 24.

Negotiations between the two parties in Germany’s ruling coalition – the conservatives of Merkel’s CDU and the Social Democrats in the SPD –have resulted in some 50 measures designed to boost consumption and speed-up the post-coronavirus recovery.

Less VAT for more consumption

Among the plan’s initiatives, one stands out in particular: the decision to reduce VAT by three points until the end of 2020. For a country that has made budgetary control its signature, giving up some €20 billion in tax revenue is no small feat. The new measure marks a significant shift in mentality at the very top in what Céline Antonin, a specialist in the German economy at the French Observatory of Economic Conjunctures, said represents “a shift in Germany’s economic paradigm”.

The sharp drop in this indirect tax also illustrates the philosophy behind the plan, which is primarily designed to trigger spending. Reducing VAT is "a simple and direct way to encourage individuals to start consuming again, quickly", explained Pascal de Lima, chief economist at the financial consulting firm Harwell Management.

Combined with other measures – such as paying each household €300 per child or extending short-term work contracts – this plan demonstrates "a keen sense of economic timing: after doing everything possible to avoid an increase in bankruptcies, the German government is now trying to get companies to start selling again by encouraging consumers to buy their products", said Baradez.

Yet gambling on an economic reboot based on lowering the VAT has its risks.

"We know that, in a traditional recession, this is a very effective way of boosting consumption,” Baradez added. “But the exceptional nature of this health crisis makes the reaction of economic players much more unpredictable.”

For example, fears of a second wave of the coronavirus might push consumers to save despite government incentives to spend, while companies might be tempted to forego passing on a VAT reduction by lowering prices to improve their bottom line.

France has less room for manoeuvre

Despite any shortcomings, all three experts consider the German plan to be well-rounded. Between the incentives to consume, the promised investments in transitioning to green energy and the technological innovations, "it is a balanced plan that addresses immediate needs – that is to say, the revival of consumption – and outlines a road map for the future", said Antonin.

And the German road map could inspire other European countries like France, which is facing similar challenges in grappling with an economy caught in a downward spiral.

Reacting to the German plan last week, French Finance Minister Bruno Le Maire told a press conference that Germany’s stimulus plan is “good news” for all European countries.  

He said France is expected to release the details of its own economic stimulus programme in the coming weeks, with a possible roll-out by September. A VAT reduction could be a key measure, especially if the French government leverages it in the hope that the French will then buy more camembert and Hermès scarves.

"There is a lot of talk about the €55 billion saved by the French [public] since the beginning of the crisis and how to harness these funds to boost the economy," Antonin said.

According to de Lima, "France has far less budgetary room to manoeuvre, and VAT accounts for half of the state's tax revenue." With a public deficit expected to reach nearly 11 percent of GDP by the end of the year, Paris can hardly afford the same largesse as Berlin.

Such budget constraints may partly explain why France’s finance minister has so strongly urged the EU bloc to fast track the shared recovery fund, even though some member states remain opposed.

Though a VAT cut is unlikely to offer a silver bullet solution, Baradez believes there is no reason to abandon the idea if it can be of benefit to some areas of the economy.

"We could see a reduction applied to a sector – which might, for example, be limited to restaurants or hotels," he said.

Political risk

A limited reduction in VAT, however, is likely to have a long shelf-life. Germany’s Finance Minister Olaf Scholz has justified the generosity of the recovery package by saying it’s about striking the right balance. He argues that if the government does not skimp on spending Germans will gain more confidence, which will in turn encourage them to consume more. Conversely, a plan that is too timid would leave consumers indifferent.

Baradez says differences in economic behaviour between the French and the Germans must also be taken into account in considering whether the German model could work in France. According to him, Germans "are more inclined to save, and a much stronger trigger is needed to change their mentalities, whereas lesser incentives can have a more significant effect on consumption in France”.

And one must remember that Germany is far better equipped to outspend most other European countries. "It is in situations like this that one realises the advantage of reducing one's debt when the world economy is doing well," observed Antonin.

And this could pose a political problem. "The risk is that if the German machine starts up again, faster and stronger than elsewhere, the question of competitiveness within the eurozone will arise. This could prompt some politicians to say that Germany is always doing better or is not showing solidarity and is taking advantage of the situation," Baradez said.

Hence the importance of the European recovery plan, which will direct funds to the countries that need it most.

"It is a mechanism that can ensure that European recovery does not take place at different speeds,” said Baradez.

This article has been translated from the original in French

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