New coalition a challenge
Key challenges for the next government are manifold. To begin with, the short-term challenge will be to create a new and stable coalition government, able to generate a coherent governmental program that guides politics and policies over the next years.
Success is paired with long-term budget risks
For this next German government, it is of crucial importance that it does not lose sight of the medium- and long-term tasks that Germany faces. It may appear paradoxical, but this risk has risen with the country’s highly successful economic and financial performance over recent years. Exceptional circumstances like the record low levels of government interest rates in combination with strong economic growth and the employment boom have considerably softened short-term budget constraints. The consequences of which were clearly visible in the last election campaign and will also impact the ongoing negotiations for a new coalition government. Politicians of all parties assume that they can extrapolate the current highly favorable economic and financial situation by increasing government and social security spending, while lowering taxes and introducing a wave of new regulations. This policy approach is hardly viable over the longer run, among other things, because of the effects of an aging population on economic growth, and increased pressure on health care and pension spending. Therefore, a responsible and realistic policy approach with a long-term perspective must develop appropriate answers regarding the following policy fields.
Long-term pension stability at risk
Pension policy: The system continues to benefit from a favorable relationship between the active population (still comprising the baby boomer generation) and pensioners. In the coming years, with the retirement of the baby boomers and as a consequence of increasing life expectancy, the dependency ratio will quickly rise. Political parties have remained largely silent on the issue of how to react and keep the system (and contribution rates) stable. The only consensus seems to relate to benefit increases for parents, workers with particularly long-working histories and measures for fighting poverty in retirement. Expert recommendations for a further increase in the statutory pension age have regularly been rejected by Germany’s main political parties.
Old-age care will be considerable drain
Health and old-age care system: The social security systems for health and old-age care are characterized by even larger pressures on spending. Demographic change, and increasing societal expectations regarding the quality of services and medical progress have meant that demand for higher spending is almost unlimited. Over recent years, governments could impress voters by regularly increasing benefit levels as the employment boom provided the necessary finances. In the coming years and decades, with the shrinking active population, the imbalance between spending demand and available finances will increase dramatically. Current political programs are completely silent on how to contain this pressure.
Risk of falling behind
in tax competition
in tax competition
Tax policy: With respect to the tax policy debate, German politics seems to be characterized by a neglect of constraining factors related to increasing international competition. With the far-reaching Trump tax reform, a new wave of global corporate tax competition may have commenced. In Europe, the United Kingdom (to compensate for the consequences of Brexit) and France (as Macron wants to push French competitiveness) plan to make their systems more competitive. Without a reaction, Germany will find itself with the highest business tax burden of any major industrial country.
Europe looking to Germany for EU,
European reforms: Another major challenge for Germany relates to the European reform debate. Europe is urgently waiting for the next German government to develop a constructive strategy for how to reform Europe and the euro zone in order to increase resilience to crises and promote citizen trust in the union. Germany has to find the right balance between defending its self-interests (e.g., preventing a strategy of fiscal exploitation with massive transfers from northern to southern and eastern Europe) and constructive solidarity.
Refugee policies remain controversial
Refugee policies: Another major challenge involves refugee and immigration policy. After a dramatic 2015, refugee numbers have decreased considerably. However, this policy field still poses highly complicated questions concerning how to foster integration and steer immigration. The refugee issue has split society. The rise of several right-wing protest movements and the success of an anti-migration party, the AfD, indicates that part of the population is deeply distrustful of Germany’s political, economic and media elites. While the right-wing anti-immigration positions still constitute only a minority, they are particularly present in the eastern part of the country, pointing to a divide that persists more than 25 years after unification. The next government must build on the last grand coalition’s effort to promote a successful integration policy and develop – together with Germany’s EU partners –workable strategies to keep migration flows at manageable levels (i.e., levels that do not overstretch popular support or undermine financial sustainability).
Coal-plant closures a thorny question
Climate policy: The radical exit from nuclear power in combination with Germany’s ambition to be a front-runner in climate policies poses complicated policy trade-offs. One of the contentious issues is the timeframe for closing down coal-fired power plants.
Good times can lead to policy mistakes
Germany is economically and financially in a very good situation. The country recovered more quickly than many other countries from the global financial crisis. Economic growth rates have been exceptionally high in recent years and the short-run outlook for 2018 remains bullish. However, far-reaching policy mistakes that endanger the long-run sustainability of economies are typically made in good times.