The next German government will need to restore optimism

This weekend Germans will go to the polls to vote for their next parliament, and with it, the next federal government. One of the major issues this election cycle has been Germany’s sluggish economy. The parties vying for representation in parliament offer different approaches to remedying the situation: while centre- and far-right parties want to lower taxes to boost economic growth, leftist parties want to improve redistribution by taxing top earners and propose targeted stimulus measures.

In the run-up to an election that will likely bring tough coalition negotiations, Professor of Economics Christian Traxler says that what the next government really needs to do is restore optimism among consumers.

How important is the economy and people’s felt economic well-being in this election? Besides immigration, this seems to be the issue in this year’s election.

After two years of economic stagnation, the mood in the population seems to be much worse than the actual situation. Many surveys document that people judge their own personal economic well-being rather positively. At the same time, the general economic situation in the country is perceived as very negative. This sentiment is a tailwind for the opposition, in particular for conservative parties, which promise economic recovery. But this will be difficult. 

The main task for the next government will be to manage a turnaround in vibes: for the German economy to grow again, we need optimistic consumers who are more willing to spend their money. Domestic demand will become much more important for Germany’s economic prosperity than it used to be in the past.

A world shaped by international conflicts and trade wars means that Germany’s export-driven success story will, most likely, not continue. To put it in football terms: the Exportweltmeister is taking its place on the substitutes’ bench.

What solutions do the parties running for parliament offer to solve the country’s economic problems?

Basically, all the parties want to reduce bureaucracy and lower energy costs. I doubt that cutting electricity tax and grid charges will do much to save German industry, but it’s a first step.

One important pillar is tax policy, and here we see two opposing alternatives in the parties’ platforms. On the one hand, the centre-right and far-right parties – the CDU/CSU, the FDP, and the AfD – all want to cut income and corporate taxes to stimulate economic activity. The proposals imply that cuts in income tax would mainly benefit the top ten per cent of earners. Historically, such income tax cuts have done little to boost economic growth. Reforms in business taxation are more promising in this regard.

The centre- and far-left on the other hand – the SPD, the Greens and the Left – propose income tax reforms that mainly aim at achieving more redistribution. That means a higher tax burden for top earners and tax cuts for those at the lower end of the income distribution. At the same time, SPD and Greens propose more targeted measures that aim to stimulate investments and growth.

Two important notes here: first, while the fiscal implications of the “left” reform proposals are manageable, the fiscal costs of the “right” proposals are vast. This will not square with Germany’s debt brake – which, at the same time, the parties on the right want to maintain.

Second, a plausible outcome of the election will be a coalition of the CDU/CSU with either the SPD or the Green Party. Hence, we’ll have parties with very different views on tax reforms sitting at the table. As noted before, I think a key task for the next German government will be to create more optimism. It’s hard to see how this will work if coalition talks start with a fight over conflicting views on tax reforms. A possible outcome is that – due to fiscal constraints, among other things – we will not see any major income tax reform at all.

You research the effectiveness of federal programmes to encourage people to buy cleaner cars. What could a CDU/CSU victory, the most likely outcome, mean for the car industry and the energy transition within the sector?

The CDU and CSU say they want to save the German car industry. This will be hard if the conservatives seriously want to fight the end of the combustion engine within the EU – which is what they promise in their electoral platform.

If the next government continues to spread myths about e-fuels and moves forward with, at best, lukewarm support for electric vehicles, producers will have to cater to a very broad range of segments – producing models with electric, hybrid and combustion engines – which is very costly. At the same time, consumers will remain hesitant to buy new cars if the government sends mixed signals about the future of this market. This combination is devastating for the German car industry – as well as for many input suppliers within the EU.

Instead of repeating the mantra of Technologieoffenheit, the next German government – and the EU more broadly – must give the industry and consumers clear guidance on the role of different technologies. The conservatives should accept the end of the combustion engine. Germany needs to accelerate the transition toward electric cars. Strong demand in domestic and European markets would also help German and EU carmakers compete with their Chinese rivals.

Christian Traxler is Professor of Economics at the Hertie School. He studies public and behavioural economics, with a focus on tax evasion and enforcement. He joined the Hertie School in 2013.

Views expressed by the author/interviewee may not necessarily reflect the views and values of the Hertie School.