Upgrading the country’s creaking infrastructure is essential, at a time of free money
Driving recently from Wiesbaden to Frankfurt, I was stuck in the usual traffic jam for almost the entire ride. But I could not call my colleagues to let them know I was running late for the next meeting because of the notorious “Funkloch” — the lack of mobile phone reception in one of Germany’s economic hotspots, the Rhine-Main area. Clearly, there is truth to the argument that Germany needs to loosen its purse-strings and spend to improve its infrastructure.
From my point of view as an economist, the so-called “golden rule of capital accumulation” argues that Germany should step up public investment in the economy. The rule, in a nutshell, suggests that capital should increase proportionally to gross domestic product and population. Public investment is long-term investment and, for the time being, money is free: government bond yields are zero or even negative, all the way up to 10 years. So, if Germany wanted to spend more, that is, by borrowing money on the capital markets, investors would pay the German government for the privilege of lending to it.
However, what appears to be a “quick win” for fiscal policy and the German economy merits further analysis.
The above-mentioned economic rule suggests that investment in a country should develop in proportion to economic activity and demography. Needless to say, the German economy, with its large current account surplus, is not on such a path. Average growth of capital, per capita, has been zero over the past five years, while net immigration contributed to a strong rise in population growth. Therefore, according to this principle, Germany shows an under-accumulation of capital of about €50bn ($56bn) a year, or some 1.7 per cent of GDP over the period.
Yes, budget rules argue that Germany should refrain from adding debt. And high capacity utilisation in the German construction sector implies that substantial investment could overheat the economy. However, that is not a decisive reason to delay investment that will raise future capacity and unplug the current bottlenecks.
Furthermore, is respecting the golden rule of capital accumulation less crucial than adhering to budget rules, or stabilising the short-term outlook to the detriment of the long-term outlook? From the point of view of growth theories, at least, a balanced growth model is a way to increase the standard of living for generations to come. Let us examine these views in detail.
The Maastricht treaty caps the ratio of public debt to GDP at 60 per cent, and Germany exceeded this cap until recently. At the federal level, the “debt brake” enshrined in Germany’s constitution does not allow the country to increase net new borrowing by more than 0.35 per cent of GDP. And let us not forget the individual states within Germany, which have committed to balancing their budgets from next year. That is all true. But investing additional money at no cost could serve the budget rules by reducing debt service costs, relative to GDP.
In addition, countless studies point to the lack of investment in Germany. Most of those studies share the same observation: the country’s public infrastructure is not being well maintained, especially by municipalities with the smallest tax coffers. The development of German digital infrastructure, meanwhile, is lagging behind European peers.
Germany’s projected increase in public investment of some €20bn by 2022 is positive from this point of view, but will only incrementally address the capital gap the economy is suffering from today. Increasing public investment substantially would raise demand and inflation. Greater public investment would help unlock private-sector investment: for the first time in a quarter of a century, productive investment to GDP is higher in France and Spain than in Germany. A positive spiral from public to private investment would narrow Germany’s current account surplus, of which one-third comes from overly high savings in the corporate sector. As a secondary benefit, some of these investments would likely spill over to the rest of Europe and spill back positively to Germany, helping its economic leadership within the eurozone.
Of course, the public sector should not be the sole source of investment. The German economy would benefit from additional measures to stimulate private investment, such as corporate income tax cuts, changes to tax rules for capital depreciation and incentives for households to home ownership.
Finally, increasing the supply of German debt could have one further advantage: helping to make the euro a more attractive reserve asset, while strengthening its internationalisation. The European Commission has identified this as a priority for protecting European interests from a possible backlash in external trade.