Focus on Future Viability Executive Summary

New challenges1
1.

Two developments dominated politics this year: the crisis in Greece and the
dramatic surge in immigration through refugees. Tackling demographic
challenges and creating suitable conditions for an ever-more globalised and digitalised world took a backseat to these pressing concerns. But the focus of German economic policy making should return to making economic processes more
efficient, rather than trying to preserve achievements and realise distributive objectives through direct market intervention.

2.

Positive overall macroeconomic developments will continue in the foreseeable future. Real gross domestic product in Germany is expected to grow by
1.7 % in 2015 and 1.6 % in 2016. For the euro area, the German Council of Economic Experts (GCEE) forecasts real growth of 1.6 % this year and 1.5 % next
year.

3.

But the two developments have highlighted the need for economic policymaking
to focus on the future viability of the German economy. Strengthening the
euro area architecture is crucial to maintaining competitiveness and stability. At
the same time, coping with the surge in immigration will only be possible if appropriate conditions are created to raise Germanys economic potential, especially in view of low productivity growth.

Coping with the consequences of refugee inflows

4.

A first topic of this report addresses the question how Germany can master the
economic challenges of refugee inflows. For this purpose, the GCEE carried out a cautious initial empirical evaluation, based on various scenarios. The
results are subject to high uncertainty given scant data availability.

5.

The scenarios show that the refugee influx will lead to direct annual additional gross expenses for public budgets of 5.9 billion to 8.3 billion in
2015 and 9.0 billion to 14.3 billion in 2016, depending on the underlying scenario. Given strong public finances, these costs should be manageable. Lengthy
processing times for asylum applications and poor labour-market integration
could raise these costs considerably.

6.

The effects of the refugee influx on employment and production potential are
expected to be moderate in the medium term. In a favourable scenario, hiring of
recognised refugees could increase employment by up to 500,000 people by
2020. In the unfavourable scenario, employment would increase by only half
this number. This rise in employment goes along with about 300,000 to
350,000 recognised refugees expected to sign on as unemployed by 2020.

1 This is a translation of the original report published in German, which is the sole authoritative text.

Annual Economic Report 2015/16 German Council of Economic Experts

Executive Summary Focus on Future Viability

7.

Immigration will raise demand for private housing in the medium term. As
a result, conditions must be created that strengthen incentives for private
investment in the housing sector. Rent price ceilings (Mietpreisbremse)
should be rescinded.

8.

Given the age and qualification structure of refugees, training and education for
recognised refugees will play a decisive role in their integration into society.
A considerable need for training can be assumed. Job market integration is
an important aspect of integration into society. Hence, barriers to employment
should not be too high. Flexible work arrangements, such as in temporary jobs
(Zeitarbeit) or contracts for specific projects (Werkvertrge), must be maintained. Migrants should not be privileged over other employees, but should
also not be disadvantaged.

9.

The minimum wage is likely to constitute a high barrier to entry into the job
market for many refugees. In view of the increasing labour supply in the lowwage sector, the minimum wage should certainly not be raised. Jobseeking recognised refugees should be treated as long-term unemployed from
the start. The exemption from the minimum wage for long-term unemployed starting a new job should be extended from six to twelve months. Internships should be exempt from the minimum wage for at least twelve months. A
minimum wage increasing gradually with age could help lower the barrier to labour market entry for young adults.

The path to more stability in Europe

10.

The second focus of this report is Europe. To strengthen the architecture of the
euro area and its no bail-out clause, the GCEE proposes a sovereign insolvency mechanism. This should facilitate debt restructuring and creditor bailin without destabilising the currency union. Debt restructuring procedures
should be specified to stabilise the expectations of market participants. This
should help strengthen market discipline. Any restructuring of sovereign debt
would take place in combination with a strict macroeconomic adjustment programme. As part of the application for an ESM programme, a maturity extension
or even a nominal debt reduction vis--vis private creditors should take place if
debt is considered not sustainable.

11.

In addition, the nexus between banks and governments should be severed by

phasing out banking regulations that privilege sovereign exposures.
The GCEE proposes the introduction of risk-adjusted large-exposure limits and
risk-adequate capital requirements for such exposures. This will reduce concentration risks in bank balance sheets and raise the ability of banks to absorb losses.

12.

A stronger integration of European capital markets through the European

Capital Markets Union is desirable as it holds the potential to improve crossborder risk sharing. The primary goal should be to reduce frictions in corporate
financing.

German Council of Economic Experts Annual Economic Report 2015/16

Focus on Future Viability Executive Summary

13.

Another important debate centres on the current low interest rate environment in the euro area. In January 2015, the European Central Bank (ECB) further eased its already very accommodating monetary policy by introducing a
new sovereign bond-buying programme. Recently, it put forth the possibility of
further easing. Core inflation has, however, stood near 1 % for months, and has
recently risen slightly. Simple interest rate rules, such as the Taylor Rule or a
rule that explains past ECB interest rate decisions quite well, suggest that monetary policy should be tightened given the current economic outlook.

14.

While the risk of deflation is currently low, there are risks for the development of
the economy in the longer term. The ECBs bond buying programme has created
favourable financing conditions and provides member states with an incentive to
defer much-needed budget consolidation and structural reforms.
However, further structural reforms to strengthen markets and competitiveness
are crucial for a self-sustaining economic recovery. In addition, monetary policy
is leading to a build-up of risks to financial stability which could pave the
way for a new financial crisis. Persistently low interest rates erode the earnings
of banks and life insurance companies, and raise the appetite for taking risks.
Although there are so far no signs of excessive credit expansion, some sectors,
like real estate, are showing some signs of exaggerated prices.

15.

Macroprudential policy alone cannot guarantee the stability of the financial system. It is important to avoid delaying an exit from the low interest rate environment for too long. A timely end to monetary policy accommodation could
effectively prevent the further build-up of risks in the financial system.

16.

Considering current economic developments and balancing deflation risks

against the risks to longer-term economic developments and financial stability
suggest that the ECB should slow down the expansion of its balance
sheet, or even end it earlier than announced.

Conditions to spur growth in Germany

17.

The future viability of the German economy is the third focus of this report. It is currently hard to detect any reform spirit enabling Germany to assert
its strong economic position in an ever more interdependent and digitised
world. Productivity growth has been slowing since 2005.

18.

Lower productivity growth can be partially explained by the successful integration of less productive workers into the workforce, and is thus the result of successful past labour-market reforms. In addition, the restructuring of value
chains by businesses worldwide, especially in manufacturing, has come to an
end. But within the service sector and in regard to the digital transformation
there appear to be obstacles to productivity growth in the German economy. In
addition, start-up activity has been low.

Annual Economic Report 2015/16 German Council of Economic Experts

Executive Summary Focus on Future Viability

19.

Improvements to general economic conditions rather than public investment programmes can ensure future productivity gains. In the service sector, barriers to competition in areas dominated by former state monopolies are
too high, and regulation in professional services is too tight. With regard to the
digital transformation, education and training policies play a key role. In addition, over-regulation of product and labour markets could prevent investments
in information and communications technologies from realising their productivity-enhancing potential.

20.

Given the importance of international trade, lowering trade barriers and

ensuring investment protection as part of the TTIP trade agreement with
the United States prove especially important for Germany. In particular, the reduction of non-tariff barriers to trade could yield enormous economic potential.
Each governments sovereign autonomy to regulate within its borders
should not be compromised. However, arbitration panels that improve investor
protection would also give German companies more legal certainty when making
investments in the United States.

21.

Tax reforms implemented in Germany since 2000 were steps in the right direction. But the tax system still suffers from major distortions. Withholding tax
(Abgeltungssteuer) has not been fully integrated into existing rules. As a result,
the corporate tax regime does not treat all financing forms in the same way and
discriminates against equity financing to the benefit of retained earnings or
debt.

22.

This problem can be resolved by introducing an allowance for corporate

equity (ACE) in the sense of a dual income tax, as proposed by the GCEE. Ending tax discrimination against equity financing would help firms that have trouble funding investment, in particular by reducing the tax burden on venture capital. This would benefit in particular investments by young, growth-oriented
companies.

23.

Education policy should ensure equal opportunities and create incentives for
individual investments in training. Concentrating public spending on education
on the beginning of the educational cycle and mobilising private funding could
help to raise economic growth potential.

24.

Given demographic and technological trends, the labour market must be

flexible enough to adjust to new developments, absorb shocks, and create employment opportunities. The challenges of an increasingly digital economy will
force employees and employers to accept lifelong learning as a matter of course.

25.

Transforming Europes energy supply is a collaborative project of utmost political importance and the basis for the regions leading role in global climate
protection. Top priority should be the reduction of greenhouse gas emissions
without losing sight of economic efficiency. To transform energy supply in economically efficient ways, a national industrial policy approach like Germanys
Renewable Energy Act (Erneuerbare-Energien-Gesetz, EEG) is unsuitable. The
German government should instead embrace Europes Emissions Trading System (EU-ETS) as a common tool guiding the regions climate policies. This

German Council of Economic Experts Annual Economic Report 2015/16

Focus on Future Viability Executive Summary

would mean applying the scheme to more sectors of the economy and stabilising
its price signalling.

Focus on future viability

26.

German economic policy must create the appropriate conditions to prepare the economy for the challenges of the future - demographic change, globalisation and digitisation. The unprecedented influx of refugees means education, integration and labour market policies will have to rise to numerous challenges. Highly diverse social groups will have to be integrated into the education
system and the labour market to prevent Germanys unemployment rate from
returning to past heights. The German economy has to adapt to a complex and
constantly changing world. As a result, economic policy should focus on the
future viability of the German economy. Just preserving the status quo is not
an option.

Annual Economic Report 2015/16 German Council of Economic Experts