Make no mistake: there’s been a lot of positive news out of Germany lately. Finance Minister Wolfgang Schäuble recently presented balanced budgets for 2014, 2015 and 2016. The economy is set to grow 1.4 percent this year and exports are peaking. To top it off, unemployment is at a 25-year low.
These solid numbers, however, mask a number of problems Chancellor Angela Merkel and her coalition government of the Christian Democrat Union (CDU), Christian Social Union (CSU) and Social Democrat PArty (SDP) have not yet tackled.
In addition to dramatic changes internationally – from Brexit to the election of U.S. President Donald Trump and the Ukraine conflict – Germany also faces several domestic challenges.
Including future obligations, such as pension payments, Germany's implicit debt pile would be 136.8 percent of its economic output, instead of the 74.9 percent recorded in 2016.
Mr. Schäuble's balanced budgets are in part due the European Central Bank’s extremely low interest rates. This, in turn, has decreased borrowing costs. Economic growth has helped increase tax payments by citizens and corporations. The tax burden, including social benefit contributions, has risen to 39.4 percent in 2015 from 38.2 percent in 2005 when Angela Merkel took office.
There have been calls for tax relief, but the grand coalition between the center-right CDU-CSU and center-left SPD has proved to be at a grand stand still. Political stagnation has been aggravated by disagreements among individual states.
Mr. Schäuble believes the country can lower taxes by around €15 - $16 billion. However, if tax relief is supposed to help Germany's Mittelstand – the millions of small and medium-sized businesses that make up its economic backbone – more funds may well be needed.
An overhaul is also required of the needlessly complicated system of exceptions that make up the country’s value-added tax, which has two rates of 7 and 19 percent. The same goes for corporate taxes, an area affecting Germany’s international competitiveness.
However, tax reform should not come at the cost of investment. An upgrade of the country’s digital and physical infrastructure is long overdue. While funds have been made available, many local and state authorities lack the manpower to implement new projects or build new roads and bridges.
The federal government is scheduled to take over road-building efforts from state governments within the next four years, though experts fear serious adjustments will need to be made to that timeline.
It is worth noting that there is still no overarching concept for transportation in Germany. This leaves open a number of burning questions: Should the German government be running the railway? How will environmental concerns impact truckers, and can waterborne transport help? How will digitization improve efficiency?
Old-age spending on state pensions and health care is another area of concern. In 2014, Ms. Merkel’s government introduced the possibility to retire at 63 without pension cuts under certain conditions. This policy is costing the state an additional €10 billion per year and has prompted many to pursue early retirement, undermining the goal of standardizing pensions at 67.
The government has also promised pensioners from former East Germany no less than seven pension increases, adding up to more than €15 billion by 2025. The move is aimed at achieving common pension laws across Germany, nearly 30 years after reunification.
Added to this are demographic changes, which raise the number of retirees and lower the labor force population. Workers are expected see their net income fall due to higher pension rates paying for those already retired. At the same time, state pensions are set to decline from 48 percent of gross salary in 2016 to 41.7 percent in 2045 – without any changes to the current system. Some Germans are already struggling to make ends meet.
By the end of this year, spending by state-backed health insurance plans will have risen 25 percent to an estimated €229 billion since 2013. A new bill expanding the eligibility of nursing care has helped an additional 500,000 people. But it has also meant every fourth health insurance plan has been forced to raise contributions. Some economists have warned that employers' health care contributions could rise to 2.4 percent of gross salary from the current rate of 1.1 percent.
Germany’s aging population is expected to further inflate health care spending. These types of costs drive up Germany’s implicit debt level, which includes future commitments the government has already made. Instead of a debt pile of 74.9 percent of gross domestic product (GDP) in 2016, the burden would rise to 136.8 percent if these obligations are included.
Despite a record low unemployment level, the labor market remains a topic of discussion. Angela Merkel’s coalition government has challenged employers with additional regulations and costs, introducing a minimum wage and stricter laws on temporary employment.
At the same time, the government has failed to tackle two major challenges: the integration of refugees and finding jobs for the long-term unemployed. More than one million migrants have entered Germany since the beginning of 2015, with some 440,000 having been granted asylum and now eligible to work. They will be joined by thousands more whose applications are still being processed.
As for German citizens, the number of long-term unemployed has been stubbornly high, hovering at around one million. Training programs have not helped them to find work.
Germany's labor market also has high job expenses. Unit wage costs are, on average, 11 percent higher than in the 25 most important industrial countries. Also, social benefit contributions – paid by employers and employees – could again rise above 40 percent of gross wages this year.
Efforts to improve education and prepare the workers of tomorrow for the digital age have progressed slowly. While the government has made €5 billion available to some 40,000 schools to boost computer skills, education policy is mostly in the hands of individual states. Indeed, Germany’s constitution prohibits nation-wide directives for education. This also makes it difficult to renovate dilapidated school and university buildings, which face a €34 billion backlog of much needed repairs and upgrades, according to a study from government-owned development bank KfW.
More money and more teachers are needed to address the schools' problems. Pupils’ performance in mathematics and natural sciences have stagnated and academic success is still shown to depend largely on class and family background.
The energy sector is another area of concern. Germany’s expansion of renewable energy sources, including wind and solar power, comes with an annual €25 billion price tag, paid for by electricity users. Vice-Chancellor Sigmar Gabriel helped reform energy laws last year in the hope of better controling costs. But this deceleration comes at a time when only 14 percent of Germany’s primary energy consumption comes from renewables. Only in electricity consumption are the share of renewables higher than 30 percent.
There is widespread consensus that the only way to attain the stated goal of a CO2-free economy by 2050 is to create more green energy to power everything from electric cars to German manufacturing. One way of achieving that would be to spread the costs of renewable energy further, from electricity onto other energy sources, such as gas, coal and oil.
Of course, it won’t be quite as easy as that. There are also social costs to consider when increasing the number of wind turbines and solar power panels – not to mention the question of what to do with outdated coal or gas-fed power stations and lost jobs.
Another important issue, both for politicians and citizens, is security. Terror attacks in Würzburg, Ansbach and Berlin have highlighted the need to invest in safety and law enforcement. Germany’s Interior Ministry, which is responsible for the federal police, has seen its budget rise from €5.9 billion in 2013 to around €9 billion this year. They are also working on legislation to better track possible suspects. Police are looking to hire an additional 7,500 new officers until 2020, including 1,300 investigators.
The difficulty, however, will be to find qualified personnel and have the necessary training capacity. Coordination between authorities in different cities, as well as between local and federal officials, also needs to improve. The same goes for skills needed to fight cybercrime.
Internationally, there is increased pressure on Germany to raise defense spending. Germany has already ended a years’ long tradition of cutting military spending due to conflicts on Europe’s periphery, including in Ukraine and Syria. This comes on top of playing a bigger role in global peace missions. Both Brexit and possible pressure from U.S. president Donald Trump could see Germany spend more on its own military as well as NATO. Defense spending currently stands at 1.2 percent of GDP, well below the NATO target of 2 percent.
Defense Minister Ursula von der Leyen is already in the process of hiring more soldiers to help staff foreign missions carried out under the flag of NATO or the United Nations. She has also helped create a new department to fight off cyber attacks. But the modernization and expansion of the armed forces is progressing slowly, with soldiers often operating at their limits.
Reporting by Frank Specht, Peter Thelen, Klaus Stratmann, Martin Greive, Jan Hildebrand, Daniel Delhaes, Donata Riedel and Stefani Hergert.