OVERCOMING THE CORONAVIRUS CRISIS TOGETHER; STRENGTHENING RESILIENCE AND GROWTH
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(1) The coronavirus pandemic has caused one of the most severe recessions in the post-war era. The economy recovered quickly when the acute measures put in place by governments against the pandemic in spring 2020 were lifted. However, the recent increase in the number of infections shows how fragile the situation remains. In various areas of the economy, a normalization of the economic situation is still not foreseeable. The corona crisis has not yet been overcome. In view of the renewed pandemic-related restrictions the recovery in Germany and in many other European countries is likely to be on hold. Furthermore, wider changes that are driven by the pandemic – such as new patterns of individual behaviour, changing consumer preferences and new framework conditions – could have a long-term economic impact.
At the same time, the German economy was already confronted with a number of long-term changes even before the pandemic. The structural changes triggered by technological progress, demographic change and the transition to a carbon-neutral economy are major challenges, but at the same time offer opportunities. Economic policy is now called upon to overcome the crisis caused by the coronavirus pandemic, strengthen economic resilience in Germany and Europe, and increase growth potential.
Overcoming the pandemic-induced recession
(2) In Germany, the coronavirus pandemic led to the sharpest fall in economic output in a single quarter since the quarterly national accounts began in 1970. The strong recovery over the summer means that real gross domestic product (GDP) for 2020 as a whole is forecast to decline by 5.1 %, which is similar to the contraction seen in 2009 during the global financial crisis. The recovery is expected to continue next year, but at a slower rate of 3.7 %. It is unlikely that the pre-crisis level of the fourth quarter of 2019 will be reached before early 2022. The incidence of infection and any resulting restrictions will continue to determine the pace of recovery. In its forecast, the German Council of Economic Experts (GCEE) assumes the infection rate can be kept largely under control with limited interventions so that no further major lockdown on the scale seen in spring 2020 will be necessary and that international supply chains will not be massively disrupted. Clear communication on the part of policymakers – e.g., with regard to the criteria that determine when new restrictions are imposed or lifted – is crucial to the fight against the pandemic.
(3) Developments in other countries also play an important role. China’s economy is growing rapidly again and the strong recovery in the third quarter meant that the United States and the euro area were able to report a significant increase in GDP. However, the rate of recovery is now expected to slow down noticeably. For 2020, the GCEE expects GDP in the euro area as a whole to fall by a total of 7.0 %. Spain, Italy and France, three of the largest EU member states, have been among the most affected economies in the euro area. In 2021, the GDP growth rate in the euro area is expected to be positive again at 4.9 %. Given the ever-changing nature of the pandemic, however, there are considerable downside risks for global economic growth.
(4) Policymakers have responded quickly and decisively to the crisis. Extensive monetary and fiscal policy measures were put in place, which supported the economy in the crisis. In addition, automatic stabilisers such as the progressive tax system, unemployment benefits and the short-time working scheme have provided a major source of support. In June 2020, the German federal government put together an economic stimulus package that is expected to boost economic output in 2020 and 2021. The funds have not yet been exhausted and are still available.
However, the stimulus package is not targeted in all of its parts. A survey carried out for the GCEE showed that the temporary cut in VAT has been of limited benefit to those households most affected by the crisis and that the tax cut has only partially led to increased consumption.In the further course of the crisis, expanding the possibilities for tax loss carry-backward and a more granular approach to stop-gap aid, depending on how affected recipients are by the crisis, would be beneficial. Moreover, an energy price reform could also provide additional stimulus.
Other EU member states and the EU itself have also implemented a wide range of measures to counter the negative economic impact of the coronavirus pandemic.The European Central Bank (ECB) has provided a lot of liquidity into the banking system at highly favourable conditions in order to support lending and prevent a potential banking crisis. At the same time, the large expansion of the asset-purchase programme has helped to stabilise the financial and government bond markets.
(5)Digitalisation helps cushion the effects of the coronavirus pandemic in many areas of the economy. Technology has enabled many companies to continue operating despite social distancing and hygiene regulations by switching to working from home. The pandemic has also highlighted deficits in the digitalisation of public administration, healthcare and education. In healthcare, a rapid expansion of the use of digital technologies in local public health authorities could create more efficient reporting paths and thus enable more rapid provision of information, which could be of major advantage in combating the pandemic. The carefully targeted use of such technologies could also help to contain further increases in the number of infections as the pandemic progresses.
In the education system there should, as a minimum, be online solutions that can be implemented at short notice in case of further school closures.There is a risk that a prolonged reduction of access to education will diminish the development of skills and the future employment opportunities of young people, especially those from educationally disadvantaged backgrounds.
(6) In the medium term, scope for fiscal and monetary policy should be created to enable an appropriate response to any future crisis. The sustainability of public finances should be ensured by appropriate consolidation steps that are designed according to the economic situation and promote growth. Monetary policy should communicate strategies for normalising the pandemic support measures, and avoid the risk of fiscal dominance of monetary policy. The establishment of a debt-financed recovery fund at the European level, which was decided upon in July 2020, offers the opportunity to increase the resilience and competitiveness of the European economy through carefully targeted investment and reforms in the member states of the EU.
Not losing sight of the long-term challenges
(7) Despite of the coronavirus pandemic the long-term challenges for the German economy must not be forgotten. Productivity growth has been declining in Germany for several decades. Technological change and digitalisation in particular are giving rise to new business models and production processes that lead to profound changes in the economic structure and the labour market. A similarly comprehensive structural change is pending as a result of the planned reduction in greenhouse gas emissions, which makes a transition to a climate-neutral economy necessary. In addition, accelerating demographic change in Germany means that there will be more and more pensioners and fewer and fewer people in work in the years to come. These structural changes are interlinked in various ways. If policymakers succeed in addressing these challenges, opportunities for the German economy may arise.
Once the economy is clearly on course for recovery from the coronavirus pandemic, it will be important to focus on the economic framework conditions that ensure a sustained upturn and long-term growth. Support measures should not impede the transition to long term competitive structures.The expansion of the short-time working scheme has prevented a sharp rise in unemployment. However, while this programme is still in place, even more extensive incentives should be offered and opportunities utilised to help employees develop their skills and equip themselves to prepare for future challenges.
(8) Structural change requires high levels of private and public investment. For private investment, the economic framework – and particularly the incentives for businesses and households – are crucial. Climate policy that is designed to encourage a move towards climate-friendly technologies and products along complex value chains should focus on market-based incentives such as uniform pricing of emissions across sectors. Government-induced distortions caused by levies and transfers should be eliminated – along with indirect support of fossil-fuel technologies – as part of a comprehensive energy price reform. This could strengthen the coordination function of carbon pricing and provide better incentives for sector coupling.
(9) A significant portion of the economic stimulus package in Germany and funds from the EU recovery package are to go into public investment. If carefully targeted, this could boost long-term growth. During times of economic crisis, public sector investment can create a growth stimulus provided that projects can be implemented without lengthy delays. However, even without the pandemic there are bottlenecks that prevent timely implementation. These include a lack of spare capacity in the construction industry, a lack of planning and administrative capacity and lengthy planning and approval procedures, particularly at municipal level. In some areas, public investment could be a useful complementary measure to accompany emissions trading in encouraging the transition to a carbon-neutral economy.
(10) The innovation process plays a central role in long-term economic growth. Innovation and the use of new technologies are also particularly important for the transition to a carbon-neutral economy. In order to strengthen productivity growth, government innovation policy can support private-sector investment, which is inefficiently low due to positive knowledge externalities. In Germany, the private sector accounts for around two thirds of research and development (R&D) spending. Innovation expenditure is increasingly concentrated on large companies. As small and medium sized enterprises are particularly affected by obstacles to innovation, their incentives to innovate should be strengthened in order to accelerate the diffusion of new technologies.
(11) Digital technologies are often cross-sectional technologies that can be used to increase productivity across large sections of the economy. In order to speed up the diffusion of digital technologies and enable the development of new business models, additional investment in digital infrastructure is required, along with elimination of the red tape that hinders its development. Germany’s small and medium-sized companies, in particular, are still finding it difficult to reap the benefits of digitalisation, implement the necessary organisational adjustments and make the necessary complementary investment in knowledge and skills. To face the deficit in the digitalisation of the public sector exposed by the pandemic, policymakers can use financial support for healthcare and education to provide the stimulus needed to close these gaps and to ensure that the benefits from the rush to digitalisation brought about by the pandemic are enduring. The measures included in the economic stimulus package may help. However, the success of these measures will not hinge solely on the amount of funding available. Even more important will be the administrative implementation.
(12) Demographic change is restricting the supply of skilled workers. Especially in construction and crafting, but also in the care sector, in medical activities and in information and communication technologies, there is already a shortage of skilled workers. In addition, rapid technological change and the transition to a carbon-neutral economy are likely to lead to greater demand for specialists in the STEM (Science Technology Engineering Math) professions. Education, further training and lifelong learning will play an important role to meet this demand in the long term. Targeted measures in schools could be particularly effective in helping to promote women in STEM subjects and the promotion of equal opportunities in education in order to close the gap in the future. A flexible education and training system can help employees to prepare for technological change. Digital key competencies should therefore be taught in schools and lifelong learning should be promoted, for example through professional development, lifelong learning and training opportunities throughout working life. Such a system also improves the chances for uninterrupted employment, reduces the risk of a reduction in earning capacity, and is therefore the most effective preventive measure against poverty in general and old-age poverty in particular.
(13) The impact of demographic change may also make it more difficult to consolidate public finances after the coronavirus pandemic. Increasing life expectancy combined with lower birth rates and moderate levels of immigration, as well as the fact that the baby-boomer generation approaches retirement age, will substantially increase the burden on the social security systems. In the short term, the reintroduction of the ‘catch-up factor’, which was suspended in 2018, could counteract the rise in costs of statutory pension insurance. This would gradually reverse any pandemic-related increase in the ratio of pension and wage levels in the coming years.
In the long term, an increase in the legal retirement age – for example by linking it to rising further life expectancy – could alleviate the sustainability problem. Two thirds of the increase in life expectancy would be allocated to a longer working phase and one third to a longer retirement phase.An actual extension of the working phase will be achieved only if the workforce is enabled to work longer. Systematic further training and education, opportunities to retrain, avoidance of incentives for early retirement, incentives for working longer and better protection against incapacity for work will play a key role.
Utilising international cooperation
(14) International cooperation and division of labour are essential in overcoming the coronavirus pandemic and coping with the long-term challenges. The coronavirus pandemic is affecting both supply and demand and interfering with national and international supplier and end customer relationships. In an open economy such as Germany, economic recovery relies on the virus being contained also abroad so that the global economy can return to normality.
Germany and the EU enjoy substantial welfare and productivity gains thanks to international trade and the international division of labour. However, during the coronavirus crisis, there has been a tendency to limit cross-border trade, as has often been the case during periods of major economic uncertainty in the past. New protectionism in the wake of the coronavirus crisis should be vehemently opposed. The EU has a key role to play in keeping trade open – primarily that of coordinator.It should operate a joint crisis management system with regard to supply chains.
(15) Climate change is another problem that can only be tackled at a global level, which is why national and European efforts must always be seen in a global context. Germany and the EU can already initiate or push ahead partnerships in areas such as the hydrogen strategy that increase the chances of meeting global climate targets. In addition to the commitment to an internationally coordinated approach to reducing greenhouse gas emissions, a shift from national and sectoral targets to a cross-sectoral European emissions trading scheme would be necessary to achieve the European targets efficiently.
(16) For its member states, the EU is an opportunity to act together internationally and use the opportunities offered by the single market. The primary goal should be for all member states to emerge from the crisis stronger than before by encouraging productivity and growth and increasing resilience to future crises. The sustainability of public finances, an effective fiscal framework and the stability of the financial system are essential prerequisites for a resilient Europe in the future. It is also important to identify the tasks that would be better located at the EU level or that should remain at the national level due to the principle of subsidiarity. For example, the EU should play a stronger role in foreign policy, defence policy, migration and asylum policy, the fight against international crime, climate protection and research funding.
The EU responded to the coronavirus pandemic with the recovery fund, which will largely benefit the national budgets of the member states and provides new funds for various EU programmes. The temporary recovery fund offers EU member states the opportunity to overcome the crisis together and improve the resilience of their economies. However, like the other temporary crisis measures, it cannot continue in the longer term without a transparent transfer of responsibilities to the EU and agreement by the member states to relinquish sovereignty accordingly.
Strengthening resilience and growth
(17) The German economy will continue to live with the coronavirus pandemic and its consequences for a long time. In such an exceptional situation, it is important to take strong economic countermeasures at all levels and with the necessary strength. Moreover, there are long-term challenges that have to be overcome. New opportunities lie, for example in the pandemic-related boost to digitalisation and innovation triggered by the pandemic, the transformation to a climate-neutral economy and increased European cooperation. Economic policymakers should seize these opportunities and create the framework conditions necessary for a resilient and future-oriented economy.
ECONOMIC SITUATION: RECOVERY DEPENDS ON THE COURSE OF THE PANDEMIC
- The global economy began a strong recovery following the major slump in spring. However, there has recently been a sharp increase in the number of infections in many places.
- In light of the renewed restrictions, the economic recovery in the affected countries is likely to regain momentum only after the second wave of infection subsides.
- The German Council of Economic Experts (GCEE) expects economic output to decline in Germany by 5.1 % this year, and to increase by 3.7 % in 2021.
STABILISATION POLICY AMID THE CORONAVIRUS CRISIS
- Monetary and fiscal policy reacted quickly to the crisis with very extensive support measures. Automatic stabilisers also play an important role.
- The German Federal Government's stimulus package is contributing to the recovery and will likely increase economic output temporarily by 0.7 to 1.3 %, but some elements are not well targeted in all areas.
- Once the economic situation improves sustainably in the future, the focus should be on consolidating public finances, and normalising monetary policy.
EMERGING STRONGER FROM THE CRISIS TOGETHER
- The temporary Recovery and Resilience Facility enables the EU member states to invest in productivity and growth, thus facilitating structural reforms.
- The sustainability of public finances, an effective fiscal framework, and the stability of the financial system are prerequisites for a Europe that will be resilient in the future.
- Strengthening the EU's Single Market can increase resilience to future crises. More diversified supply chains and a European system of inventory management can contribute to this.
CLIMATE PROTECTION AS AN INDUSTRIAL POLICY OPPORTUNITY
- Commitments worldwide to reduce greenhouse gas emissions make structural change inevitable. This will create significant industrial policy opportunities.
- The reduction of distorting incentives through an energy price reform with simultaneous strengthening of carbon emissions pricing could increase the coordination function of the market.
- Complementary measures can address obstacles that delay the penetration of lower emission technologies, by increasing the steering effect of the pricing of carbon emissions.
PRODUCTIVITY GROWTH THROUGH INNOVATION: ADVANCING DIGITALISATION
- Private innovation spending in Germany is concentrated among large companies. Incentives for innovation and diffusion at small and medium-sized enterprises should be strengthened.
- Germany is well positioned in the development of digital technologies, but the framework conditions for digital services and business models should be improved.
- The pandemic has highlighted deficits in the digitalisation of public administration, healthcare and the education system. These should be reduced quickly and consistently.
DEMOGRAPHIC CHANGE: SUSTAINABLE RETIREMENT PROVISION
- Population ageing is creating a considerable sustainability problem for the statutory pension scheme.
- In the long term, linking the retirement age to rising further life expectancy could ease the sustainability problem. In the short term, the reinstatement of the 'catch-up factor', which was suspended in 2018, would help.
- Mothers' Pension and Basic Pension reduce the risk of old-age poverty but are not well targeted. Better labour market integration and education are long-term options for preventing poverty.
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