Euro Watch – German elections: Merkel sailing through

by: Aline Schuiling

  • Polls indicate that Angela Merkel will stay firmly in the driving seat …
  • … as her conservative CDU will beat all competitors by a wide margin on 24 September
  • Her coalition partner could possibly change though
  • A coalition with the liberal FDP in stead of the centre-left SPD would be a shift to the right in Germany’s policy making …
  • … and would probably also mean less support for further European integration
  • However, as the CDU should continue to dominate the agenda, a new coalition partner would not be a major game changer
  • Limited impact on German economy and financial markets expected
  • Only in the improbable event that the election results would open up the possibility of an all left-wing coalition some financial market instability can be expected
170915-Euro-Watch-German-elections.pdf (225 KB)
Download

Recent polls for Germany’s federal election on 24 September show that Angela Merkel will probably have an easy ride in keeping her position of Chancellor. Her conservative CDU and its sister party CSU together (hereafter called CDU) are running well ahead in the polls. They will probably get around 37% of the votes, followed by its current partner in the coalition government, the centre-left SPD with 25% of the votes. The Eurosceptic AfD seems to get around 10% of the votes.

  

… but coalition with SPD might come to an end

Angela Merkel’s preferred coalition partner probably still is the liberal FDP. During the period 2009-2013, the CDU was in a coalition government with the FDP, but the FDP subsequently failed to meet the 5% threshold needed to secure representation in the Bundestag in the 2013 elections. Re-allocating the proportional share of the votes that would go to the parties that miss the 5% threshold, a coalition of CDU and FDP would just about fail to get a majority of the seats in the Bundestag (around 49%). This means that they would either have to form a minority coalition government or be joined by the Greens. However, it would be hard to bridge some differences between the FDP and Greens about environmental policy and refugees, while both parties have stated in the press that they do not see themselves working together.

Alternatively, continuation of the current grand-coalition of CDU and the centre-left SPD would be an option, although the SPD has shifted to the left of the political spectrum following the nomination of its new leader Martin Schultz earlier this year. This shift in the agenda of the SPD is probably also pushing the CDU into the arms of the FDP. An all-left coalition of SPD, Greens and die Linke would only get only around 42% of the seats in the Bundestag, so does not seem feasible.

  

The CDU will dominate the next government’s economic agenda …

Irrelevant of the colour of the next coalition, the plans of the CDU will probably dominate the economic policy agenda. The election manifesto of the CDU is largely aimed at supporting middle income families. Income taxes will be cut by EUR 15bn (equal to 0.5% of GDP) by, among other measures, raising the top-income bracket to EUR 60,000 from EUR 52,000. Moreover, the solidarity tax (special tax to support eastern Germany after the re-unification) will be phased out. Also, the party wants to support first-home buyers and raise child allowance. Finally, military spending will rise from 1.2% GDP in 2016 to 2% by 2024. Despite the tax cuts and extra expenditure, the party wants to stick to its principle that the government budget remains balanced. This should be feasible, given that the government’s budget surplus expanded from 0.8% GDP in 2016 to around 1.2% in the first half of 2017. So, there seems to be quite some room for stimulus. Indeed, the debt ratio is expected to continue to gradually move in the direction of the 60% threshold of the European Commission in the next few years (see graphs above).

… as well as the plans for further European integration

With regard to the CDU’s European agenda, the party wants to harmonize corporate tax rates with France (France currently has a minimum rate of 33.3% and wants to lower this to 25% by 2020; Germany’s average rate is around 30%). The CDU supports an EU defence union, in line with the plans of President Emmanuel Macron. The CDU’s programme says that the EU must be able to defend itself, although Germany remains committed to NATO. In regard of the cooperation with France, the manifesto mentions that the CDU wants to work together with the new French government to further develop the eurozone gradually, for instance by building an independent eurozone monetary fund. Also, according to reports in the press, finance minister Wolfgang Schäuble would support plans to work on a fund that would give emergency financial support to countries in crisis. However, it remains essential that countries stick to the conditions of the Stability and Growth Pact. Also, debt mutualisation (or the introduction of eurobonds) remains a taboo subject.

  

Big differences between FDP and SPD …

The main points of the liberal FDP’s economic programme are a tax cut of around EUR 30bn and higher spending on education, infrastructure and technological progress (largely paid by EUR 10bn extra privitasation income). The economic programme of the centre-left SPD mainly focusses on cutting income taxes, raising the top-income bracket (to EUR 76,000) as well as the top-tariff from 42% to 45%. Morover, the SPD wants to spend some EUR 30bn (around 1% of GDP) extra on infrastructure, education and health care, introduce a financial transactions tax and an inherintence tax and wind down some of the past labour market reforms. Both the FDP and the SPD agree with the CDU that the solidatiry tax needs to be phased out.

… also concerning their plans for Europe

In regard to European integration, a coalition between the CDU and FDP would probably mean a less ambitious agenda. The FDP does support European reforms, but has serious doubts about creating a common eurozone budget or a common investment fund and fiercely opposes debt mutualisation. It is in favour of a Europe of two-speeds and would like to create the possibility of countries (temporarily) leaving the eurozone, without losing EU membership. In contrast, the SPD has a more ambitious agenda for European reform and integration than the CDU. The SPD is in favour of co-ordinating economic policy, harmonizing taxes and creating a European social union to guarantee common welfare standards. It wants to establish a European economics and finance minister and a common European budget, which is in line with the more ambitious parts of President Macron’s European agenda. Still, SPD leader Schultz seems no longer in favour of introducing eurobonds. In comments to the press he has said that the issue had become irrelevant after the establishment of the ESM.

Limited impact on economy …

Given the election programmes of the CDU and its most important potential coalition partners, it seems that the next government probably will have a modest positive impact on economic growth in the next few years, as fiscal policy will be stimulative. That said, a coalition including the liberal FDP would probably be more business friendly and more supportive for the long-term growth potential of the German economy. Indeed, Germany has lost some competitiveness in the past few years as its unit labour costs have risen faster than in the eurozone as a whole and also faster than in its main peer France (see graph above). Moreover, the country has lost some of its advantages over other eurozone countries related to the quality of infrastructure and education during the past six years, although its overall business environment has remained very competitive.

… and financial markets

The upcoming German elections and the presentation of the various party’s programmes have not received a lot of attention in financial markets in the past few months. The most likely outcome – again – is a stable government led by Ms Merkel. Only in the improbable event that the election results would open up the possibility of an all left-wing coalition some financial market instability can be expected.