Angela Merkel has vowed to end Germany’s long-standing freeze on public and private investment. But she is only considering symbolic actions that will not reverse two decades of negligence. The country’s depleting infrastructure is threatening its long-term economic potential.
The Kiel Canal – the world’s busiest man-made waterway, which connects the North Sea and the Baltic Sea – had to be partially closed last year after worn out locks built in 1914 broke down. The average German car commuter wastes eight working days per year in traffic jams, because Autobahns, once a prime symbol of national pride, have been neglected. On the Cologne beltway, a major bridge crossing the river Rhine close to the headquarters and main factory of pharmaceutical giant Bayer BAYGn.DE is so dilapidated it has been declared off-limits for heavy lorries, while ordinary cars must slow down to a demeaning 60 kilometres per hour.
The ramifications of Germany’s public-investment thrift have become increasingly visible in everyday life. Angela Merkel, who pledged to tackle the growing problem, is failing to deliver on her promise. For two decades, Europe’s largest economy has been neglecting maintaining its roads, railways and waterways, resulting in a huge investment backlog. The dearth of public investment adds to a longstanding investment restraint in the private sector, which will only be partly offset by a cyclical recovery in 2014. Its decaying capital stock puts the growth perspectives of Europe’s economic powerhouse at risk.
German governments have been in denial about the problem. At least current Chancellor Angela Merkel admits it exists. Yet her promise to increase annual infrastructure expenditure by 1.25 billion euros falls way short of the actual needs. Remedying 20 years of underinvestment requires a spike in public investment at least six times bigger, according to an independent panel of experts. Even worse: the new government in Berlin shuns effective incentive programmes to boost capital expenditure in the private sector.
Germany can easily afford the large-scale investment programme it needs so badly. The country enjoys booming tax revenues and an impeccable borrower reputation. Its interest rates have been hovering around historical lows for more than a year – it costs the country only about 1.8 percent a year to borrow over 10 years. But Berlin has painted itself in a corner with its narrow-minded fixation on fiscal consolidation. Furthermore, the new government prefers splashing out the bulk of additional tax revenues on increased welfare benefits.
In the decade following reunification, Germany spent billions on the modernisation of the former communist East. But maintaining infrastructure in the West was put on hold as a consequence. Once reconstruction was achieved, public investment plummeted from 13 percent of federal spending in 1998 to less than 10 percent today. Government investment currently constitutes only 15.4 percent of total investment in Germany, which puts the country in 25th place among 31 industrial countries.
Merely preventing further decay requires increasing annual public infrastructure expenditure by 4.5 billion euros or 45 percent, government advisors estimate. This still would not address the pent-up demand created during two decades of negligence. The sins of the past add up to at least another 40 billion euros. Sorting this out over 15 years would require another 2.7 billion euros per annum.
The bulk of the cash should be spent on the transport network. Every second bridge in German cities is in need of repair. In coming years, things will only get worse. Sixty five percent of all highway bridges were built between 1965 and 1985. The state-owned railway is craving for cash. One-third of the country’s railway bridges are more than a hundred years old. Deutsche Bahn would have to spend 4.2 billion euros per year to keep tracks, rolling stock and stations in good nick, but can only afford three-quarters of this.
Berlin should act now. The longer it dithers, the more it will eventually have to spend. Furthermore, tighter legal limits on new public debt, which are phased in until 2020, will make borrowing harder as time passes.
The good news is that tackling the public investment crisis is merely a question of political will. By contrast, reversing the longstanding restraint within the private sector is much more intricate. Despite Germany’s strong growth, real equipment investment is still 15 percent below its 2008 peak. After six quarters of decline, it seems to have bottomed out last year.
A cyclical recovery driven by reduced uncertainty in the euro zone and low interest rates may temporarily revive private investment this year. Economic think tank RWI expects a 4.8 percent hike in fixed investment. While welcome, this rebound won’t be strong enough to undo the longstanding investment weakness. Economists still struggle to explain the fundamental reason of the extraordinary slump.
Angela Merkel has promised to lift Germany’s total gross fixed capital formation above the OECD average in the next four year. This is not an ambitious target given that gross fixed capital formation in Germany in 2011 was merely 0.2 percentage points below other OECD countries.
A lasting turnaround would require more structural reforms that would lift the long-term profitability of domestic investment – such as a less complex corporate tax system and a lower tax burden. A more active economic policy, offering tax incentives for companies investing at home, would also help.
So far, none of this is even discussed in Berlin. Germany, but also the rest of Europe, will pay dearly for this myopic frugality.