The Federal Government's growth initiative

Professor Holtemöller, the Growth Initiative aims to provide incentives for more economic growth. Do you think this is the right approach?

Oliver Holtemöller: Boosting economic growth is not a bad idea. While potential growth, i.e. the trend medium- to long-term growth of economic activity adjusted for short-term economic fluctuations, amounted to 1.3% per year in Germany in the period from 1997 to 2023, it has slowed considerably in the last five years and is expected to be only around 0.5% in the coming years. Economic growth is not an economic goal in itself, but prosperity is much more difficult to achieve without economic growth. One only has to think of the challenges posed by transport infrastructure, digital infrastructure, health and care systems and the energy transition.

Why is economic growth slowing down in Germany?

Firstly, the German economy is losing labor. The volume of labor measured in hours is coming under pressure from several sides: on the one hand, natural demographics are dampening the potential labor force, i.e. the population of working age, and on the other hand, those who are still in employment want to work fewer and fewer hours. About half of the decline in the potential growth rate from 1.3% to 0.5% is due to the contribution of the volume of labour. Secondly, less is being invested, meaning that the capital stock is growing more slowly: while its average growth rate in the period from 1997 to 2023 was 1.5%, the economic research institutes assume in their spring 2024 estimate of potential growth that it will be only 0.9% in the coming years. Since the weight of the capital stock in the aggregate production function is about one-third, the difference of 0.6 percentage points means that the contribution of capital accumulation to economic growth is 0.2 percentage points lower. And thirdly, productivity in Germany is no longer increasing as strongly as it used to. Its contribution to economic growth has halved in recent years. Labor input, investment and productivity thus all offer starting points for reviving economic growth.

What effect can the growth initiative have here?

In the case of labor input, economic policy can influence the number of people in employment. However, the number of working hours per employed person has been declining for decades. Looking ahead, it is likely that, with increasing prosperity, many people will prioritize leisure time over higher personal income. Nor can natural demographics be controlled by economic policy, so migration and labor force participation remain as starting points. An extension of working life is just as unpromising politically as more (skilled) immigration, so labor force participation seems to be the most important factor. The main issue here is getting people into work in the first place: better incentives are needed for those moving from unemployment into employment (keyword: transfer withdrawal rates), and the integration of immigrants into the labor market must be accelerated (language acquisition, recognition of qualifications, removal of labor law hurdles). The tax burden also plays a role; however, the expected dynamic of social security contributions is a particular factor that slows down employment. Relief from the solidarity surcharge, as proposedin the growth initiative, is likely to have little quantitative effect.

The growth initiative mixes various instruments and target groups. Some elements are also aimed at private investment: in your opinion, is this the right approach?

I think that expanding depreciation allowances and promoting research can definitely help. But the question is whether this addresses the most important bottlenecks. Probably an improvement in the regulatory environment through a more rational and better predictable policy and additional public investment in infrastructure and human capital (education) are more important for Germany's attractiveness as a business location than additional incentives for private investment. And even if the growth initiative succeeds in stimulating private investment, the effect on economic growth is limited to a few tenths of a percentage point due to the weight of the capital stock in the production function; labor input and productivity offer greater leverage.

How should the economic policy measures aimed at increasing productivity, as outlined in the growth initiative, be evaluated?

Reducing bureaucratic requirements, for example in the Supply Chain Due Diligence Act or in public procurement law, is useful, but not a game changer. Productivity growth is largely based on innovation and the reallocation of resources (labor and capital) from less productive to more productive areas. Germany has a hard time with this. It is true that the loss of jobs is often associated with serious individual hardships. But if you try too hard to save existing jobs or distribute subsidies according to regional considerations, then there is a risk of slowing down productivity growth. The fact that the USA is increasingly outpacing continental Europe in terms of labor productivity is also due to the fact that more creative destruction is taking place on the other side of the Atlantic. Particularly in view of the expected competitiveness of energy-intensive industries in Germany, it seems that policymakers here lack a clear perspective.

What is your overall conclusion regarding the growth initiative?

The approach of strengthening potential growth in Germany is the right one. The growth initiative also offers some not insignificant steps, but they are more of a series of baby steps. The growth initiative is unlikely to have a significant quantitative impact because it contributes too little to Germany's major challenges – demographics, the energy transition and progress through innovation. These are the issues that need to be focused on and given more emphasis in order to increase potential growth.

The questions were asked by Wolfgang Sender.