June 05, 2020
What to make of the German fiscal expansion
The German fiscal stimulus is large - at €130bn. On balance, it is also quite good.
The most important fiscal component of the package is the cut in VAT from 19% to 16% for the normal rate, and from 7% to 5% for the reduced rate, from July until December. It constitutes the single biggest element, at €20bn. This is unprecedented in Germany. VAT normally only goes up. What is good about a time-limited VAT rate cut is the purely discretionary aspect of it. Europeans are terrible at discretionary stimulus because they tend to conflate the structural and the cyclical. If you can't send people a check in the post, a dumb but effective form of stimulus common in the US, at least you can cut VAT. Whenever you cut taxes or send a check, you have to consider whether the money will be spent or saved. When you cut VAT, you have to consider whether companies will cut prices to stimulate demand, or whether they will maintain prices and increase profit margins.
We noted a comment from Gustav Horn, the SPD's chief economic strategist. He is clearly unhappy about the VAT cut, which came at the behest of the CDU. Horn thinks it will not do enough to protect vulnerable sectors, and is not big enough as a stimulus of consumption. Its effect will be to widen profit margins.
In its coverage this morning, FAZ points to two conflicting studies on the impact of a VAT cut. One study found that prices react asymmetrically: they rise when VAT goes up, but stay sticky when it goes down. Another study concluded that prices shift in both directions. One point we would make is that past data are useless since we are in very different situation today. The lockdown has damaged supply chains, and caused scarcity of goods in some sectors. This not an environment conducive to economy-wide price cuts.
Most elements of the package were uncontroversial, like the extension of the short-time work programme.
The SPD's big victory is having killed the cash-for-clunkers scheme. The SPD's overt greening has the clear purpose to regain voters it has lost to the Green party. This is an interesting shift. Under Gerhard Schröder, the SPD was the carmakers' party.
We agree with the arguments against a cash bonus for cars. It would be economically inefficient, distort competition and stifle innovation. The only car bonus in the package is a doubling of the government's subsidy for electric cars to €6000, but only for those that cost €40,000 or less. That price ceiling excludes all Teslas. This is a small consolation price for the German car makers, who are struggling with this technology. That programme's value is €2.2bn. Another €2bn is earmarked for public subsidies to high-tech investments, plus a separate €2.5bn for battery production and electric charging stations. This is all good, but not great.
The German car industry is not happy about this mix. Its lobbying power is waning. The big impact, however, will not be on the main car companies, like VW, which is already shifting production towards electric cars. It will be on suppliers, which are much more dependent on the specific engine technology. Fuel-driven engines need a lot more parts, and of different types, than electric engines. We expect big cuts in employment in those sectors.