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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.

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June 05, 2020

Inequality through and after lockdown

The mass protests in the US over George Floyd's death come at the tail end of the pandemic lockdown. After months of isolation to prevent the virus from spreading, people are protesting against racism and police brutality even a the risk of another surge in infections. The protests signal wider discontent about a future that promises even more inequality as a result of the lockdown. 

The lockdown has affected different groups of people differently. Mohamed El-Erian and Michael Spence argue that Covid-19 has led to more inequality in the US and they warn that it will get worse without public support. 

Despite a stimulus package worth 28% of GDP, roughly one quarter of the US labour force filed for unemployment in the last three months. The distributional effects are even more alarming. A survey from the Federal Reserve shows that 39% of workers in households with annual incomes below $40,000 have been laid off or furloughed. About 55% of jobs lost were women's, with African American and Hispanic women being particularly hit. These jobs won't come back soon, as the service sector will witness a slow recovery. But for those at risk of poverty, time is critical.

High-wage white-collar workers survived the lockdown much better, as about 78% in finance and insurance continued to work from home. At the lower end of the wage scale, jobs that have not disappeared are the ones in hospitals, nursing homes and supermarkets, all prone to end up in poverty if they fall ill. Educational inequality also increased as children in households hit by unemployment may have less access to online education. 

El-Erian and Spence called on governments to ramp up their efforts to prevent straining the social fabric further. They recommend increased coronavirus testing as a way to allow activities to come back quicker in the service sector. The stimulus needs to continue with more focus on the vulnerable, and speedy actions will have the biggest impact. Relief and stimulus measures should aim at re-engaging the vulnerable, including through labour retaining and retooling programmes implemented by the government and by public-private partnerships. Without such policies, alienation and marginalisation will fester, increasing the potential for social unrest, the authors warn.

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