Domestic policy makers have few means of sustainably reducing Germany’s current account balance from its present 8 percent of gross domestic product (GDP) to below the 6 percent target set by the European Commission. The kind of debt-financed increase in public spending being called for in many quarters would have only a limited effect, as would unfunded tax cuts. That is the finding of a report titled “Economic, Financial, and Monetary Policy: Effects on the German Current Account,” prepared by the Kiel Institute for the World Economy (IfW) on behalf of the Federal Ministry of Finance. The report is published today in the Kieler Beiträge zur Wirtschaftspolitik series.
“Any attempt to drive the German current account balance below the EU Commission’s target by 2021 via a single policy measure would require borrowing and tax breaks on an unrealistic scale,” said Stefan Kooths, Head of the Kiel Institute Forecasting Center and co-author of the study. “Public investment, for example, would need to be boosted by around €90 billion a year through taking on debt. That represents an increase of 150 percent, which would require borrowing 3 percent of GDP.”
Doing the math on eight scenarios
A more realistically designed set of measures could, according to the report, reduce the current account balance by more than one percentage point by 2021. To achieve this, public investment would have to be increased by €15 billion a year, via borrowing, and corporate taxation would need to be cut by €15 billion—sums equivalent to around 0.5 percent of GDP in each case. This approach would entail some €30 billion of additional borrowing per year. In addition, trade in services would have to be deregulated.
Trade liberalization per se and measures beyond the direct control of German policy makers, such as an increase in nominal wages in Germany, a rate hike by the European Central Bank, or improvements in competitiveness by other EU member states, would not noticeably reduce the German current account balance. Depending on the assumptions made, they might actually increase it.
In their report, the IfW researchers simulate the impact of eight different scenarios on Germany’s current account balance through to 2021. This analysis revealed that the greatest effect in terms of reduction would be generated by debt-financed cuts in corporate taxes. National savings would be absorbed, the domestic economy would be stimulated through greater investment, and imports would rise.
The effect of funded measures is short-lived
Tax cuts totaling 1 percent of GDP would lower Germany’s current account balance by 1.2 percentage points. “At around €30 billion, the reduction in tax would correspond roughly to a 2/3 cut in trade tax rates. Such a drastic reduction is likely to be politically unacceptable,” said Kooths. For a 2 percentage point decrease in the current account balance, the level of tax cuts would have to be doubled, which would equate to abolishing trade tax completely and slashing the corporate tax rate by 50 percent.
If the German government were to increase its investment by 1 percent of GDP, funded by additional borrowing, this would shave just 0.7 percentage points off the current account surplus. An increase in consumer spending would result in a reduction of 0.6 percentage points, while tax breaks for private households would only lead to a fall of 0.4 percentage points.
However, if the measures are fully funded, the impact on the current account balance would be much smaller, according to the researchers. “The effect of all these measures would be only temporary and limited to the duration of savings made elsewhere,” said Kooths.
Irrespective of the report’s findings, the IfW’s economic experts do not feel it is appropriate to target the current account. “The causes of the current account surplus are still poorly understood and it is doubtful whether and to what extent there is any need for a correction,” said Kooths. “Economic policies should not be adopted solely for the purpose of reducing the current account surplus.”
Full report (in German):
Kieler Beiträge zur Wirtschaftspolitik, „Wirtschafts-, Finanz- und Geldpolitik: Wirkungen auf die deutsche Leistungsbilanz“