Beruflich Dokumente
Kultur Dokumente
Introduction
The German economy is the worlds third largest, and IT alone accounts for more or less one-fourth of the European
Unions GDP. With regard to world trade it is second in the world4 . It is the biggest trading partner of U.K., France and
Italy, Europes second-, third- and fourth-largest economies, respectively5 . From the 1948 currency reform until the
early 1970s, West Germany experienced almost continuous economic expansion, but real GDP growth slowed down
and even declined from the mid-1970s through the recession of the early 1980s. The economy then experienced eight
consecutive years of growth that ended with a downturn beginning in the late 1992 (Annexure 1). Since reunification
in 1991, Germany has seen annual average real growth of only about 1.4% and stubbornly high unemployment6 . The
best performance since reunification was registered in 2000, when real growth reached 3.0% on account of global
economic recovery and domestic private consumption (Annexure 2)7 .
German unification has not been a qualified success in terms of economic integration and GDP growth8 . Private
consumption, which accounts for more than 60% of the GDP, rose by 46% for the period 1991-2003. This was insufficient
to offset the decline in government consumption and the volatility of exports. Since 2000, even private consumption
has been declining due to consumers not so optimistic expectation of the economy9 and their increasing propensity to
save. This was partly due to the rise in unemployment and uncertainty of the sustainability of socio-welfare schemes.
Helmet Kohl, who was preoccupied with the unification to the detriment of economic growth, was given marching
orders and was replaced with Gerhard Schrder (Schrder) on October 27th 1998. As promised in the election campaign,
Schrder tried to kick-start the economy with the tax reforms, an exercise with a little success. Subsequently in his
second term, he sought to revive the economy by implementing comprehensive economic reforms, titled Agenda
2010.
1
2
3
4
5
6
7
8
This case study was written by CAnanda Prasad under the guidance of G Srikanth, IBSCDC. It is intended to be used as the basis for class
discussion rather than to illustrate either effective or ineffective handling of a management situation. The case was compiled from
published sources.
2004, IBSCDC.
No part of this publication may be copied, stored, transmitted, reproduced or distributed in any form or medium whatsoever without
the permission of the copyright owner.
FCP0006
Germanys Economic Dilemma To Save or To Spend?
Policy experts believed that Agenda 2010 could be a success only if consumers dilemma to save or to spend,
was settled boosting consumer spending10 . Schrder had to achieve this without resorting to too much of Keynesian
economics as his fiscal and monetary policy maneuverability was constrained by the euro areas stability and growth
pact(SGP) and European Central Banks monetary policy decisions.
12
13
14
15
16
17
18
FCP0006
Germanys Economic Dilemma To Save or To Spend?
The tax cuts cheered companies and consumers alike19 . Germanys business leaders hailed the governments
deficit reduction package as a breakthrough for economic reform. The government reformed corporate tax law with a
view to creating an internationally competitive tax system Corporate tax was cut from 40% to 25% effective from
2001. Moreover, the government spending cuts amounted to DM30bn ($15.9bn). Most of these cuts came from the
labor and social security budget. The rest was spread evenly throughout other government departments. A big chunk
of savings came from linking the annual rise in pension payments to the rate of inflation, as opposed to average
earnings20 . These measures were supposed to strengthen private consumption and facilitate the financing of
investments, both of which are prerequisites for more growth and employment. In the wake of the world economic
recovery in 1999 and 2000, German economy also seemed to recover. In September 2000, 60% of the respondents of
the economy survey said that economic situation looked good or very good21 . However, Germanys economy, which
was dependent on exports, remained vulnerable to external shocks22 . The September 11th 2001 terrorist attack on
World Trade Center shook investor confidence not only in United States but also in Germany along with that in many
industrialized nations. In this context, German employers who needed flexible hire and fire policy failed to get adequate
support from the government authorities, to keep their going concerns going. Budget cuts and tax reforms neither did
address the concerns of international investors nor that of German companies for that matter. As a result corporates
consistently criticized the structural rigidities in the economy, the high and rising cost of labor and the poor mix of fiscal
and monetary policy since German unification.
Corporate tax reform has been a stop-start process, leaving companies uncertain about future tax bills and benefits.
The level of basic corporate tax is still the highest in Western Europe, at 38.7%, compared with 35.4% in France, 34%
in Austria (falling to 25% next year) and 12.5% in Ireland. Though there are ways for companies to reduce this burden,
they tend to favor the larger firms. According to Lorenz Jarass, an economics professor at Wiesbaden University, the
top 30 listed companies tend to get more credits back from the government than they pay in tax. For example, in 2002,
DaimlerChrysler reclaimed a net 1.2 billion ($1.5 billion), while the tax payments of Thyssen Krupp and Lufthansa
netted out at zero23 . That sort of favoritism nags the smaller, Mittelstand companies, which insist they are the backbone
of the German economy, employing 70% of the workforce, accounting for 46% of investment and creating 70% of all
new jobs. There are fewer ways open for them to reduce their tax bills24 .
Apart from employers, employees have also been unhappy about the way the tax cuts were structured. Between
1991 and 1997, the cost of employing German workers went up by 11%. And, since 1999, tax cuts put more money in
the hands of consumers. Consequently consumer demand was supposed to pick up and lift the economic growth rate.
Despite the rise in wage costs, net incomes remained virtually flat because of increases in tax and social security
contributions. Income taxes were reduced only marginally and the social security contributions, which amounted to
40% of wage costs, only came down by a fraction. Since Germany had been a country with high income tax rates, but
relatively generous tax write-offs the combined result was an effective tax increase for many middle - and highincome earners, who drive the consumer demand up (Annexure 4). Moreover, unemployment continued to increase
since 2001, making people pessimistic in their outlook. In May 2002, IFOs25 report mentioned that its business
confidence index fell to 96 from 96.3 in April 2002, according to the median of 38 forecasts in a Bloomberg News
survey26 . A separate survey of economists showed that household spending failed to increase. GDP rose 0.25% in the
months of April, May and June, barely above the 0.2% rise in the first three months of 2002. Unemployment in
Germany rose to a three-year high; business confidence among top companies faded and the countrys leading stocks
markets index, the Xetra Dax, fell by almost 30% further hampering consumer and business confidence27 .
In the backdrop of rising unemployment and poor economic growth, Schrder was expected to lose in the September
2002 elections. However, he was reelected28 . He understood that tax reforms and budget cuts would fail to take the
economy much further and that his country needed the long delayed structural reforms to revive the economy. So, on
March 14th 2003, he announced comprehensive structural reforms labeled Agenda 2010 (Annexure 5). He indicated
19
20
21
22
23
24
25
26
27
28
Tax cuts put extra money in the hands of employers and consumers.
http://www.international.se/wolfgang.htm
German Business Climate darkens July 25th 2002, http://www.cnn.com/2002/BUSINESS/07/25/german.ifo/index.html
Companies generate almost a third of their profits through exports, and almost one in four jobs are dependent on foreign trade., http://www.tatsachen-ueber-deutschland.de/641.0.html
How to pep up Germanys Economy May 6th 2004, The Economist
ibid
IFO Institute is one of the largest economic research institutes in Germany. It is a service-based research organisation with a three-fold orientation: conducts economic research, offers advice
to economic policy-makers and provides services for the research and business communities.
opcit - German Business Climate darkens
German economy barely grew August 19th 2002, http://edition.cnn.com/2002/BUSINESS/08/19/german.gdp/
His re-election in September 2002 was by a tiny margin, based in large part on his opposition to American foreign policy and his response to the preceding summers floods, not on a mandate
for economic change. - http://www.iie.com/publications/papers/posen0903-3.htm
FCP0006
Germanys Economic Dilemma To Save or To Spend?
that the objective of the program was to make structural improvements that would save 45 billion euros in federal
budget expenditure29 . The program was aimed at cutting spending on health, pensions and social welfare, streamlining
the job market, relaxing employment legislation, encouraging people back to work and lowering taxes to boost consumer
spending. The chancellors most controversial reform was aimed at the long-term unemployed, who comprised twothirds of the jobless. Under his proposals, those who remained out of work for six months or more receive lower
benefits, paid out over a shorter period 12 months, rather than 32. Furthermore, if they are offered a job and refuse
to take it, they may lose their benefits altogether. The labor market reforms, part of Agenda 2010, made it easier for
firms to hire and fire employees. Moreover, Schrder and Wolfgang Clement, the Economics & Labor Minister, brought
changes in working hours30 , pushed back retirement age and reduced holidays31 . This was supposed to absorb the
shocks in both the demand and supply side of labor and in turn boost consumer spending. However, the German
consumers seemed to remain in a state of suspended animation unable to decide to save or spend.
To Save or To Spend?
Germany is willing to undergo change. Germany is moving forward. Schrder used these words in a policy
statement delivered on July 3rd 2003, to describe a new mode of thinking brought about by the Agenda 2010 reform
program32 . However, his decision in mid-December 2003, to bring forward the tax reform evidently failed to have the
desired effect on consumers of removing their dilemma to save or to spend. The uncertainty resulting from the continued
controversy regarding tax, social security and pension reforms impacted on the mood and consequently, all consumer
climate indicators were down in January 2004.
The survey carried out by GfK33 in January 2004, showed that the bad mood among German consumers deteriorated
further. It was in direct opposition to the optimism felt by companies (IFO) and the financial analysts (Zentrum fr
Europische Wirtschaftsforschung). According to the IFO business climate index and ZEW, companies and financial
experts continue to be positive about the future. The recent consumer low is attributable to the unresolved political
debate surrounding the tax, pensions and healthcare reforms. The consumer climate indicator, which had been rising
slowly but surely since May 2003, is slightly down for the first time in the recent months.
At the end of 2003/beginning of 2004, German consumers were once again pessimistic about an economic upturn,
following several months of optimism in 2003. With a value of -1.6 points in December 2003, the economic outlook
indicator decreased by a further 4.2 points in January 2004 to stand at -5.8. Consumers did not share the positive
expectations of companies, financial and economic experts with regard to the economy34 . Income expectations were
down again. The indicator lost 2 points in December 2003 and a further 6 points in January 2004. The sobering
development was the manifestation of consumer irritation as to their future financial situation. In the consumers
minds, the fear of potential financial burdens outweighed any possible benefits resulting from the healthcare reform.
Pensioners, in particular, were worried about having to get by on less money at the beginning of 2004. From January
2004 onwards, pensioners had to pay the full healthcare contribution on company pensions. Even the IFO Business
Climate index of manufacturing, construction, retailing and wholesaling in Germany continued its downward slide
during the months of January, February and March 2004. It slightly rose in April only to fall again in May35 (Annexure 5).
In manufacturing, both the appraisals of the business situation as well as the expectations improved slightly. In
retailing the business climate index remained largely unchanged; whereas the assessments of the current business
situation worsened, the business expectations for the coming six months improved. In construction and wholesaling,
however, both components of the business climate index weakened.
The slight decline in the business climate was a result of a worsening in East Germany, but in West Germany the
climate indicator rose a fraction. The latest survey results, especially the nearly unchanged business expectations,
speak for an ongoing, moderate economic recovery in Germany in the later part of 2004. May be Germany was willing
to undergo change. And Germany was moving forward.
29
30
31
32
33
34
35
FCP0006
Germanys Economic Dilemma To Save or To Spend?
Annexure 1
Contd...
FCP0006
Germanys Economic Dilemma To Save or To Spend?
Contd...
FCP0006
Germanys Economic Dilemma To Save or To Spend?
Annexure 2a
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
%
12
11
Inflation (LHS)
10
8
1998
1999
2000
2001
2002
2003
2004
http://www.tradewatch.dfat.gov.au/TradeWatch/TradeWatch.nsf/vEconomicWeb/Germany
2005
2003
FCP0006
Germanys Economic Dilemma To Save or To Spend?
Annexure 3
Highlights of Tax Reforms
A) Highlights of the Tax Reform 2000
The rate of corporate income tax was reduced from 30 percent 40 percent down to 25 percent.
The tax imputation system was abolished. Inter-company dividends between German corporations are
exempt from tax. Individual shareholders are only taxed on 50 percent of the dividends received from
corporations.
A national participation exemption was introduced. All capital gains realized directly or indirectly by a German
corporation from the sale of shares in a German subsidiary are exempt from tax. (Previously, such exemption
was available only in a sale of shares in a non-German subsidiary).
German thin-capitalization rules for foreign investors were tightened.
The depreciation of assets was restricted.
The conversion model, which enabled a step up in basis upon a conversion of a corporation into a
partnership, was abolished.
The quota for a material holding in a corporation was reduced from 10 percent to one percent. Consequently,
the gain resulting from the sale of shares in corporations is tax exempt if the seller owns less than one
percent of the corporation (previously less than 10 percent).
The requirements for a fiscal unity for trade tax purposes have been adapted to the requirements for a
fiscal unity for corporate tax purposes.
The transfer of assets between partnerships and partners and vice versa is tax neutral under certain
conditions.
Partnerships and sole proprietorships are entitled to a tax free rollover of capital gains up to 500,000 from
the disposal of corporations if such capital gains are utilized for the investment in another corporation.
No tax relief is available for the disposal of only a part of a partnership interest by individuals.
Portfolio dividends (participation of less than 10 percent) are subject to trade tax. Expenses connected to
such dividends are deductible for trade tax purposes.
Capital gains by corporations from the disposal of partnership interests are subject to trade tax.
Dividends and capital gains are defined as active income in the context of CFC-regulations.
Dividends and capital gains are tax exempt if the income of a CFC was subject to tax.
FCP0006
Germanys Economic Dilemma To Save or To Spend?
Contd...
FCP0006
Germanys Economic Dilemma To Save or To Spend?
Annexure 4
http://www.international.se/wolfgang.htm
http://www.economist.com/agenda/PrinterFriendly.cfm?Story_ID=1619628
Annexure 5 a
Contd...
10
FCP0006
Germanys Economic Dilemma To Save or To Spend?
Contd...
89.4 90.6 91.7 92.8 93.0 95.3 96.2 97.0 97.5 96.4 95.4 96.3 96.1
Situation
87.1 88.1 88.2 89.5 88.3 91.0 91.8 91.9 92.5 92.6 92.2 94.9 94.4
Expectations 91.8 93.2 95.2 96.3 97.9 99.7 100.9 102.4 102.8 100.3 98.8 97.7 97.8
Source: Ifo Business Survey
Annexure 5b
Contd...
11
FCP0006
Germanys Economic Dilemma To Save or To Spend?
Contd...
-8.4
-Manufacturing
4.5
6.2
-Construction
-44.0 -40.6 -43.5 -42.0 -45.4 -45.2 -41.8 -39.8 -39.2 -39.8 -37.8 -39.5 -41.4
-Wholesaling
-30.9 -29.0 -25.5 -17.9 -20.3 -15.1 -14.6 -12.9 -12.7 -18.0 -15.6 -14.3 -18.1
-Retailing
-22.2 -18.0 -17.1 -25.0 -19.0 -17.6 -23.6 -23.1 -25.1 -24.3 -31.7 -21.7 -21.9
12
0.5
8.3
5.7
3.2
3.9
4.4