For decades, Germany has been the poster child of fiscal conservatism, adhering to its self-imposed debt brake and prioritizing balanced budgets over long-term investment. While this approach kept government debt low, it came at a significant cost: namely, crumbling infrastructure, lagging digitalization, and an underfunded military.
But now, in a dramatic shift, Germany is embarking on a historic fiscal reset. The recent announcement of a massive stimulus package marks a clear departure from austerity, signaling a pivot in policy with the potential to reshape Germany’s economic future.
We will explore what the implications of the massive fiscal spending surge are for the German economy and labor market.
Germany has enough fiscal space for the €1 trillion bazooka
The new coalition between CDU/CSU and SPD plans has come to an agreement with the Green party (future opposition) to push through a massive fiscal package for infrastructure and defense spending, which has been approved by parliament this week.
The bill contains additional defense spending worth several hundred billion euros. Another €500 billion would be allocated to a special fund for investments in infrastructure and green energy. Additionally, the bill gives German federal states more leeway to increase their deficits.
Summing up the various measures means that German public spending might increase by more than one trillion euros in the coming years. The public debt-to-GDP ratio, currently at the lower end amongst advanced economies, would increase from below 65% to 70%.
While this sounds alarming, economists think that Germany has enough fiscal space to spend an additional two trillion euros in the coming decade without harming growth.
So, higher spending equals higher growth?
Yes, but caveats apply.
Economists generally agree that the massive fiscal bazooka that the government is pulling out will generally be good for growth, especially since Germany’s economy has contracted for two years in a row.
There is some uncertainty about the size of the growth effect though. Economic estimates about the so-called fiscal multiplier – the extent to which fiscal spending can generate GDP growth – vary widely. It depends on a large number of factors, such as the state of the economy, what the money is spent on, and to what extent rising interest rates and monetary policy will offset the effect.
Initial estimates suggest the German stimulus will significantly boost economic growth in the coming years, and the positive effects would last until the early 2030s.
In response to the stimulus, both research institutions and financial institutions have significantly revised up their growth estimates for Germany for this year and next.
Interest rates are surging across Europe
Interest rates across Eurozone economies increased by about 0.4 percentage points following the announcement of the public spending bazooka suggested by the coalition.
However, this is not a “Liz Truss moment”. Rising yields do not reflect panic in the market but rather the prospect of higher economic growth and slightly higher inflation thanks to the German stimulus and higher defense spending across all of Europe.
Financial markets now believe that interest rates will remain higher for longer and that the ECB will not cut the policy below 2.25% by the end of this year (previously below 2%).
Some of the economic stimulus will therefore be offset by tighter monetary policy to contain inflationary pressures. Nevertheless, growth will be higher than in the absence of said fiscal easing.
What are the implications for Germany’s labor market?
A large determinant of the size of the growth boost is the state of the labor market. Economic research shows that the fiscal multiplier is substantially higher when the economy is weak and the labor market has a lot of slack.
While there is no doubt that the German labor market is weaker compared to the period coming out of the pandemic, Germany’s unemployment rate has remained relatively low.
The unemployment rate measure that is comparable to other countries currently stands at about 3.5%. The unemployment rate published by the German Federal Employment Agency – a broader definition of unemployment – has risen by more than one percentage point and now stands at about 6.2%.
While the trend is obviously alarming, the rate is still low compared to where it has historically been in recent decades.
Given Germany’s demographic outlook, labor shortages remain a big obstacle for companies across all sectors. Surveys show that a lack of labor has been one of the biggest constraints to economic production in recent years.
Even though the economy has been stagnating since 2022, more than 30% of businesses in the construction sector currently report that labor shortages affect their production.
This is bad news for the German government and their infrastructure-heavy stimulus. Tightness in the construction sector will therefore only increase. This will lead to rising wage pressures and higher construction costs, both of which will spill over into other sectors.
We recently saw a similar phenomenon happening in the U.S. with the Biden stimulus. New analysis suggests that the increase in infrastructure spending (when adjusted for inflation) was smaller than anticipated, precisely because the hot labor market exacerbated wage pressures and rising input prices, both of which led to runaway costs in construction.
While Germany’s situation is somewhat different because it has experienced a more severe cyclical downturn, labor shortages in construction and other sectors remain a big concern.
Population projections show that Germany’s working age population might decline by close to five million in the coming ten years, subject to large uncertainty since future migration movements are hard to predict.
The decline in the German labor force can therefore only be stopped if workers retire much later – somewhat unlikely in the construction sector which requires manual labor – or if Germany continues to receive significant migration inflows. However, the latter, even if economically desirable, has become politically more challenging with the far-right party getting about 20% of the vote in the last election.
The German infrastructure stimulus will therefore offer less bang for the buck than if Germany had done this a decade ago. First, long-term interest rates were below 1% instead of 3%, meaning a lower debt burden. Second, labor shortages are more prevalent right now than before the pandemic, which leads to rising costs of said infrastructure projects.
A new European skills index shows that the construction sector is already suffering from labor shortages (a value of one indicates no shortage while four indicates an intense shortages). Once the large infrastructure program has ramped up, the demand and competition for workers in construction, transport, and skilled trades is only going to intensify.
Explanation of the index:
The index focuses on three pillars driving labour shortages: demand, where high-growth occupations may outpace skill provision; supply, highlighting replacement needs as workers retire or change careers; and imbalances, identifying mismatches between job qualifications and requirements.
What does that mean for recruiters?
Germany stimulus spending means labor shortages in construction will become even more prevalent. Compensation in the sector will rise and wage pressures will spill over into other sectors. Currently, the market for blue-collar workers in Germany is already relatively tight with significantly higher wage growth than before the pandemic. If you are recruiting in that space, do not expect your hiring challenges to go away any time soon. And prepare for even tougher competition for labor in the future as the stimulus will further increase labor demand for these workers.
