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The German Grand Coalition Agreement: A Triumph for Merkel



Despite the concessions made by Chancellor Angela Merkel to the also-ran parties in the German election last month, the new governing Grand Coalition strengthens her dominance of German and European politics for several reasons.

For the Social Democrats, a No-Win Situation

The 470,000 members of the Social Democratic Party (SDP) must still vote on whether to join the government, knowing that if they balk they will be left out in the cold. Their likely assent will give the Social Democrats a mandate for their program, but they have embarked on a dangerous strategy. True, the SPD has won major victories on policy substance, from the inclusion for the first time of a German minimum wage, to the lowering of the retirement age to 63 for workers with long contribution periods, and several other rollbacks of parts of former Chancellor Gerhard Schröder's labor market reforms of a decade ago. But the SPD will find it hard to take much credit for adjustments introduced by a Merkel-led government. Instead, the chancellor has again proven her ability to adopt parts of her opponents' agenda, depriving them of ways to attack her. The SPD may well end up having won on policy substance, but losing power in the next election. Ironically, Merkel—despite securing her political right flank by avoiding new taxes—has become the longest serving "social democratic chancellor" in German history.

In the end, the chancellor controls the political center in Germany and holds all cards in Berlin. And if the grand coalition succeeds, it is hard to see what will stop Merkel from running and winning again in 2017, when she will be just 63 years of age.

The Grand Coalition Agreement at a Glance

The concessions won by the SPD amount to something its leaders can take to their members, even though they are not very dramatic. Changes can still be made during implementation, but this is a status quo agreement. It does little, for example, to address the two largest challenges facing the German economy—the aging population and a seemingly intractable low rate of investment in the economy. The main components of the accord are:

1) A new minimum wage of €8.50 an hour.

The new statutory minimum would start in 2015, though exceptions are possible until 2017 for sectors covered by agreements among the social partners. A permanent exception is moreover given to those 12 sectors covered by the Posted Workers Act (Arbeitnehmer-Entsendegesetz, AEntG) in federal German law. Several of these regulated sectors already have minimum wages of around €7.50 an hour in the former East Germany1, making it likely that they will remain below the new €8.50 minimum after 2017. Moreover, the coalition agreement calls for an expansion of the coverage of the Workers Act to still other sectors of the economy.

A German sector falls under the AEntG's jurisdiction if the social partners in the sector request that the federal Ministry of Labor and Social Services elevate their agreed wage and working conditions as "generally binding in their sector." This is typically a practice requested if a sector is subject to competition from foreign-owned firms unbound by the German collective bargaining agreements. Some sectors have also had a minimum wage dictated by the AEntG rescinded again.2 The federally mandated minimum wage under the AEntG amounts to a voluntary option for the social partners in a sector. Many more sectors will likely seek to come under its coverage if the partners feel that such a step is in their best interest. The €8.50 minimum is thus an optional minimum.

The new minimum wage will also be subject to regular review by a new commission of the social partners—who for decades have opposed a federal statutory minimum wage in Germany—with the power to adjust it "as required."3 Were the new minimum to be found as damaging for job creation, it could be lowered again, notably in East Germany. The new German minimum wage therefore may not last very long at the agreed (by the politicians) €8.50 an hour level.

The other noteworthy proposed labor market policy change would limit temporary work at the same location to 18 months. In addition, anyone working "temporarily" at a job for more than nine months must be paid the same as a permanent worker. These steps may reduce employer flexibility, but they would lower the differences between permanent insiders and temporary outsiders.

2) A reduction in the pension age to 63 for workers with long contribution periods.

Since 2012, the age at which workers with 45 years of pension contributions can retire with a full pension has been 65 years. The coalition agreement lowers this age to 63. But the age at which a full pension is available will rise again from to 65 years in line with the rise in the general German retirement age from 65 to 66 in 2023 and 67 in 2029. The change amounts to only a temporary reduction in the retirement age lasting 15 years. There seems to be no compelling inter-generational fairness reason for granting this temporary reduced retirement age for access to a full pension, and it is an example of pure short-term pandering to voters.

It is also not clear just how many periods of unemployment will now begin to count towards the 45 years of contributions, though this opens a potentially substantial hole in the German government pension system's sustainability.

Lastly, a new minimum pension for lower paid and minimally employed workers is to be introduced, along with a special "mother's pension" for women who have left the work force to raise children. The "mother's pension" could reinforce the atavistic German tradition of expecting women to raise their children while not working, however.

All together, the pension changes weaken long-term sustainability for the pension system and inter-generational fairness. They will also lower Germany's credibility in structural reform negotiations with other euro area countries.

3) €23 billion in increased government investment in the next four years.

The coalition agreement calls for adhering to balanced budgets and all EU fiscal policy restraints while adding €23 billion in additional spending on such "priority measures" as education, infrastructure, urban renewal, and research and development over the next four years, equivalent to only 0.2 percent of GDP annually.

For a country that has experienced a decline in levels of investment, producing a record 6 to 7 percentage point gap in GDP between gross national savings and investments in recent years, this is underwhelming. This is especially so because the German government faces record low financing costs, with public investments as a share of GDP declining from around 2.2 percent in the mid-1990s to just 1.65 percent.4 Germany's general government investment ratio is well below the euro area average of 2.3 percent and likely to remain at that level through 2017. This constitutes only around half of the public investment levels in France, the Netherlands, and Sweden. Surely, for Europe's leading economy to remain at its current capacity, there must be more things worth investing in by the German government in Germany these days!

4) Steps toward a banking union.

Germany favors a full imposition of costs on creditors in troubled banks along with a speedy and effective Single Resolution Mechanism (SRM) for their dissolution. The Germans also seek to respect the budgetary sovereignty of the member states5 when it comes to using taxpayer funds to help banks. As the German finance minister Wolfgang Schäuble has insisted, the power to dissolve banks is to rest with member states and not the European Commission.

The cost of bank rescues to member state taxpayers can be excluded from the 3 percent fiscal deficit ceiling imposed by the Stability and Growth Pact, but states unable to finance a bank bailout without risking economic instability can apply for help with the European Stability Mechanism (ESM) according to the existing procedures.6 The current timetable for the SRM calls for it to be established by next May. The German Bundestag would have to approve any bailout that imposes a cost on German taxpayers. In addition, the European Central Bank (ECB) is to become the chief European bank regulator by next November. Because it will take years for a euro area resolution fund supported by the banking industry, the new German coalition is committed to support a new ESM direct bank recapitalization instrument of up to €60 billion, available only after full creditor haircuts and exhaustion of available national resources. In other words, direct ESM bank recapitalization is only available to countries that would otherwise lose market access because of losses in their banking systems.7

The agreement clearly envisions a direct bank recapitalization of banks as potentially part of the upcoming bank stress test exercise, the results of which are to be published late next year, after which undercapitalized banks must seek private capital. Only if such private solutions are not possible are the public backstops to be required—something that will be discovered after the stress tests and after the ECB begins its supervisory function in November 2014.

The guidelines for direct bank recapitalization from the ESM are not without risks. Banks can lose the confidence of markets very quickly, after all, and governments are generally unwilling to accept "appropriate conditionality" in the absence of financial market pressure. The coalition agreement therefore sets up a plan for handling holes in the euro area bank balance sheets (and sovereign finances) that could be visible in 2014. It might take some financial market volatility to make it succeed, however. For the euro area, plus ça change, plus que c'est la même chose!


1. For instance, security services (Sicherheitsdienstleistungen) and indoor maintenance cleaning (Innen- und Unterhaltungsreinigungsarbeiten).

2. This is for instance the case in mail delivery services and some mining and laundry services. See Statistisches Bundesamt: Mindestlöhne.

3. The agreements states: "Die Höhe des allgemein verbindlichen Mindestlohns wird in regelmäßigen Abständenerstmals zum 10. Juni 2017 mit Wirkung zum 1. Januar 2018von einer Kommission der Tarifpartner überprüft, gegebenenfalls angepasst und anschließend über eine Rechtsverordnung staatlich erstreckt und damit allgemein verbindlich."

4. General government investments, as a percent of GDP from the Eurostat sector GDP accounts from 1995 and latest available data from 2011.

5. The agreement states: "Wir wollen den europäischen Abwicklungsmechanismus auf einer rechtssicheren Grundlage errichten, sodass Banken rechtzeitig, effektiv und effizient abgewickelt werden können. Für den Abwicklungsmechanismus wollen wir eine zügige Lösung erreichen, die ausreichenden Schutz für die Budgethoheit der Mitgliedstaaten bietet."

6. The agreements states; "Sofern ein Mitgliedstaat zur Bankenrettung alleine nicht in der Lage ist und in eine gefährliche ökonomische Schieflage geraten würde, kann er im bestehenden Verfahren ESM-Hilfe beantragen."

7. The agreements states; "Sobald der Aufbau eines europäischen Abwicklungsmechanismus beschlossen ist, kann, nachdem der deutsche Gesetzgeber eine entsprechende Entscheidung getroffen und die EZB die Aufsicht operativ übernommen hat, als Zwischenlösung ein neues Instrument zur direkten Bankenrekapitalisierung auf Basis der bestehenden ESM-Regelungen mit einem maximalen Volumen von 60 Mrd. Euro und insbesondere mit der entsprechenden Konditionalität und als letztes Instrument einer Haftungskaskade in Frage kommen, wobei sichergestellt ist, dass vorher alle anderen vorrangigen Mittel ausgeschöpft worden sind und ein indirektes ESM-Bankenprogramm mit Blick auf die Schuldentragfähigkeit des Staates ausgeschlossen ist. Eine dauerhafte übernahme direkter Bankenrisiken durch den Steuerzahler lehnen wir ab."

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