Germany’s Beveridge Curve

Today’s blog post is all about the so-called Beveridge curve. It describes the negative empirical relationship between the unemployment rate and the job vacancy rate. It can be used to gauge the state of the labour market and generally indicates where an economy is in the economic cycle (Bleakley and Fuhrer, 1997). In recessionary times, the economy moves towards the lower right corner due to an increase in unemployment and a reduction in vacancies. In expansionary times, the economy moves towards the upper left corner due to a natural fall in unemployment and an increase in vacancies posted by companies (figure 1). The position of the Beveridge curve itself is dynamic over time. It can shift out- or inward due to changes in factors like matching efficiency. An example would be the implementation of effective training programmes by the government which reduce the skills mismatch between the readily available labour and the job openings in the country. Such policies would tackle structural unemployment, shifting the Beveridge curve to the left (figure 1).

beveridge-curve-1
Figure 1 – The Stylised Beveridge Curve (Own work)

While figure 1 represents a stylised Beveridge curve, one can obtain actual data from the OECD, Eurostat or other national databases to estimate the curve empirically. I plotted the empirical Beveridge curve for Germany over the period from 2006 to 2016 in figure 2. First, the job vacancy rate can be obtained from Eurostat and is represented on the y axis. To be more exact, it is the vacancy rate for industry, construction and services (except activities of households as employers and extra-territorial organisations and bodies). The unemployment rate can be obtained from the Deutsche Bundesbank and is represented on the x axis. They have seasonally adjusted unemployment data readily available but I used the quarterly unadjusted unemployment rate because the vacancy rate quoted in Eurostat is likewise unadjusted. Also, in order to distinguish between the different states of the economic cycle, I divided the empirical Beveridge curve into the expansionary and recessionary periods in the Euro area as defined by CEPR (2016). Since 2006 there have been two major downturns, namely the global financial crisis and the European debt crisis:

Start End Euro Area
1993Q4 2008Q1 Expansion
2008Q2 2009Q2 Recession (Global Financial Crisis)
2009Q3 2011Q3 Expansion
2011Q4 2013Q1 Recession (European Debt Crisis)
2013Q2 today Expansion

Having described my methodology, let’s look at the diagram in detail. First, we can compare the state of the labour market in the first quarter of 2006 with the second quarter of 2016 and it becomes obvious that the German economy has moved along its Beveridge curve from a low vacancy/ high unemployment state to a high vacancy/ low unemployment state over the last decade. In the second quarter of 2016, the job vacancy rate quoted by Eurostat was at 2.4 percent while unemployment was at a historic low of 6 percent in comparison to unemployment rates in the years before.

beveridge-curve-2
Figure 2 – Germany’s Beveridge Curve (Data source: Deutsche Bundesbank, 2016; Eurostat, 2016)

Second, we can look at the Euro area expansionary and recessionary periods sequentially and examine potential changes in the German labour market. In the run-up to the global financial crisis (dark blue section), we can see a significant movement along the curve to the left, indicating major improvements in the German labour market. Over the financial crisis itself (green section), we observe a significant temporary dislocation of the Beveridge curve in the first two quarters due to a reduction in the job vacancy rate. However, the vacancy rate jumped back up in the third quarter of the recession followed by an increase in the unemployment rate of 1.2 percent from the last quarter of 2008 to the first quarter of 2009. The subsequent expansionary period (grey section) has overall led to further increases in the vacancy rate and reductions in unemployment despite considerable temporary jumps. More recently, however, the German economy has appeared unimpressed by the weak European macroeconomic outlook (blue and orange section) and its labour market recovered quickly from the increase in unemployment of around 1 percent over the course of the European debt crisis at the end of 2012. Since the second quarter of 2013, its job vacancy/ unemployment rates cluster in the upper left corner, signalling a strong labour market and a relative resilient national economy compared to the rest of Europe. Lastly, one could argue that, according to the data, Germany has not experienced major permanent shifts in its Beveridge curve over the last decade but rather movements along the curve. This stands in contrast with economies like the US where economists debate over a permanent outward shift in the Beveridge curve over the global financial crisis with higher structural unemployment rates for a given job vacancy rate post-recession (Zumbrun, 2014).

So that’s me for today; my post looked at the Beveridge curve both theoretically and empirically for the case of Germany. I hope you enjoyed my work and many thanks for reading!

Jasse


References

Bleakley, H., and Fuhrer, J.C. (1997). Shifts in the Beveridge Curve, Job Matching, and Labor Market Dynamics. New England Economic Review, Sept./Oct. 1997, p.3-19.

CEPR (2016). Euro Area Business Cycle Dating Committee. Available at: http://cepr.org/content/euro-area-business-cycle-dating-committee [Accessed 01 November 2016]

Deutsche Bundesbank (2016). Time series BBDL1.Q.DE.N.UNE.UBA000.A0000.A01.D00.0.R00.A: Unemployment registered pursuant to section 16 Social Security Code III / Germany / Social Security Code III and Social Security Code II / Rate / Unadjusted figure. Available at: https://www.bundesbank.de/Navigation/EN/Statistics/Time_series_databases/Macro_economic_time_series/its_details_value_node.html?https=1&tsId=BBDL1.Q.DE.N.UNE.UBA000.A0000.A01.D00.0.R00.A [Accessed 01 November 2016]

Eurostat (2016). Job Vacancies Database. Available at: http://ec.europa.eu/eurostat/web/labour-market/job-vacancies/database [Accessed 01 November 2016]

Zumbrun, J. (2014). Peter Diamond Thinks the Beveridge Curve Might Not Tell Us Much of Anything. The Wall Street Journal Online. Available at: http://blogs.wsj.com/economics/2014/08/26/peter-diamond-thinks-the-beveridge-curve-might-not-tell-us-much-of-anything/ [Accessed 01 November 2016]

Germany’s Energiewende – The New Electric Mobility Strategy

I am pleased to see that Germany continues to drive its energy transition. The so-called ‘Energiewende’ (German for energy transition) is overhauling the country’s energy concept fundamentally. Thereby the three pillars of the new energy concept are reliability, environmental sustainability and economic viability. The government’s vision is to transform the country into a role model for energy efficiency and a green economy coupled with competitive energy prices and a high level of prosperity (BMWi, 2010). The four main political objectives of the energy transition are to combat climate change, to avoid the risks of nuclear power, to improve Germany’s energy security and to increase competition and growth in the sector (Pescia and Graichen, 2015). But there are more potential benefits to it, including the reduction of energy imports and therefore oil dependency and exposure to external energy supply shocks, as well as the strengthening local economies and the provision of social justice (Morris and Pehnt, 2015).

In order to achieve the ambitious vision, the government’s agenda includes:

  1. Cost-efficient expansion of renewables, e.g. expansion of offshore and onshore wind farming and increasing sustainability and efficiency in the use of bioenergy
  2. Enhancing energy efficiency of private households, the industry and the public sector, e.g. the modernisation campaign for buildings with the vision of energy-efficient buildings by 2050
  3. Shifting the energy mix away from nuclear power and fossil-fuel power plants toward renewable energy sources
  4. Improvements in the country’s grid infrastructure and storage technologies with demand-responsive electricity generation
  5. Electric mobility strategy with one million electric vehicles on Germany’s streets by 2020 and six million by 2030
  6. Energy research programme with focus on innovation and new technologies regarding renewable energies, energy efficiency and storage methods (BMWi, 2010).

Although some of the policy measures, which the government has adopted, are debatable, the overall plan is clearly well thought out. A month ago I already dedicated a blog post to the idea of ecological fiscal reforms (green tax shift) and eco-social market economies. In this post I used Germany as a textbook example for the evidence of the wide-ranging benefits of such green reforms.

In my opinion, the ‘Energiewende’ provides the necessary nudge to the industry, consumers as well as the public sector to enhance their energy efficiency and sustainability. It reshapes the incentives of economic actors in favour of green research, innovation and consumption. In addition, it is also a poster child for demonstrating that “coherent government policy can transform an industry” and that it is possible to “to blend low-risk feed-in tariffs with market price signals” (Fares, 2014).

The motivation for today’s post stems from the fact that Germany is now starting to implement its electric mobility strategy (item 5 on the agenda above). It is about to introduce a new nudge targeting electric cars. In particular, the German Federal Cabinet has just approved a new legislative package for the preferential treatment of electric cars. It will include a subsidy of 4,000 Euro when purchasing a new electric car and 3,000 Euro when purchasing a hybrid car. In addition, electric cars will be exempt from the motor vehicle tax for a period of 10 years (Tagesschau, 2016). This initiative for electric mobility will be funded jointly by the government and the automobile industry, each contributing 0.6 billion of funding. According to the government Daimler, VW and BMW have already agreed to the 50:50 split in costs (ZEIT, 2016). The initiative will be coupled with the roll out of charging points. This, in turn, will be funded by the Federal Government swallowing another 300 million of public funds.

The main goal of the latest initiatives for electric mobility is to achieve a more than ten-fold increase the amount of electric and hybrid cars from currently less than 50,000 to more than 500,000 in the short-run and to more than one million in the medium-run (Tagesschau, 2016). As noted earlier, electric mobility is at the heart of the country’s energy transition. Transport is currently one of the main drivers of Germany’s oil dependence. It continues to rely heavily on fossil fuels rather than renewable energy sources despite efforts like the development of the National Hydrogen and Fuel Cell Technology Innovation Programme (BMWi, 2010). This is why the government is now taking action. It is starting to pave the way for preferential treatment of electric cars in order to increase the incentives for both fleet operators and first-time private buyers to purchase an electric car and to drive its energy transition also in the area of transport.

Overall, the legislative package still has to be discussed and approved by the German Federal Parliament and Federal Council. However, the package is likely to go through shortly with the subsidy for the purchase of electric and electric cars being expected to already begin in May. Subsidies will be claimable through an online application facility (Tagesschau, 2016). So there are interesting times to come; especially whether the subsidy will be sufficient to increase the adoption of the electric mobility technology. Electric cars continue to carry an excessive price tag for their zero emissions image. Even under the assumption that both fleet operators and first-time private buyers care about the image associated with a zero-emission vehicle (BMWi, 2010), it is not clear whether this together with the government’s subsidy and tax exemption is an incentive large enough to justify the higher initial investment costs. One should not forget that it is ultimately the price which determines demand (and supply). The initiative has the potential to break ground, but it is unlikely to turn the larger share of society into electric car users; at least not yet. Still, I would argue that we are heading into the right direction due to the right policy mix. Firstly, Germany focuses on competition and market orientation. Secondly, Germany introduces incentives in favour of greener transportation without restricting society’s choices as well as important incentives for green innovation. Both are key to rethink transportation and mobility issues in a century where renewable energy sources are clearly on the rise.

 Thanks for reading,

Jasse


BMWi (2010). Energy Concept for an Environmentally Sound, Reliable and Affordable Energy Supply. Berlin: Federal Ministry of Economics and Technology. Retrieved from: http://www.bmwi.de/English/Redaktion/Pdf/energy-concept,property=pdf,bereich=bmwi,sprache=en,rwb=true.pdf

Fares (2014, 7 October). Energiewende. Two Energy Lessons for the United States from Germany. Retrieved from: http://blogs.scientificamerican.com/plugged-in/energiewende-two-energy-lessons-for-the-united-states-from-germany/

Morris, C., and Pent, M. (2015). Energy Transition: The German Energiewende. Berlin: Heinrich Böll Stiftung. Retrieved from: http://energytransition.de/wp-content/themes/boell/pdf/en/German-Energy-Transition_en.pdf

Pescia, D., and Graichen, P. (2015). Understanding the Energiewende: FAQ on the ongoing transition of the German power system. Berlin: Agora Energiewende. Retrieved from: https://www.agora-energiewende.de/fileadmin/Projekte/2015/Understanding_the_EW/Agora_Understanding_the_Energiewende.pdf

Tagesschau (2016, 18 Mai). Kaufprämien und Steuerboni für Elektroautos: Kabinett beschließt Förderung. Tagesschau Online. Retrieved from: http://www.tagesschau.de/wirtschaft/elektro-autos-103.html

ZEIT (2016, 27 April). 4.000 Euro Prämie für Kauf eines Elektroautos. ZEIT ONLINE. Retrieved from: http://www.zeit.de/politik/deutschland/2016-04/bundesregierung-elektroautos-subvention-kaufpraemie

A Decade of Inflation* in Germany

I was keen to get my hands on more data on Germany and finally found out about the GENESIS online database of the Federal Statistical Office. It gives you access to a vast range of datasets, for example longitudinal data on the labour market, demographic trends or inflation. What I want to do today is to use the CPI and its sub-indices for the period 2005 to 2015 to analyse which goods and services have become much more expensive over the last decade. So what has really driven (and what has not driven) inflation in Germany? And what has contributed to the slowdown of inflation and deflationary pressures recently?

For this I obtained the CPI data from the GENESIS database. Originally it was indexed to 2010. However, to spot trends more easily, I changed the base year to 2005. So let’s look at the basket of the typical German consumer first. What is included?

  1. Food and non-alcoholic beverages
  2. Alcoholic beverages and tobacco
  3. Clothing and footwear
  4. Housing, water, electricity, gas and other fuels
  5. Furniture, lighting equipment, appliances etc.
  6. Healthcare
  7. Transport
  8. Communication
  9. Recreation, entertainment and culture
  10. Education
  11. Accommodation and restaurant services
  12. Miscellaneous goods and services

The CPI consists of 12 categories of which some contain further sub-indices. For example food is separated into bread, meat, dairy, fruits etc. while transport contains the purchase of vehicles as well as maintenance and service costs or the cost of transport services (railway, road, air, waterway).

Germany Inflation CPI 1
(Source: Destatis, 2016)

So let’s look at the data. The CPI rose by 15.6 percent over the period from 2005 to 2015. This means that inflation, on average, was at around 1.6 percent per annum which is close to the ECB’s desired target of just under 2 percent. However, this does not reveal the significant differences among the categories and the differences in price increases between certain years. While categories 4, 7 and 12 saw a similar total increase as the overall CPI over the period, others rose a lot more rapidly, as shown in the diagram above. Germany saw the most significant price increases in the areas of food, beverages and tobacco. On the other hand, prices actually fell in the area of communication, driven by much cheaper prices for telephones and other communication devices and cheaper telecommunication services. Prices in categories like healthcare or recreation, entertainment and culture rose to a lesser extent than the CPI in total. Overall, inflation came almost to a halt in the period from 2008 to 2010 (global financial crisis) and again recently since 2014.

Germany Inflation CPI 2
(Source: Destatis, 2016)

Let’s take a closer look at the first category – food and non-alcoholic beverages. For example, there is a significant difference among animal source foods. Dairy and eggs saw a price spike in 2008 and 2014. Compared to 2005, the price for dairy and eggs was more than 25 percent higher in 2015. Meat prices rose by 22.6 percent over the decade but prices were much less volatile than dairy prices. The most significant price increase in animal source foods was recorded in fish and fish products of more than 36 percent over the decade.

Germany Inflation CPI 3
(Source: Destatis, 2016)

The highest total price increase in the food category for the complete period was recorded in the price of fruit. Compared to 2005, fruit prices today are more than 40 percent higher. One can also see that prices fell during the global recession 2008/09 but thereafter picked up again. In comparison, vegetable prices actually saw higher price increases until 2010 with a similar drop during the global recession. After 2010, however, vegetable prices decreased in some periods and increased in others, so that the total price increase over the decade turned out to be only around 27.9 percent. Prices for edible fats and oils peaked in 2013 with a total price increase of almost 45 percent from 2005 to 2013. Since 2013 prices in this category have fallen by 6.72 percent.

Germany Inflation CPI 4
(Source: Destatis, 2016)

Bread and cereal prices as well as prices for sugar, jam, honey etc. rose more than the overall CPI over the decade but with less price fluctuations than the other food categories. However, while inflation has almost come to a halt recently, prices in these two categories still increase. Bread and cereal prices rose by more than 5 percent from 2012 to 2015. Sugar, jam and honey prices rose by more than 7 percent. Over the same period the CPI only rose by 2.7 percent.

Germany Inflation CPI 5
(Source: Destatis, 2016)

Regarding non-alcoholic beverages prices for coffee, tea and cocoa were relatively volatile from 2005 to 2015. They increased by 10.6 percent from 2010 to 2011, that is in only one year. Since 2013 the prices have picked up again. Both prices for coffee, tea and cocoa as well as mineral water, soft drinks and juices stagnated or actually fell during the period from 2008 to 2010 due to the global recession. Since 2014, however, mineral water, soft drinks and juices have become cheaper.

Germany Inflation CPI 6
(Source: Destatis, 2016)

In the second category the main price driver is tobacco. Prices for alcoholic beverages rose in tandem with the CPI. In comparison, tobacco prices rose by more than 38 percent over the decade. This has been a steady increase, even during the recession.

Germany Inflation CPI 7
(Source: Destatis, 2016)

Another important category is housing and in particular gas and electricity. Germany passed its green energy agenda in the last decade in order to turn to more sustainable sources of energy in the long run. Many have argued that this has contributed to the significant cost increases in electricity. Electricity prices increased steadily from 2005 to 2014 by more than 63 percent. From 2014 to 2015 they fell slightly. From 2012 to 2013 alone electricity prices rose by almost 12 percent. However, the price of liquid fuels at its peak in 2012 was actually even higher; compared to 2005 it was almost 66 percent higher. Liquid fuel (oil) prices were much more volatile than electricity prices over the last decade. During the recession liquid fuel prices fell to 2005 levels and since 2012 they have become significantly cheaper for German consumers. The tremendous fall in oil prices is also one of the reasons for low inflation recently and might push Germany into deflation if the fall continues. In comparison, gas and central heating rose a lot until 2009 but have recently receded to 2008/09 levels.

Germany Inflation CPI 8
(Source: Destatis, 2016)

Transport includes air, waterway, road and railway but CPI data on the latter is only available from 2010. Hence it is not included in the diagram. One can easily see that, while all means of transport have become more expensive, waterway is by far the most expensive today. It increased by more than 63 percent from 2005 to 2015. Air travel prices rose significantly until 2012 and have more or less stagnated since then. The highest increase in air travel prices occurred over the period from 2010 to 2012 where prices went up by more than 20 percent. In comparison, road transport actually rose in tandem with the CPI at least until 2013. But over the year from 2014 to 2015 prices in this category increased by more than 12 percent, despite the stagnating CPI, making other alternatives like air travel more attractive.

Germany Inflation CPI 9
(Source: Destatis, 2016)

As mentioned earlier, communication was the only category that actually saw a decline in prices. This is largely due to cheaper telephones (smartphones) and the advancement of technology. Over the last decade, telephone prices have fallen by more than 68 percent. Prices for telecommunication services fell by almost 19 percent. On the other hand, postal and courier services prices stagnated until 2012 but have picked up recently.

Germany Inflation CPI 10.png
(Source: Destatis, 2016)

Price increases in the category newspapers, books and stationery differed in the last decade. While newspapers and periodicals have become more expensive, i.e. more than 45 percent more expensive than in 2005, the price for books has risen to a much lesser extent and actually declined slightly from 2014 to 2015. Book prices stagnated until 2008 and were back to 2005 levels in 2011. On the other hand, stationery and drawing materials rose in tandem with the CPI.

Germany Inflation CPI 11
(Source: Destatis, 2016)

Lastly, I want to take a closer look at education. The CPI component ‘services of secondary education’ is only available from 2010 and therefore not included in the diagram. Still, the picture is an interesting one. By 2008 tertiary education prices had more than doubled. This was caused by the introduction of tertiary tuition fees. But in the years that followed these fees were abolished step by step and by 2015 none of the federal states charged tuition fees anymore. The spike in the price for tertiary education also drove the CPI Education index (in green) in total. It therefore hides the fall in the price of pre-primary and primary education from 2007 to 2012. By 2012 prices in this category had fallen by more than 10 percent. In 2015, they were back at 2005 levels.

I hope you enjoyed today’s exercise. It gives some insight into the major differences in inflation across different categories of the CPI basket. Thanks for reading!

Jasse


*moderate to low inflation

Destatis (2016). Consumer price index: Germany, years, individual consumption
by purpose (COICOP 2-4-digit hierarchy) [Data file]. Retrieved from: https://www-genesis.destatis.de/genesis/online/data;jsessionid=B59BF66301C1C234D86C5CD4208C6CFF.tomcat_GO_1_1?operation=abruftabelleAbrufen&selectionname=61111-0003&levelindex=1&levelid=1462699226069&index=3

Germany’s Shrinking Middle Class

The DIW has released an alarming new study on the shrinking middle class in Germany. It also links neatly into the debate of rising income inequality. New calculations based on the Socio-Economic Panel (SOEP) revealed that Germany’s middle class shrunk by 6 percentage points from 1991 to 2013 (Grabka, Goebel, Schröder and Schupp, 2016). This is as alarming as the adverse developments in the USA.

Germany income inequality 1
Diagram 1 (Source: Grabka et al., 2016; World Bank, 2016)

Germany’s middle income class includes all people in households that earn a gross total income of 67 to 200 percent of the median. The country’s middle class is still the largest income group today. However, the DIW study reveals that Germany’s middle class is now on decline. This is due to the fall in the middle-income group’s share in the adult population, meaning that less people earn a wage (high or low enough) to be classified as ‘middle class’. On the other hand, there has been an equal increase in people earning more or less (Grabka et al., 2016).

The DIW states that over the period from 1983 to 2013 the middle income group’s share in the adult population declined from 62 percent to 54 percent. This 8 percent decrease has been redistributed evenly to the other income groups. While 4 percent entered the low income and lower-middle income group, the other 4 percent entered the upper-middle income and high income group (diagram 1). Furthermore the middle class also saw a significant decrease in its share in total income while the high income group saw a significant rise in its share in total income. The study finds that the middle class’ share fell by more than 10 percentage points over the period from 1991 to 2010 (Grabka et al., 2016).

 Table 1

Gini Coefficient – Net Household Income

Year Germany West East
1991 0.247 0.245 0.205
2011 0.288 0.291 0.257

(Source: Sachverständigenrat Wirtschaft, 2015)

The DIW findings are not completely new. The Sachverständigenrat Wirtschaft releases a periodic study on income and wealth distribution in Germany. Its analysis published in 2014/15 (also based on the SOEP) showed similar trends. The study revealed that Germany’s Gini coefficient in net household incomes increased from 0.247 to 0.288 in 2011. Thereby it actually peaked in 2005 with a coefficient of 0.293. Importantly, income inequality is still greater in West Germany (0.291) compared to East Germany with a Gini coefficient of only 0.257 (2011).

 Table 2

Gini Coefficient – Equalised Disposable Income

Year Germany West East
1991 0.411 0.406 0.375
2011 0.485 0.472 0.529

(Source: Sachverständigenrat Wirtschaft, 2015)

When one looks at equalised disposable incomes (Marktäquivalenzeinkommen), the problem of income inequality becomes even more apparent. The Gini based on equalised disposable incomes has seen an increase from 0.411 in 1991 to 0.485 in 2011. Importantly, East Germany has seen a significantly greater increase than West Germany and is now more unequal than its counterpart. While East Germany’s Gini was 0.375 in 1991 it had risen to 0.529 in 2011. Over the same period West Germany’s Gini only rose from 0.406 to 0.472.

Germany income inequality 2
Diagram 2 (Source: BPB, 2014; Sachverständigenrat Wirtschaft, 2015)

The rise in the Gini coefficient can be shown graphically if one constructs Germany’s Lorenz curve for 1991, 2005 and 2011 based on the SOEP data (diagram 2). It has shifted outward and, because the Lorenz curves do not cross, it is clear that income inequality has risen from 1991 to 2005 while it somewhat improved from 2005 to 2011. The diagram shows nicely that the main shrinking in the middle class happened in the 1990s and the early 2000s. When one looks at equalised disposable incomes, the story remains the same even if it is less pronounced (diagram 3). However, this Lorenz curve was already significantly farer away from the line of equality than the net household income distribution Lorenz curve in 1991.

Germany income inequality 3
Diagram 3 (Source: BPB, 2014; Sachverständigenrat Wirtschaft, 2015)

 

While Germany’s middle class is in decline and income inequality on the rise, it should be noted, that the country still performs considerably better than the OECD average and other highly developed countries. Germany’s society is still a rather equal society in international comparison. The inequality adjusted HDI sat at 0.853 in 2014 and recorded a loss of 6.9 percent in potential human development due to inequality. Thereby inequality in life expectancy at birth (3.7 percent) and inequality in education (2.4 percent) played only a minor role. The main driver is income inequality at 14.1 percent, dampening potential human development. In international comparison, however, inequality in income is at 22.5 percent for very high HDI countries and even at 23.6 percent for OECD countries (UNDP, 2015).

Hence income inequality is of concern now but it is not too late to revert these adverse developments. It should be a key priority to stop a further increase in income inequality so that the fruits of economic growth and development continue to benefit the larger share of the population. Germany needs to ensure that it does not miss out on people at the lower end of the income distribution and does not further diminishes its middle class which has been one of the drivers of the country’s economic success since the mid-2000s.

Thanks for reading my post today as this is an issue one should care about.

Jasse


BPB (2014). Die Soziale Situation in Deutschland: Zahlen und Fakten – Einkommen und Vermögen [pdf]. Retrieved from: http://www.bpb.de/system/files/dokument_pdf/08%20Einkommen%20und%20Verm%C3%B6gen_1.pdf

Grabka, M.M., Goebel, J., Schröder, C., and Schupp, J. (2016). Shrinking Share of Middle-Income Group in Germany and the US. DIW Economic Bulletin, 18, 199-210. Retrieved from: https://www.diw.de/documents/publikationen/73/diw_01.c.533123.de/diw_econ_bull_2016-18.pdf

Sachverständigenrat Wirtschaft (2015). Analyse: Einkommens- und Vermögensverteilung in Deutschland [pdf]. Retrieved from: http://www.sachverstaendigenrat-wirtschaft.de/fileadmin/dateiablage/gutachten/jg201415/JG14_09.pdf

UNDP (2015). Human Development Report 2015: Briefing note – Germany [pdf]. Retrieved from: http://hdr.undp.org/sites/all/themes/hdr_theme/country-notes/DEU.pdf

World Bank (2016). World Development Indicators: Germany. Retrieved from: http://data.worldbank.org/country/germany

The Recent Slowdown of Inflation in Germany

Today I want to take a look at two common measures of inflation, namely (1) the Consumer Price Index (CPI) and (2) the GDP deflator for Germany from 1991 to 2015. For this I obtained the indicators from the World Development Indicators database (World Bank, 2016). The database contains the CPI and the GDP deflator as well as the corresponding inflation rates.

germany inflation 1
(Source: World Bank, 2016)

Let’s take a look at CPI inflation in Germany first. Inflation came down from 5.08 percent in 1992 to 0.23 percent in 2015. After 1994, the country experienced CPI inflation below the 2 percent level except from 2007/08 (still below 3 percent) and 2011/12 (little above 2 percent). Overall, many of the fluctuations in Germany’s CPI can be attributed at least partly to changes in the price of oil. In particular, the spike in inflation in 2008 was triggered by the oil price shock, resulting in rising transport and heating costs, as well as by the 2007-08 world food price crisis. The temporary drop to 0.31 percent CPI inflation per annum thereafter derived from rapidly falling oil and commodity prices. This was because the global recession led to a negative demand shock in 2009 after the initial negative supply shock in 2008. Also the second spike after the recession in 2011/12 can be attributed to the recovery of oil prices and their subsequent fall to extremely low levels in 2014 and 2015 compared to the 2000s.

In comparison, inflation measured by the GDP deflator has somewhat diverged from CPI inflation after 1995. It fell rapidly most of the time from 1992 to 2000 to -0.45 percent and it was highest in 2013 at 2.09 percent. In most years since 1995 it has been below CPI inflation except from 2003, 2009 and 2013. The difference between the two measures was greatest in 2000 at 1.9 percentage points followed by 2008 with 1.8 percentage points and 1997 with 1.6 percentage points. As the GDP deflator only includes domestic produce, it underestimates inflation in case of imported inflation such as through oil imports, which is what seemed to have happened in 2008 or 2011/12, for example.

germany inflation 2
(Source: World Bank, 2016)

But how did Germany perform overall over the period? Germany has an inflation target close to 2 percent in line with the Eurozone and the ECB. The diagram above shows that after the slowdown of inflation in the 1990s, Germany came close to its inflation target from 2003 to 2008. After 2008, however, inflation took a further hit and reduced to an average of 1.26 percent per annum over 2009 to 2014, not to mention the recent fears of deflation. This slowdown in inflation is of concern as interest rates – as the main tool to control inflation – are already low, almost tying the hands of monetary policy (liquidity trap). It can be said that Germany is currently performing better than its European peers in terms of unemployment and recovery from the GFC with a strong manufacturing sector which has shifted its focus to faster growing eastern markets (Speciale, 2015). However, somewhat higher inflation could support GDP growth and the restrengthening of the economy. Conversely, if low inflation was to become persistent, it could induce consumers to delay spending as things get cheaper over time or companies to hoard cash rather than invest. A slide into deflation would increase debt servicing costs, i.e. the debt burden, which would pose a drag on government finances and economic growth.

In summary, Germany did ‘tame’ inflation, but after 2008 the success reversed from too high inflation to too low inflation. Low inflation has played a key part in the sluggish recovery, even if Germany is currently outperforming its European peers.

Thanks for reading!

Jasse


Speciale, A. (2016, 7 January). Germany Tracking Shift in Global Growth Drives Europe’s Recovery [online]. Bloomberg. Retrieved from: http://www.bloomberg.com/news/articles/2016-01-06/germany-tracking-shift-in-global-growth-drives-europe-s-recovery

World Bank (2016). World Development Indicators: Germany [Data file]. Retrieved from: http://data.worldbank.org/country/germany

The Great Green Tax Shift – Evidence from Germany

I would like to dedicate today’s post to ecological fiscal reforms and eco-social market economies. It is inspired by Paul Krugman’s essay Earth in the Balance Sheet: Economists Go for the Green in The Accidental Theorist (1998). In the essay Krugman proposes a green tax shift away from taxes on employment and income towards pollution taxes. Therefore the first half the post looks at the concept of such a green tax shift. In the second half I want to take Germany as a textbook example to provide evidence for the wide-ranging benefits of such a tax shift.

What is the concept of a green tax shift? A green tax shift (also called ecological fiscal reform) is a reform of a country’s tax system by shifting existing taxes towards pollution taxes. Its aim is to facilitate a long-term transition to sustainable development (Beauregard-Tellier, 2006). These pollution taxes as well as taxes on other negative externalities include for example carbon taxes, waste disposal taxes or taxes levied on companies for effluents that lead to a degradation of the environment. The IMF goes further than this and names a second dominant economic instruments for controlling pollution, namely tradable permits and emissions taxes (Norregaard & Reppelin-Hill, 2000).

The main idea of a ecological fiscal reform is to induce companies to internalize the social costs they impose on society via fiscal policy. This is because in the past companies have benefited from facing production costs far less than their true social costs. Things like the depletion of resources, pollution and disposal of waste water into rivers do not have a price tag on them and are therefore not factored into the private costs of firms. This problem is normally associated with public goods (like fresh air and water) which suffer from the free rider problem or the tragedy of the Commons. Public goods are by definition non-excludable and non-rival inducing people to overuse resources, pollute etc. However, the ecological fiscal reform also targets individuals through taxes on fossil fuel or electricity consumption. Therefore such a green tax shift is both levied on consumers and producers.

The green tax shift concept is more complex than introducing pollution taxes. It recognises that – like any tax – it comes with side effects, i.e. incentives to work and save less ultimately reducing GDP. To mitigate this effect, the revenue collected by the green taxes is offset by reductions in taxes like social security (Krugman, 1998). To keep GDP stable a country should pursue a revenue neutral tax shift and maintain the same tax progressiveness. In addition, the country probably has to take measures to mitigate the effects on the country’s poorest people because they tend to spend relatively more of their income on gas, electricity, water and transport (BBC, 2004).

Nonetheless, the burden for such a green tax shift to work is high. Reforms need to be accompanied by the improvement of local amenities. One issue is to ensure the supply of local products and services to reduce greenhouse gas (GHG) emissions to a minimum level. This could work in practice if people need to spend less on transport and have a higher share of their income available for locally sourced products and services. Also, such a green tax shift only works if lifestyle becomes more focused living “locally” in the community. In such an environment there would be no need for commuting anymore. There are many levers that need to be put in place to make this vision reality. Examples are more telework or local permaculture (e.g. urban farming in Cuba).

What would be the potential benefits of such a shift? Firstly, if the revenue from green taxes exceeds the amount needed for the tax relief in other areas it could be used to subsidise research and development in sustainable energy. Furthermore, one would hope to see a change in the society’s attitude towards more environmentally friendly cars, housing and consumption goods. What is more, it could lead to a rethinking in the real estate sector favouring green buildings if their return on investment increases to levels above the one of conventional buildings.

According to Krugman (1998, p.171) there are three main problems that have led the Great Green Tax Shift to be a “complete political nonstarter”; he calls them three I’s:

  1. Ignorance
  2. Interests
  3. Ideology

As far as I understand, ignorance is associated with the credibility of levying taxes on the one hand and lowering taxes on the other hand. Public debates tend to be biased towards tax increases, ignoring the tax relief in other categories. Secondly, interests play an important role. “Anti-environmental” groups like energy companies tend to lobby governments actively while society is less powerful when it comes to lobbying “pro-environment”. Lastly, ideology is a major burden. The left-wing tends to declare pollution as evil and that “it is immoral to put a price on it” (Krugman, 1998, p.172) because it would ultimately justify pollution and the right-wing completely refuses government action in favour of free markets. In addition to these problems mentioned by Krugman one should also note that determining the correct level of taxation and designing a complete new green tax collection system poses a huge challenge. It could lead to further distortions and unintended consequences.

In the remainder of the post I want to look at Germany and its Ecological Tax Reform Act passed on 24 March 1999. This reform led to an initial increase in fossil fuel taxation and a new tax on electricity consumption. Over the period from 2000 to 2003 there were four further tax increases. The objective of the Ecological Tax Reform Act is to mitigate carbon dioxide emissions and foster job creation as well as more innovation (IEA, 2013). The reform was mainly a green tax shift because up to 90% of the revenue from the green taxes went to “offset payroll contributions from employers and employees with much of the remainder going towards the funding of renewable energy schemes” (IEA, 2013, p.28). A drawback of the reform is that there are some exemptions for certain manufacturers in energy-intensive industries.

green tax shift.png

What were the effects of the green tax shift in Germany? For this I obtained data from the World Bank’s World Development Indicators on aspects like Germany’s GDP and GHG emissions. Most notably GHG emissions fell – mainly in the transport sector – and people reduced their energy consumption. The fall in GHG emissions is even more impressive because GHG emissions have decreased despite people using more transport. This finding is in line with the concept discussed before, i.e. inducing people to change habits towards cleaner cars and new technologies.  The IEA also reports that environmental taxes on transport as percentage of total taxation have fallen from 5.2% in 2005 to 4% in 2010. This refutes the argument that a green tax shift could be a major burden for the economy. This can also be seen in the diagram. It seems that GDP per capita has not been constrained by the Ecological Fiscal Reform Act. What is more, research and innovation seem to have taken off to new levels if one uses Researchers in R&D (per million people) as an indicator. The IEA also notes that Germany is now “among the world leaders in terms of energy-efficient buildings” (2013, p.41) due to heat demand reduction, its upcoming clima-neutral policy for new buildings and reduction in primary energy demand. Hence, rather than an adverse effect on GDP the green tax shift seems to have had positive effects due to higher R&D and the search for new cleaner technologies. This induces more sustainable wealth-creation and a future-oriented economy. Innovation is one of the drivers of productivity and a main determinant of long-term growth (see augmented Solow growth model). This seems to hold for Germany as fiscal policy has induced the society to rethink. Therefore the IEA rightly concludes that Germany has mastered the green tax shift and that the Ecological Tax Reform Act has allowed the country to decouple economic growth from GHG emissions with the help of renewable energy and improved energy efficiency.

That’s me for today! I hope you enjoyed today’s topic as much as I did. I was surprised to find such a forward-looking essay on a more eco-social market and ecological fiscal reforms in a book of the 1990s while it took the OECD until 2011 to publish an Environmental Taxation Guide for Policy Makers. Germany is only one of few OECD countries having implemented such a shift but the concept has the potential to change a lot!

Thanks for reading!

Jasse


BBC (2004, October 26). Green taxes ‘would hit poor most’. BBC News. Retrieved from: http://news.bbc.co.uk/2/hi/uk_news/3955285.stm [Accessed 20/04/2016].

Beauregard-Tellier, F. (2006). Ecological Fiscal Reform. Ottawa, Canada: Parliamentary Information and Research Service. Retrieved from: http://www.lop.parl.gc.ca/content/lop/researchpublications/prb0595-e.pdf [Accessed 20/04/2016].

IEA (2013). Energy Policies of IEA Countries: Germany 2013 Review. Paris, France: International Energy Agency. Retrieved from: https://www.iea.org/publications/freepublications/publication/Germany2013_free.pdf [Accessed 20/04/2016].

Krugman, P. (1998). The Accidential Theorist: And other Dispatches from the Dismal Science. New York, N.Y.: W.W. Norton & Company.

Norregaard, J., and Reppelin-Hill, V. (2000). Taxes and Tradable Permits as Instruments for Controlling Pollution: Theory and Practice (Working Paper No. WP/00/13). Retrieved from International Monetary Fund website: http://www.imf.org/external/pubs/ft/wp/2000/wp0013.pdf [Accessed 20/04/2016].

OECD (2011). Environmental Taxation: A Guide for Policy Makers. Retrieved from: http://www.oecd.org/env/tools-evaluation/48164926.pdf [Accessed 20/04/2016].

World Bank, 2016. World Development Indicators. [data] Retrieved from World Development Indicators (WDI) database: http://databank.worldbank.org/data/reports.aspx?source=world-development-indicators&preview=on [Accessed 20/04/2016].