ESG & Policy Research

German Election 2021: What’s the outlook for economic policy?

On 26th September, Germans will go to the polls to elect the first government of the post-Merkel era. With only days to go, polls remain in flux and leave a wide range of coalition options open. In this blog, we assess the likelihood of different coalition paths and discuss the potential implications for both domestic and European-level economic policymaking.

Turning Left?
In the latest polls, the Social Democrats (SPD) have overtaken the Christian Democrats (CDU/CSU) by around 5 points, raising the possibility that Germany may get an SPD-led government after 16 years of leadership under the CDU/CSU. The latest data place the SPD at around 25-26% of the votes, and the CDU/CSU shockingly below 20% for the first time in post-war electoral polling. Following an early summer debacle, the Greens have now settled at around 15-17% and the FDP follows at 12-13%. The sudden rise of the SPD has been a major change from just a few weeks ago – when it seemed the color of the Chancellorship would be decided in a challenge between the Greens and the CDU – and it opens the door to a whole new range of coalition options. To better understand the feasibility and likelihood of the various election outcomes, we ran a Monte Carlo Simulation Model on poll data.

Our Monte Carlo Simulation Model Suggests a High Probability of an SPD-led Government

We ran 10,000 simulations to compute potential vote distributions, assuming the share of vote for each party follows a normal distribution. The mean of the distribution was calculated by taking the average of the last five polls, while the standard deviation was calculated as the standard deviation of all polls conducted in 2021. The probability of each potential outcome is calculated as the share of its occurrences out of the 10,000 runs. Based on the latest poll data, our model suggests that there are a range of feasible coalition options simply based on the combined votes of their underlying parties. These include three-party coalitions consisting of:

  • CDU/CSU-Greens-SPD (“Kenya”)
  • CDU/CSU-SPD-FDP (“Germany”)
  • Greens-SPD-FDP (“Traffic Light”)
  • CDU/CSU-Greens-FDP (“Jamaica”)
  • Greens-SPD-Left (Left coalition)

as well as the two-party option of CDU/CSU-SPD (Grand Coalition). Other two-party options like CDU/CSU-Greens or CDU/CSU-FDP currently seem mathematically impossible to strike a majority.

In addition, our model suggests an 84% probability for the SPD to come first in the election, compared to a 16% probability for the CDU/CSU. This likely raises the chances of the “Traffic Light”, “Jamaica” and Left coalitions, as the CDU/CSU may dislike the idea of being a junior partner in an SPD-led government. Hence, while mathematically feasible, the “Kenya” and “Germany” coalitions may well be politically less plausible.

Implications for Policy

The latest prediction market odds are in line with the findings of our election model discussed above and point to the top three most likely coalitions being “Traffic Light” (37% probability), Left coalition (17%) and “Jamaica” (15%). What do these options imply for economic policy in Europe’s largest economy?

A Left coalition would certainly constitute the most marked break with the fiscal conservatism embodied by the “Schwarze Null” budget policy and the constitutional debt brake (Schuldenbremse). All members of a Left coalition would be in favor of a more expansive fiscal policy, with strong focus on investment. In their electoral programs, both the Greens and the SPD advocate for EUR 50bn in annual public investment throughout 2030, and they all support an increase in public spending on R&D. On the revenue side, SPD, Greens and Linke share an intention to reform the taxation system in a markedly more progressive direction – including with the introduction of a wealth tax, which they all support albeit with differences in the preferred structure and rates.  

Key Domestic Policy Issues for Germany’s four Largest Parties

Public DebtNo weakening the debt brakeQuickly revert to 60%No mention of debt brakeNo post-COVID austerity, use all ‘constitutionally possible leeway for borrowing’Keep the debt brake but reform to enable more investmentNo weakening of debt brakeQuickly revert to 60%
InvestmentPublic R&D investment of 3.5% of GDP by 2025Strengthen climate for private investment (eg. Through streamlining procedures)Public R&D investment of 3.5% of GDP by 2025The State as a ‘strategic investor’: federal investment of at least 50bn per yearRelief for heavily indebted municipalities and East DE housing associationsAdditional public investment of 50bn per year in this decadePublic investment at 25% of GDP by 2025
TaxationNo tax hikeNo wealth taxNo increase in inheritance taxAbolish solidarity surchargeIncrease family tax breaks and children allowances25% corporate profit tax rateLower income tax for ‘the majority’, hike for top 5%Keep and extend solidarity surcharge for top earnersIn favour of wealth tax (uniform 1% on ‘high assets’)Reform inheritance tax with effective minimum for ‘corporate heirs’ and ‘asset holding family foundations’Increase income tax allowance on lower middle-income groupsIncrease marginal rate for income tax to 45% above 100k and 48k above 200kWealth tax (1% over 2 million)Introduce citizenship-based tax liability (like in the US)25% corporate tax rateReduce tax burden for employees below 40%Shift top tax bracket to income above 90kAbolish solidarity surcharge
Labor / WelfareIncrease retirement age to 67 years old in 2030Strengthen and expand the scope of collective bargaining agreementsMinimum wage raised to 12€, same wage for temporary and permanent workersExpand social security provisions on mini jobsSecure pension level at 48%Non-insurance benefits to be financed through the budget
Climate Carbon neutral by 2045Cut GHG emissions by 65% by 2030 compared to 1990Phase out coal by 2038Extend European ETS to include mobility and heatingAbolish renewable electricity surcharge (EEG)Increase tax deductions for investment in energy efficiencyCarbon neutral by 2045Cut GHG emissions by 65% by 2030 compared to 1990, 88% by 2040Abolish renewable electricity surcharge (EEG) by 2025, financed by federal budgetBuildings’ CO2 price to be borne by landlordsCut subsidies for activities environmentally harmfulCarbon neutral in 20 yearsCut GHG emissions 70% by 2030100% renewable energy by 2035Phase out coal by 2030CO2 price at 60/ton euro from 2023 for industry and electricityLowering EEG surcharge and climate bonus fundAnchor ‘CO2 brake’ in Basic LawNo combustion engine cars sold by 2030 onwardsCarbon neutrality by 2050Abolish EEG surcharge
Source: Algebris based on electoral programs published by CDU/CSU, SPD, Greens, FDP

A Left coalition government would also have an unambiguously positive implication for European integration and EU-level fiscal spending. All three parties advocate a reform of the rules of the Stability and Growth Pact (SGP) to allow for more public investment in the future, and they all see Next Generation EU as a first step towards closer fiscal integration. They are all in favor of introducing an EU digital tax, an EU financial transaction tax, and they support both a common corporate tax base at the European level and minimum global tax. The SPD also advocates the introduction of a Euro-wide unemployment insurance scheme, while the Greens explicitly endorsed the project of a common deposit insurance scheme (EDIS) to complete the EU Banking Union.

Key European Policy Issues for Germany’s four Largest Parties

EU Fiscal RulesReinstate SGP rules with no softeningLess discretion, stricter conditionality in EDPSGP to be reformed into a ‘Sustainability Pact’ to promote investmentSGP to be reformed to support investmentReform SGP to increase penalties for infringement
NGEUTemporary one/offShould become a ‘lasting process’ of integrationTurn it into a permanent investment fundTemporary one/off
EMU ArchitectureNo debt MutualizationComplete BU and CMUNo liability pooling EDISSovereign insolvency framework for EA statesEU should evolve into a ‘real fiscal, economic and social union’Complete BU and CMUIn favor of new EU Own ResourcesIn favor of EZ permanent unemployment reinsuranceStrengthen EU budget with own resourcesTurn ESM into an EU Monetary Fund (EMF) allowed to issue unconditional ST credit linesComplete BU w. EDISNo EDISSovereign insolvency framework for EA statesTurn ESM into EMFNo debt mutualization  
EU Digital TaxationIn favorIn favorIn favorOwn resources are illegal
EU CCTBIn favorIn favor of a minimum global taxIn favor 
EU FTTIn favorIn favorIn favorOwn resources are illegal
Source: Algebris based on electoral programs published by CDU/CSU, SPD, Greens, FDP

Linke’s foreign policy positions (advocating for the abolition of NATO) as well as the party’s low polling numbers may ultimately make a Left coalition impossible. A Traffic Light coalition would appear to be a more feasible option based on polls, but its implications for both domestic and European policy would be more ambiguous. On the domestic front, the fiscal policy stance of a Traffic Light coalition would likely be only slightly less conservative than in the pre-COVID period, but not as expansionary as it would be under a Left coalition. While supportive of public investment, the FDP is in fact strongly opposed to any weakening of the debt brake (although open to exempting some kinds of investment from the rule) and advocates for a swift reversal of the debt-to-GDP ratio down to 60%.

The presence of the FDP in the coalition would also limit considerably Chancellor Scholz’s room for maneuver at the European level, as the party holds a conservative position on all the major files that will be discussed in the coming years. Like the CDU/CSU, the FDP opposes the idea of making NGEU permanent, opposes any kind of debt mutualization, and supports the creation of a sovereign insolvency framework for EA members states. Like the CDU/CSU, the FDP supports the reinstatement of the Stability and Growth Pact as it was before the COVID-19 crisis but also calls for increasing the penalties for infringements. Unlike the CDU/CSU, the FDP goes as far as to oppose any kind of tax levied at the EU level, arguing that EU own resources are illegal.

On both domestic and European-level fiscal policy, the position of the FDP is close to that of the CDU/CSU, making the parties natural coalition allies in a coalition that would be markedly conservative of both domestic and European economic policy issues. With the Christian Democrats polling so low, however, a third partner would be required – raising the possibility of a “Jamaica” coalition including the Greens. At the same time, it is difficult to see how the Greens could compromise to this, as their position on almost any salient campaign issue appears completely incompatible with that of CDU/CSU and FDP.

Overall, it remains exceptionally difficult to predict the outcome of the German election, but we think that the most likely scenario will be one where the SPD emerges as the first party. However, this fact alone would not necessarily imply a major shift in German position on domestic and European fiscal policymaking. A Left coalition would be unambiguously the most positive outcome in terms of both the domestic and the European fiscal policy outlook, but we think the position of Die Linke on foreign policy and the currently underwhelming polling performance of Die Linke and the Greens will make it impossible, leaving a Traffic Light coalition as the most likely scenario. In that case, compromise will need to be found between the progressive platform of the SPD and Greens, and the conservative stance of the FDP. The domestic and European economic policy outlook will therefore hinge on whether the SPD’s advantage will be large enough to give Chancellor Scholz the power to turn the FDP into a real junior partner within the coalition.