Germany: Successful Implementation of Infrastructure Investment Key to Growth, Fiscal Sustainability
Fiscal Space Will Shrink Without Pension and Labour Market Reform
Despite the increase in borrowing, pressure to consolidate the federal core budget will increase over time. Growing expenditures on interest and social security, including on pensions and healthcare, will reduce fiscal flexibility. Projected revenue and expenditure trends imply a reduction in the headroom of non-mandatory spending to only 3% of total expenditure in 2035, from 24% in 2024, according to the think tank Dezernat Zukunft. Scope estimates an increase in net interest expenditure to 1.6% of GDP by 2030, from 1% of GDP in 2024, which, while remaining favourable compared to euro area peers, will reduce Germany’s fiscal space.
With limited fiscal headroom, German governments will likely become even more reliant on exemptions to the existing debt-brake rules or use special funds more frequently to address future challenges. However, both mechanisms come with significant political hurdles as these decisions require two-thirds parliamentary majorities. The current government lacks such a majority, and Scope believes it will be increasingly difficult also for future governments to meet that hurdle given the country’s rising political fragmentation.
To create fiscal flexibility over the medium term, structural reform efforts will need to focus on pensions, since top-ups to the pay-as-you-go pension system are projected to increase from EUR 93.1bn in 2025 to EUR 116.4bn (2.3% of GDP) in 2030. Tax revenues could be supported by increasing employment, including by increasing full-time employment among women and the elderly.
Infrastructure Spending Vital to Closing Investment Gap and Boosting Growth
The timely disbursement of the EUR 500bn infrastructure special fund through 2035 is critical for Germany’s growth trajectory. To ensure additionality, investment levels in the core budget will need to be maintained. Planned investments target high-impact projects primarily in road, rail and digital infrastructure, which should address the most urgent needs to narrow the existing investment gap.
If well executed, these investments could lift Germany’s growth potential towards 1%. Before the special fund was announced, Scope had projected that potential growth would decline to around 0.7% by the end of this decade. Nevertheless, execution risks remain high, since many projects need to be completed in a short period of time. This could stretch planning and construction capacity but also lead to higher inflation. Investments also need to be supported by supply-side and labour-market reforms to raise the country’s growth potential above 1% in line with the government’s goal.
Germany Aims to Meet Revised NATO Target by 2029 With Uncertain Growth Effects
The government has significantly raised its ambitions for defence spending. Spending under the NATO definition is planned to increase from 2.1% in 2024 to 2.4% this year and then trend towards 3.5% by 2029, six years ahead of the agreed timeline (Figure 3). As the planned increase affects Germany the most among EU member states when viewed relative to central government revenues, the German government proactively reformed the debt brake to borrow in excess of 1% of GDP for defence spending.
But the growth impact associated with higher defence spending is likely to be moderate, although that remains somewhat uncertain at this stage. The Kiel Institute estimates that fiscal multipliers for defence spending are only around 0.5x, depending on the extent to which equipment is procured domestically, and how quickly production capacity can be increased.
Figure 3: Germany plans to meet revised NATO target of 3.5% of GDP by 2029
NATO defence spending, % of GDP
