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Municipal infrastructure in Germany requires significant strengthening

Press Release of October 22, 2015

Persistent lack of investment among municipalities – social expenditures diminishing financial leeway – structurally weak regions threatening to fall further behind – DIW experts recommend temporarily making use of solidarity contributions to relieve municipalities of social expenditures

Investment in public infrastructure is critical for ensuring competitiveness and creating growth potential in Germany; nevertheless, the country’s municipal infrastructure, in particular, has been deteriorating for years. A group of experts at the German Institute for Economic Research (DIW Berlin) have thus examined Germany’s municipal investment activities.

“In spite of the government surpluses, a large proportion of the municipalities are investing too little, and the problems they are facing will be exacerbated if the economic policy does not swiftly and definitively counteract these issues. Above all, municipalities with high social spending are investing significantly less,” explains DIW Berlin President Marcel Fratzscher. DIW Berlin’s experts therefore recommend temporarily using the solidarity surcharge to relieve municipalities of providing the social benefits for housing and heating costs. This would create the framework for more municipal investment.

Major challenges for investment

Over half of investment in Germany is made at the municipal level, financing day-care centers, schools, and local transport. The future challenges that municipalities will face are manifold, given the shifting demographics and the requirements for the energy transition. Furthermore, municipalities are responsible for organizing and managing the influx of refugees. “By investing in integration, municipalities are shaping not only these individuals’ futures, but their own futures as well,” explains Fratzscher.

Negative net investment since 2003

DIW Berlin’s assessments show that municipal investment activities have been markedly weak for years. The investment rate has dropped by roughly half since 1991, and since the turn of the millennium, municipal investment is no longer sufficient to maintain or modernize existing infrastructure. “The net investment—that is, the balance of investment and depreciation—has been negative since 2003. Since then, more than 46 billion euros’ worth of infrastructure has yet to be replaced,” explains DIW investment expert Claus Michelsen. Even investment from municipal companies has not been able to compensate for this deficit.

Municipal investment unevenly distributed among the states

Clear differences—even at the overall state level—can be found among the thirteen Flächenländer (the federal states excluding the three city-states). The economically powerful states of Bavaria and Baden-Württemberg have the highest expenditure per capita in all of Germany, with 469 and 371 euros, respectively. In contrast, investment expenditure in other West German states is considerably lower, with expenditure in North Rhine-Westphalia and Saarland often amounting to under 200 euros per capita.

An exception is East Germany: There, capital expenditures overall have been rapidly declining since 2004 with the disintegration of the funds from the Solidarity Pact II. In Mecklenburg-Vorpommern, for example, the per capita expenditure dropped from 393 euros in 2000 to just 148 euros in 2013. “The lower the special federal allocations, the more the states’ own minimal tax and financial power come to light—an effect that is exacerbated by population decline,” says DIW regional expert Ronny Freier.

Extreme differences among individual districts and district-free cities (kreisefreie Städte)

Nine of the ten municipalities with the highest investment expenditures are in Bavaria. Topping the list is the district of Munich—one of the strongest economic regions in Germany—with an investment of 724 euros per capita in 2013. By contrast, Wilhelmshaven, in Lower Saxony, was only able to invest 35 euros per capita, making it one of the top ten municipalities with the weakest investment (of which nine are district-free cities). Three cities from North Rhine-Westphalia—Bielefeld, Hagen, and Duisburg—are also among these top ten. No municipalities from Saarland or Mecklenburg-Vorpommern make this list, although these states have the lowest level of investment on average. Halle (Saxony-Anhalt) and Jena (Thuringia) are the only two East German municipalities among the top ten. The only entire county on the list is Odenwaldkreis in Hesse.

Large disparities even within individual federal states

Overall there is a clear north-south divide, with high investment in Baden-Württemberg and—with few exceptions—in Bavaria, and low investment in the other parts of Germany. In Bavaria and Baden-Württemberg, investment is high nearly across the board. In most other states, however, districts with high and low investment can often be found right next to each other. 

Regional differences in municipal capital expenditures have barely changed in years. Municipalities with the lowest investment in the year 2000 could also be found, for the most part, among the municipalities that invested below average amounts in 2013—usually structurally weak regions with low tax revenues and high social spending. The DIW experts have found a clear correlation between low investment and high social spending: “A key factor in consistently low investment is social spending, which reduces the financial scope for investment,” says Freier.

Create more financial leeway for cash-strapped municipalities

Financially weak municipalities are caught in a downward spiral: Since they have no money for investment, they become even more economically disconnected. To break this vicious circle, the DIW experts propose several measures. The federal government can support financially weak communities by shouldering some of their financial burdens, leaving them with more funds for investment. The restructuring of the inter-state fiscal adjustments also offers room for new solutions: “If municipal tax revenues were fully taken into account in the inter-state fiscal adjustments, it would enable the cash-strapped federal states to make more funding for investment purposes available to their communities,” says DIW financial expert Kristina van Deuverden.

Strengthen municipal companies

One significant way to work toward overcoming investment weakness is to strengthen municipal companies, which already finance a substantial portion of infrastructure in many communities. “Municipal companies should take on more tasks, such as constructing administrative buildings and care facilities, because this type of model has for the most part proven successful in the past,” says DIW’s Martin Gornig, who specializes in regional economics. “This would decouple the investment decisions from the community’s day-to-day politics, and make the cost-benefit analyses more transparent.”