Germany’s debt-brake drama is poison for Deutschland Inc and for Europe’s monetary union
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Economists have long warned that Germany’s constitutional debt-brake is a timebomb on a long fuse. That bomb has now detonated at the most critical moment in German economic history since the launch of the Wirtschaftswunder in 1949.
The Scholz government must plug a fiscal hole of €128bn to comply with a ruling by the top court, either by slashing spending, or by raising taxes or by bleeding investment in the rising technologies of the next half century. Analysts at Citigroup estimate that €87bn of this must be covered over the next 13 months.
Finance minister Christian Lindner on Thursday took the dramatic step of suspending the debt-brake for 2023 to cover part of the problem, invoking an emergency clause to justify raiding the Economic Stabilisation Fund for money to pay for Germany’s energy price cap.
“We put the expenditure for the price cap on a constitutionally secure basis,” he said.
It remains to be seen whether the judges at the Verfassungsgericht agree. There must be a high risk of further court challenges by the defenders of Ordoliberal purity. The larger problem remains in any case: the government cannot fund its core technological investments without cannibalising other parts of the budget.
It must either abandon its plans or tighten fiscal policy into the teeth of a deepening economic slump, amid the steepest fall in property prices since modern records began.
Even “Olaf Scholz Tower” is in trouble. Signa Group has run out money to pay wages on its 64-storey Elbtower in Hamburg, leaving a half-built concrete shell brooding over the port district of the Chancellor’s home town.
“It is a dangerous situation. Investment is going down, construction is going down, and we could be heading into a very deep recession,” said Heiner Flassbeck, former state secretary for the economy.
“The debt-brake is the result of pure ideology. Austerity will lead to a deeper recession and then the deficit will grow, and there will have to be further cuts, and so on,” he said.
The law is written into the constitution. It restricts the structural budget deficit to 0.35pc of GDP and became the role model for the eurozone regime of budget surveillance, culminating in the final folly of the Fiscal Compact. In short, it drove the macroeconomic errors that inflicted a debt-deflation crisis and a lost decade on the eurozone.
The debt-brake was introduced by finance minister Peer Steinbrück in 2009, who misunderstood the global financial crisis in every way and at every stage, famously accusing Gordon Brown of “crass Keynesianism” for the sin of countercyclical stimulus during the worst peace-time crash since 1931.
Herr Steinbrück has since recanted. His baleful creation endures. It cannot be repealed without a two-thirds majority in both houses of parliament. The opposition Christian Democrats show no willingness to oblige.
The court judgment that set off this drama a week ago is technical and complex. The key point is that the judges ordered the coalition to stop using ring-fenced funds to evade the deficit ceiling. This cuts off €60bn earmarked for clean-tech from the Climate and Transformation Fund (KTF).
Some €20bn of state and local subsidies promised to Intel and Taiwan’s TSCM for advanced semiconductors plants near Magdeburg are now in jeopardy. So is Solar Valley in Saxony-Anhalt.
“If nothing is done. Our solar industry is going to be destroyed a second time,” said Michael Kellner, the economic state secretary. Last time the cause was technology theft and predatory dumping by China. This time the threat is coming from Joe Biden’s Inflation Reduction Act.
ThyssenKrupp has already begun work on low-carbon steel with a switch from blast furnaces to a direct iron reduction process using green hydrogen. State support for its multi-billion “tkH2Steel” project is now up in the air.
Bernhard Osburg, head of the German Steel Industry Association, said the court ruling has created an economic emergency. “It threatens to bring investments to a standstill, and cause massive and irreparable damage to our industrial fabric (Standort)”.
What about Northvolt’s EV gigafactory in Schleswig-Holstein, with a half a billion of state aid? Or CATL’s plant in Erfurt?
The Institute for Economic Research in Berlin (DIW) said Germany is in danger of losing its footing across swathes of industry, from electrification, to green hydrogen and digital technology, if the country cannot match the incentives of the US and China.
You could argue that Germany alone has been a model of fiscal probity while others have succumbed to ruin. It has a debt-to-GDP ratio of 66pc: France is at 112pc and the US will soon be above 130pc (IMF measure).
But there is a price to pay for this national doctrine of Ordnungspolitik.
“Net public investment has been negative for 20 years. The state is living off its capital at the expense of future generations,” said Marcel Fratzscher, the DIW’s director and author of the Germany Illusion. The country has clung too long to an obsolescent economic model and has failed to build the foundations of a new model.
The rot was disguised during the long years of Merkel immobilism, when Germany’s export industries rode the China boom, and enjoyed a sweetheart gas deal with Russia. Those props have been knocked away. China now competes toe-to-toe with Germany across the same products in global markets.
If ever there was a moment for Germany to tap the lowest borrowing costs in the West to reboot its manufacturing system, it is surely now, as the economy ministry under Robert Habeck understands perfectly. But the country is stuck with the debt-brake, and the mindset that led to it.
The fiscal drama in Germany makes Europe’s monetary union even less workable. It demolishes any last hope that Berlin will let the EU’s €800bn Recovery Fund evolve into a proto-EU treasury. There will be no joint debt issuance to underpin the euro, and no Hamiltonian fiscal union.
The gaping hole in the construction of the single currency will remain. The debt ratios of Germany and France will diverge ever further, putting intolerable strain on the EU’s central axis.
There will be a further bias towards fiscal contraction across the monetary bloc. “If the Germans are saving like Hell, they are going to put enormous pressure on everybody else to do the same,” said Prof Flassbeck.
There is no going back to the extreme austerity of 2010-2015 in Europe but the logic of German retrenchment is that the country will again try to export its way out of trouble by compressing labour costs, taking market share from the rest of the eurozone via beggar-thy-neighbour mercantilism.
That may not be the intention. It is the outcome of such a policy mix within a fixed exchange regime. The German current account surplus is already 6pc of GDP. It could return to the toxic level of 8pc. This time the South will fight its corner more tenaciously.
Whether the nine scarlet judges of the Verfassungsgericht realise it or not, they have just made Europe’s monetary union an even more fractious and unhappy house for everybody.
