Germany Needs a Recession to Start Spending

Leonid Bershidsky

(Bloomberg Opinion) -- Germany is on the brink of a recession. This isn’t happening because of any structural problems: U.S. President Donald Trump’s trade wars are the main culprit. Still, Germany’s powerful industrial lobby now is openly questioning the government’s adherence to the famous schwarze Null, or zero budget deficit, policy.

Output shrank by 0.1% in the second quarter compared with the previous three months. The contraction is a consequence of a drop in industrial production and construction that amounted to 0.6% of gross domestic product. Government spending and domestic demand, which was stronger than in the first quarter, compensated for most of this decline. “Had we seen a domestic demand in this cycle as weak as we saw it in the recovery after 2005, the German economy would already be back in a deep recession,” tweeted Sebastian Dullien, an economics professor at the University of Applied Sciences in Berlin. 

Germans haven’t felt too much pain from weakening demand for the country’s export goods, especially cars and machinery.  Unemployment dropped to a record low of 3.1 percent at the end of June on the back of a healthy services sector and domestic demand. 

Yet with more trade shocks possible – after all, Trump has kept threatening the European Union with tariffs – pressure is mounting on the German government to do more to boost the economy. The Greens and some Social Democrats from the party’s left flank have called for more government spending to fund a quicker green energy shift and infrastructure improvements. But more importantly, the country’s mighty industrial lobby, the Federation of German Industries (BDI), has also argued for reexamining the deficit-free policy. 

In an op-ed published in the business daily Handelsblatt on Wednesday, BDI chief Joachim Lang called for investment incentives for innovation and government funding for artificial intelligence and a stronger digital infrastructure.  While the government can borrow at negative rates, it should go to the financial markets and obtain “a double-digit billion amount in the medium term” for a state venture fund; it should also cut taxes for businesses by 15 to 20 billion euros ($17 billion to $22 billion) to stimulate private investment.

“Unlike the debt brake, which is enshrined in the constitution, the schwarze Null ought be reexamined given the fragile situation,” Lang wrote.

Germany’s constitution, indeed, limits the structural budget deficit to 0.35% of economic output and only allows a bigger shortfall during a slowdown if it’s repaid when growth picks up again. But Germany’s negative borrowing costs make the government’s determined stinginess rather illogical to an increasing number of political players. Chancellor Angela Merkel’s ruling Christian Democratic Union clearly won’t be penalized by its traditional support base for loosening the purse strings in such a situation. On the contrary, more generous policies can increase its support and bring back some of the voters the CDU has lost in the last two years, especially to the Greens.

Merkel and her chosen successor, Defense Minister Annegret Kramp-Karrenbauer, as well as Finance Minister Olaf Scholz, recently have defended the deficit-free policy. They have argued that the current budget surplus provides enough flexibility for added spending if needed, and more stimulus would come from the planned elimination of the so-called solidarity tax, meant to boost the economic development of Germany’s eastern states, in 2021. The government’s draft 2020 budget is still based on a zero deficit.

On Tuesday, though, Merkel gave the first indication that this conservative stance could be reconsidered if things get worse. “We will react according to the situation,” she said.

It’s unclear what it will take for Merkel finally to change her mind. In a way, it’s sensible for her and Scholz not to rush things. Giving up the schwarze Null would be a major turnabout, and the government needs a strong reason for it. The CDU and the Social Democrats don’t want to be seen yielding to pressure or engaging in cheap populism to win back voters.

They need to decide whether a technical recession is a good enough reason to use the heavy artillery or whether it would be wiser to wait for more clarity on how Trump’s trade wars play out. Given Germany’s low unemployment, strong domestic demand and long horizon before the next big election, Merkel can afford to ponder the right timing.

To contact the author of this story: Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor responsible for this story: Stephanie Baker at stebaker@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Leonid Bershidsky is Bloomberg Opinion's Europe columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.

For more articles like this, please visit us at bloomberg.com/opinion

©2019 Bloomberg L.P.