The end of a German illusion

9 months ago 32

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Germany thought it could provide the necessary investments for the green transition, all the while adhering to its strict budget rules. It turned out it could not, and this should give everyone pause for thought about the EU’s own fiscal rules.

The German constitutional court is notorious for its far-reaching judgements, particularly on all things money. Several EU policies, including the bailout of Greece during the sovereign debt crisis, as well as the European Central Bank’s bond-buying programmes, have in the past been subject to judicial review by Germany’s top court.

Reactions to the rulings typically differ, with lawyers praising the court’s clarity and commitment to given rules, and economists blaming the judges for not understanding the severe economic consequences of their decisions.

Last week, the power of the court was felt by Germany’s three-party government. In one fell swoop, the judges cancelled €60 billion off a climate fund which the government had planned to use to finance key investments into the industrial future of the country, including electric mobility, hydrogen, and semiconductors.

Several of the projects put into question are considered “Important Projects of Common European Interest” (IPCEIs) and the planned subsidy for a chip factory by Taiwanese manufacturer TSMC was even called the “culmination” of the EU’s industrial strategy by the Internal Market Commissioner Thierry Breton.

It’s all up in the air now.

Government representatives in Berlin are in panic mode. Economy Minister Robert Habeck (Greens) blamed the conservative opposition CDU/CSU, who brought the case to court, for the potential cuts.

Meanwhile, Rolf Mützenich, parliamentary group leader of Chancellor Olaf Scholz’s SPD (S&D), blamed the court for being contradictory by obliging the government to follow strict climate objectives, and on the other hand, “restricting our room for manoeuvre” on fiscal spending.

It’s not the court, however, that is contradictory, nor is the opposition to blame for scrutinising the legality of the government’s policies. It’s the rules that are the problem.

Germany has one of the strictest deficit rules in the world, with its “debt brake” allowing the federal government to only take on 0.35% of GDP as new debt each year, with some additional spending allowed in times of economic downturn.

This was written into the constitution in 2009, aiming to tie the hands of politicians, who were considered not to be trusted when it comes to sensible public spending. Sounds familiar?

It’s the same logic that is guiding Finance Minister Christian Lindner (FDP/Renew) when he calls for “common safeguards” and “numerical benchmarks” in the EU’s debt rules.

Some politicians and economists in Berlin have started questioning the “debt brake” as it seems incompatible with the need to massively invest in the economy over the coming years to replace “dirty”, CO2-intensive production with clean technologies. But a two-thirds parliamentary majority needed to change the constitution seems out of reach.

If this ruling teaches us anything, it should be the fact that once something is set as a rule, it is hard to circumvent.

The German government tried to do so by declaring an emergency over the COVID pandemic and thereby justifying taking up more debt to invest in the green and digital transition over the subsequent years. Sounds familiar again?

By triggering the general escape clause to deactivate its fiscal rules and by launching the “Next Generation EU” programme, the EU did exactly the same, realising that its rules for national spending would not allow the member states to invest properly – and had cost Italy economic growth for 20 years.

If you don’t like rules to be circumvented by tricks – and judges certainly don’t like that – you have to design them in a way that they can realistically be followed.

Neither the German “debt brake” nor the EU’s fiscal rules have so far been up to the task, with neither of them allowing the necessary investments over the next decade.

As things stand now, the EU is on track to make the same mistake again, with all the flexibility to invest that the Commission wanted to give member states over the next four to seven years being effectively blocked by Lindner’s insistence on deficit reductions from day one.

Looking at the mess in Germany, other EU countries are well-advised not to follow the German example: Don’t commit to rules that you cannot keep. Tricking the rules is not a sustainable solution.

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Chart of the Week

In all this talk about public debt, it’s important to remember that Germany doesn’t have a debt problem. It has a growth problem.

The chart shows the 2022 debt-to-GDP ratio for G7 countries, of which Germany has by far the lowest one.

The second graph shows the expected economic growth in 2023 of top global economies, of which Germany also has the lowest one – being the only major country to shrink this year.

You can find all previous editions of the Economy Brief Chart of the week here.

Economic Policy Roundup

Germany’s Lindner to suspend debt brake for 2023. Germany’s finance minister announced on Thursday (23 November) plans to present a supplementary budget for this year, in order to secure the legality of the expenses taken to counter the energy crisis. This will include suspending the constitutional ‘debt brake’ by declaring another emergency situation for 2023, the minister wrote on X. The step came after legal experts questioned the legality of debt approved with an emergency in 2022 to be used for the energy aid in 2023, following a ruling by the Constitutional Court on the “Climate and Transformation Fund”.

EU Parliament greenlights trade deal with New Zealand. On Wednesday (22 November), the European Parliament voted in favour of the free trade agreement between the EU and New Zealand. The agreement was concluded in June 2022 and is the first EU trade deal to include the EU’s new approach to trade and sustainable development chapter, which makes sustainable development commitments more enforceable. The deal is yet to get the formal approval of the EU Council. Pending ratification by New Zealand, the deal can enter into force, likely by mid-2024, according to the Parliament.

UN votes to create a global tax convention against resistance from EU and other wealthy countries. A resolution put forward by Nigeria received 125 supporting votes against only 48 opposing ones in a UN vote on Wednesday (22 November). The resolution calls for the creation of an intergovernmental committee responsible for drafting a UN tax convention by mid-2025 that should give special consideration to the needs of poorer countries. The tax deal brokered by the OECD in 2021 was criticised by many for weighing more in the interests of rich countries than poorer countries. Most European countries, as well as the US, Canada, Australia, Japan, and South Korea, rejected the resolution.

EU parliament votes to exclude Chinese renewables manufacturers. The European Parliament approved on Tuesday (21 November) its negotiation position on the “Net-Zero Industry Act”, a law that aims to boost production capacity in key green industries, such as solar PV modules, wind turbines and heat pumps. The parliament thereby also approved a proposal by the parliament’s Industry Committee for a limit of 50% on Chinese products for auctions for renewable energy, as well as public procurement. Bidders using only e.g. Chinese solar PV modules could thus not apply for funding via an auction any more, which are used for large-scale projects such as ground-mounted solar. The law still needs to be negotiated with EU countries in the Council. Read more.