A key mistake to avoid in thinking about Germany’s future economic policies is to personalize. In Germany, the broad thrust of economic policy is not decided by one person, but by the preferences and priorities of the main parties, which in turn reflect the preferences of the electorate. The main parties, i.e., those five which could conceivably be part of the new governing coalition do not differ fundamentally on the thrust of fiscal policy. A different government made up of these parties — only with different weight — means that fiscal policy will only change marginally.
A key cornerstone of German fiscal policy is the famous ‘Schuldenbremse’, or debt brake, which is part of the constitution. It limits the deficit in ‘normal’ times to about 0.35 % of GDP. This limit has, of course, been suspended throughout 2020 and 2021; and it is not certain whether this suspension, which is foreseen for extraordinary times, will be renewed next year. But it is certain that sooner or later the provisions of the debt brake will soon enter into force again.
Moreover, the debt brake is, and remains, popular. This implies that a government which runs large deficits once ‘normal’ times have returned would face not only the constitutional court, but also hostile public opinion.
To understand this enduring popularity of ‘frugality’ in Germany it is useful to go back further in history. In their insightful book ‘The Euro and the battle of ideas’, three economists (from the US, France, and Germany, respectively) analyse the role ideas played between 2010 and2014, when the euro area was in deep crisis and seemed, at times, in danger of breaking up under the pressure exerted by financial markets. The thesis of the book is that the management of the euro crisis was dominated by clashes between France and Germany and that the position of these two countries was largely determined by their basic economic ideas.
The German position is that fiscal policy should be rules-based, and that high debts always create problems. The French position emphasizes the primacy of politics over economics: rules should not stand in the way of fundamental policy choices. If the government needs to spend more, it should do so whatever the rules say. A similar fault-line can be observed between Germany and Italy – or, more generally, between the ‘frugal’ North and the ‘free-spending’ South of the euro area.
There is no shared vision of the underlying long-term principles for fiscal policy in Europe. Why has the Coronavirus crisis failed to lead to a critical re-examination of European fiscal policy strategy? The underlying reason is probably confirmation bias, which has hardened the positions on all sides because in a crisis, people look instinctively for a confirmation of long-held beliefs, as Dani Rodrik claims.
Those who have long criticized ‘austerity’ feel vindicated because nobody can object to large deficits in a crisis. They point at the suspension of the fiscal rules of the Stability Pact for Germany’s large deficit as a confirmation of their position.
But the German public has a different view. The shared impression in Germany is that a prudent approach to fiscal policy has been vindicated by the crisis. Years of balanced budgets have given the German government a strong position, enabling it during the crisis to spend freely to help German workers and enterprises to overcome the crisis.
This view also reinforces the belief that a frugal fiscal policy pays off. Twenty years ago, Germany was the ‘sick man of Europe’, with low growth, high unemployment, and in violation of the Maastricht fiscal rules with deficits above 3 % of GDP. In 2003, the German government even banded together with those of Italy and France to prevent the Commission from enforcing the Maastricht rules. However, this left a sour taste in German public opinion and led to a concerted national effort to reduce the deficit. This fiscal effort, which was widely shared because it had to involve both the federal and regional (Länder) levels, succeeded mainly by reducing overall expenditure by about 4 percentage points of GDP.
The key point is that this fiscal adjustment was not accompanied by a recession. On the contrary, growth actually increased and unemployment fell steadily. Some argue that this was a coincidence due to rising demand from China for German machinery. Others argue that the recovery was due to labour market reforms. Others still argue that the economy recovered because fiscal policy had finally become sustainable. It does not matter whether it was a lucky coincidence or whether a fiscal adjustment always pays off quickly. The key fact is that in the nation’s collective memory, frugal fiscal policy has come to be associated with better times – confirming a preconceived belief already held before the crisis.
Another indicator of Germany’s continuing fiscal prudence can be seen in a little noticed choice made in 2020. When the NGEU was created, the outgoing government decided the (small) funds the country will receive should be used to reduce public debt. This decision was taken without any opposition from the Finance Ministry, headed by Olaf Scholz of the SPD, who is currently leading the polls.
The green party, which is likely to be part of any government is, of course, less focussed on fiscal prudence, but its main objectives do not necessarily require large government expenditure. Most green objectives involve taxes or regulation in some form. The green party in government could also delay part of the much-needed improvement in Germany’s crumbling motorways, as the Greens oppose spending on road transport.
All in all, it seems that post-Merkel (and post-Schäuble) Germany will continue a by now firmly established tradition of fiscal prudence.