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Germany’s obsession with debt threatens to paralyse its economy

Constitutional court ruling leaves the country’s federal budget in disarray and threatens investment in climate transition projects, rail system upgrades and Intel factory

Germans pride themselves on having a word – or phrase – for everything. But a week-old court ruling has revealed a glaring gap in the language. Germans need, urgently, their own version of GUBU.

That is the only way to describe the potential effects of a 62-page ruling from the federal constitutional court in Karlsruhe that has blown a €60 billion hole in Berlin’s federal budget. That multibillion hole is growing by the day – and could yet reach three figures – as the grotesque, unbelievable, bizarre and unprecedented consequences of the judgment continue to reveal themselves.

Chancellor Olaf Scholz and his three-way coalition – Social Democratic Party (SPD), Greens and Free Democratic (FDP) – have until the end of the year to present a legal budget. It is not clear if their two year-old so-called traffic light coalition will survive. A battle is under way for Germany’s economic and political soul.

Moment of historic consequence

The Basic Law from May 1949 is postwar Germany’s holy repository for big ideas. Informed by the horrors of the Hitler era, its opening paragraphs assert that human dignity is inviolable; all persons are equal before the law; freedom of faith and conscience are guaranteed.


Flick to Article 115 and you will find the spot where, on May 29th, 2009, a two-thirds Bundestag majority inserted the following: “Income and expenses must generally be balanced without income from loans. This principle is met if the income from loans does not exceed 0.35 per cent in relation to the nominal gross domestic product.”

In that parliamentary debate, chancellor Angela Merkel’s first finance minister, Peer Steinbrück, described the birth of what is colloquially known as the debt brake as a “moment of historic consequence”.

He was right, just not in the way he intended. Back then, the euro crisis was roaring into life with unforeseeable consequences. German MPs went further than others on new fiscal rules to, effectively, don a fiscal chastity belt that coupled debt issuance to the performance of Europe’s largest economy. It remains a curious no-confidence vote of MPs in themselves.

Today, Steinbrück, father of the debt brake, insists the instrument was not about pandering to any German “fetish” on debt but prioritising “generational justice”.

“Before taking on debt, there should always be an effort to make savings,” he told Die Zeit on Thursday, offering a neat summary of the theory of ordo-liberalism that guides mainstream German economics. He added another: “There are good reasons against taking out loans to finance future-oriented investment.”

Many disagreed strongly with this thinking, then and now. At a sitting of the Bundestag budgetary committee earlier this week, MPs heard a wide range of views on what needs to happen next. It didn’t make for comfortable listening.

Debt brake critic Jens Südekum, economics professor at Düsseldorf’s Heinrich Heine University, recalls how those who demanded reform in the past were dismissed as “irresponsible debt addicts”.

“There are good reasons against taking out loans to finance future-oriented investment.”

—  Peer Steinbrück, father of the debt brake

“Now the debt brake has fallen on our toes and the consequence of putting it in the constitution has become clear,” Prof Südekum told The Irish Times.

He sees the debt brake less as a practical fiscal tool than a “matter of faith” in failing to distinguish between far-sighted, sustainable borrowing – on infrastructure or schools – and debt-financed fireworks of election year giveaways.

The consequences were becoming obvious in the last years of Merkel’s 16-year rule. Rather than find ways to take advantage of its top credit rating and a historic zero interest rate on sovereign bonds, the Merkel administration pushed instead to reduce the national debt. This “black zero” budgetary policy was the main priority of Steinbrück’s successor as finance minister, Wolfgang Schäuble.

The pandemic and Russia’s invasion of Ukraine saw all that go out the window: in March 2020, Berlin used emergency provisions to suspend the fiscal brake. Merkel’s third finance minister, Olaf Scholz, launched a €100 billion budgetary “bazooka” of loans and subsidies for coronavirus-hit businesses, the “economic stabilisation fund (WSF).

Things took an interesting turn weeks after Scholz won the 2021 federal election for his Social Democratic Party (SPD). The chancellor-elect and acting finance minister asked officials for a way to relabel and repurpose unspent WSF funds for his new coalition’s priorities: more generous welfare, building insulation programmes, e-mobility and charging infrastructure. Moscow’s invasion of Ukraine brought new financial demands: an energy price cap and costly alternatives to Russian gas.

Moscow’s invasion of Ukraine brought new financial demands: an energy price cap and costly alternatives to Russian gas. Contrary to the SPD and Greens, the liberal Free Democratic (FDP) – and its leader, finance minister Christian Lindner – was determined to restore balanced budgets and the debt brake.

To have their cake and eat it, new spending was financed from the residual Covid funds in the WSF, other projects from a second pot, the fund for energy supply and climate protection (KTF).

Last week Karlsruhe ruled that €60 billion of KTF funding, around one third of the total, contravenes the debt brake. As well as banning moves to relabel emergency corona-era funding, the court also took how issue with how the other, WSF, fund is structured. Effectively a series of blank cheques, finance ministry officials set up the WSF so that disbursements will not appear in the balance sheet - and as a debt burden - at the time of issue but when it is deployed.

To be on the safe side, the finance ministry has frozen the WSF and imposed a total spending ban on all ministries. While Berlin’s €100 billion fund to support Ukraine and boost domestic military spending remains untouched, Mr Lindner announced on Thursday evening, in a painful concession, that he would set aside the debt brake for another year.

Plans to finalise the federal budget on Thursday and vote on it next week in the Bundestag have been abandoned

So where do things go from here? No one knows. Plans to finalise the federal budget on Thursday and vote on it next week in the Bundestag have been abandoned.

While finance ministry officials inspect the damage, the fallout was felt most keenly in the office of Green economics and climate change minister Robert Habeck.

Along with breaking Germany’s addiction to Russian energy, Habeck’s main priority in office has been to protect German jobs and prosperity by making Germany’s industrial base fitter – and greener – for the 21st century. Until, that is, Karlsruhe called time on crucial sources of funding.

“We could really have done with that money,” said Habeck this week. “The problem we face now is that it is – for now, at least – gone.”

This was a negligent deception of German voters

—  Friedrich Merz, CDU leader

As the days pass, the debate over the Karlsruhe ruling is gathering pace. Not all economists agree that Germany’s problems lie with the debt brake. Some point to the politicians who agreed and implement it.

Even with the debt brake, economist Thies Büttner points to how recent record budget surpluses were “burned up on public consumption, mainly social spending”.

“If politicians can’t set their priorities well in times of surpluses,” said Prof Büttner, of the University of Erlangen, “why should setting aside the debt brake see them change their approach now?”

Another speaker this week in the Bundestag, even he agrees that existential fears over the euro zone in 2009 saw MPs agree an overly strict interpretation of EU fiscal rules.

“There is some room for adding flexibility,” he told The Irish Times, “but this is unrelated to the current problems.”

He attributes Germany being so caught off guard by the Karlsruhe ruling to another error made during the birth of the debt brake: while other euro members set up independent institutions to supervise fiscal rule compliance, Germany’s federal and state finance ministers supervise themselves.

“Various emergency budgets were, as a result, just waved through,” said Prof Büttner, an economics professor at the University of Erlangen and member of the federal finance ministry’s economic advisory board. “An external independent institution wouldn’t have necessarily improved the direction of public spending, but would have criticised more effectively the risky strategy to rely on these funds.”

Cash cow for ‘black zero’

To understand the reality – and strictures – of these risky strategies, look no further than the sorry state of Germany’s state-owned rail company, Deutsche Bahn (DB).

In its last pre-pandemic years, the Merkel administration squeezed DB for a €200 million annual dividend. Rather than invest, DB was a cash cow to help deliver the so-called “black zero” of balanced budgets. This push for sustainable public finances was, for DB, an austerity track that has left ageing trains, worn-out tracks and temperamental signals. (I am writing this article on a Leipzig-Berlin train, a one-hour journey, on a train that is running two hours behind schedule.) To reverse these years of underinvestment, the Scholz cabinet agreed an ambitious €25 billion rail investment programme. If, that is, it ever happens.

This major investment in core state infrastructure was financed by the same off-balance sheet funds cancelled by Karlsruhe’s defence of the constitutional debt brake.

Some €10 billion in federal subsidies for Intel, part of a new tech hub in CDU-ruled Saxony Anhalt, now hangs in the balance

Several attendees of this week’s Bundestag budgetary committee sense a shift in thinking about the debt brake and its unintended long-term effects.

“The consequence of putting the debt brake in the constitution is now becoming clear to many politicians, finally,” said Prof Südekum. “Allowing constitutional lawyers have the last word allows them to decide on purely legal grounds, without having to think about the ecological, economic or political consequences of the shards they have left behind them.”

Amid growing uncertainty in the Scholz coalition, attention has shifted to the opposition Christian Democratic Union (CDU). The centre-right party filed the complaint behind last week’s ruling which, the CDU says, has called time on creative accounting used by the three-party Scholz coalition to resolve their political differences.

“This was a negligent deception of German voters,” declared CDU leader Friedrich Merz.

While his proposed path out of the crisis is to cut back on spending, backed by the liberal FDP, this is opposed vigorously by the SPD and Greens.

But just as all major German parties voted for the debt brake in 2009, adjusting the fit of its fiscal chastity belt will require cross-party agreement. SPD and the Greens want a more flexible debt brake but will need to compromise to secure CDU votes and the two-thirds majority they require to change the constitution. The stakes, political analysts say, could not be higher.

If politicians can’t set their priorities well in times of surpluses, why should setting aside the debt brake see them change their approach now?

—  Prof Thies Büttner of the University of Erlangen

A week on, even CDU delight at scoring two black eyes on the Scholz coalition is dissipating. Behind the scenes, party officials know to be careful what they wish for.

The Karlsruhe ruling they triggered will curtail for them, whenever they return to power, much of the off-balance sheet creative accounting invented in last CDU-Merkel era. In addition, at least two CDU-ruled federal states have budgets affected by the same constitutional ruling. Meanwhile, some €10 billion in federal subsidies for Intel, part of a new tech hub in CDU-ruled Saxony Anhalt, now hangs in the balance.

“When Germany cannot afford such future projects like Intel any more,” said Sven Schulze, Saxony-Anhalt’s economics minister, “then the economic damage will be enormous and the damage to image gigantic.”

Prof Klaus Schubert, political scientist at the University of Münster, calls the debt brake a “very German mistake”.

“It was an attempt to create rules and principles to address our anxiety about our unplannable and risk reality,” he said. “In a time of major crises – war, climate change and migration – we can’t move ahead by standing on principles. What is lacking in Germany is a healthy dose of pragmatism.”