One constant during the Eurozone’s largely torrid economic decade and a half after the financial crisis – a period which included the Eurozone crisis, Brexit, Covid lockdowns, post-Covid inflation and the war in Ukraine – has been that solitary economic locomotive pulling the whole teetering mass of Europe along: Germany. Now it also seems to have been derailed.
Europe’s biggest economy has gone from a growth leader to a laggard.
Between 2006 and 2017, Germany outperformed the rest of Europe and kept pace with the US. Yet it has just experienced three consecutive quarters of contraction or stagnation. It may be the only G7 economy to shrink in 2023, and the outlook is equally bleak.
According to the IMF, Germany will grow more slowly than America, Britain, France and Spain over the next five years.
Several structural factors have led to this sad decline and fall of the German economic powerhouse. First, having phased out nuclear power post Fukushima and developed a near dependence on cheap Russian gas to power its manufacturing-based economy, the energy crisis hit hard.
Second, the slowdown in China has been bad for German exports. By far their most critical export market, buoyant Chinese demand underpinned soaring sales for the better part of two decades, rising from $13bn in 2002 to peaking at $120bn in 2021.
Now, exports are down to barely $100bn, according to Bloomberg.
Finally, after years of obsessively paying down its debt and running budget surpluses, Germany needs investment. Yet the most damaging structural flaw of the German political economy is that it is constitutionally barred from running budget deficits.
One does not have to be an avid Keynesian to argue that in the event of a recession, increased government spending tends to greatly speed up a recovery.
As aggregate demand falls, unemployment increases and inventories grow, government investment should take up as much of the slack left by lower consumer spending and private sector investment as possible.
When Germany enshrined a “debt brake” in its Constitution in 2009, it was celebrated as a victory for fiscal rectitude and a definitive break with the spendthrift ways of the past. Fourteen years later, with Chancellor Olaf Scholz’s government facing the worst economic slowdown for 30 years, the strict curb on public deficits is now an albatross around the neck of the economy.
“It was the biggest mistake in German economic policy in the last 20, 30 years,” said Jens Südekum, professor of international economics at Heinrich Heine University in Düsseldorf.
“The stupid thing is now in the Constitution and you can’t get rid of it.”
Doubts about the debt brake — which Germany has sought to impose on other Eurozone countries through the much-maligned Stability and Growth Pact — have proliferated since last week’s bombshell ruling by its Constitutional Court that an accounting trick used to get around the law was illegal.
It has thrown spending plans into disarray, plunged Scholz’s fragile coalition into the worst crisis of its two-year reign, and opened a €60bn hole in the country’s public finances.
The torrid constitutional gridlock and economic malaise that Germany finds itself in has lessons for other economies.
Fiscal rectitude and credibility are key. But so is flexibility. Fiscal policy must be countercyclical and not pro-cyclical.
Should a country not be able to run higher deficits into a downturn, the recession will lead to lower tax revenue, necessitating further spending cuts and an even deeper economic slowdown. Any recovery is then likely to be anaemic.
Furthermore, debt to GDP is by definition a fraction. A lower denominator after a crunching recession means that through the business cycle, an overly rigid fiscal policy can counter-intuitively worsen debt metrics.
There is much to be learnt from the morass in which Germany finds itself.
Fundamentally, the political checks and balances around which countries write budgets and implement fiscal policy matter. South Africa, for example, has the opposite problem from Germany; National Treasury has too much leniency. Repeated promises by National Treasury to cut spending and get back to a balanced budget have all proven to be empty.
The most recent statements by the Minister of Finance in the last MTBPS – that non-interest expenditure will decrease by a net R3.7-billion in 2023/24, and a monstrous R85-billion over the next two fiscal years – are simply not credible.
Likewise, much of their forecasting – particularly on economic growth and fiscal revenue – has proven to be consistently overly optimistic.
Step one for Germany’s economic recovery is to dump the debt handbrake, run a larger deficit and crank up much-needed government investment to power the economy out of recession.
Fiscal policy decisions for Germany should, like all other Eurozone members, be the preserve of government and overseen by the European Commission, but not hard-coded into the Constitution.
By contrast, in South Africa, more oversight of National Treasury is crucial.
The two parliamentary bodies that oversee budgetary decisions and processes – MinComBud and Scopa – are toothless.
While a debt handbrake is overly rigid, it seems essential that some Section 9 watchdog, such as the UK’s Office for Budgetary Responsibility, or Italy’s Ufficio Parlamentare di Bilancio, is needed.
South Africa should reassess how it monitors long-term budgetary planning and implementation.
Credibility matters. DM
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