In light of a consequential constitutional court decision last week on the German ‘debt brake’, Mark Hallerberg outlines the origins of the debt brake and the implications for Germany’s international competitiveness.
A fiscal rule, known as the ‘debt brake,’ and a constitutional court decision last week on how to enforce it, is a big deal in Germany. The Court’s decision on 15 November to declare a special fund created during the pandemic as unconstitutional implies big changes to the current coalition’s plans. But what is the debt brake and where did it come from? What will be the impact of the ruling on Germany’s ability to compete economically with China and the United States?
Background to the creation of the debt brake
Prior to 2009, Germany had a version of a ‘golden rule’ as its main fiscal rule: one can only borrow to invest. Another part of the framework specified that the government should take into account the macro-economy too. This means that, in bad economic times, the federal government borrowed more as part of counter-cyclical policy to stimulate the economy. During good times, though, the macro-economy was not similarly considered. One then got a ‘step function,’ or pauses of debt followed by increases, over time, and an increasing overall debt burden debt. This situation frustrated many observers, and many voters.
Something had to give during the global financial crisis, which started a year before federal elections. It was clear that Germany needed a big stimulus package and funds to bail out troubled banks. But many balked at the debt implications. The deal struck was to allow more borrowing, but only in combination with a rule that would lower debt over time. In particular, it would allow deficits in bad economic times but demand surpluses in good times. To make this credible, it was anchored in the constitution. At the time, I was very much in favour of the rule for a simple reason – it promised to be symmetrical.
As it turned out, the rule was not implemented in a symmetrical way. Overshoots indeed had to be paid back, but – because of implementation legislation after the rule was anchored in the constitution – undershoots could not be spent later but simply reduced the debt. Additionally, Finance Minister Wolfgang Schäuble, introduced a more understandable rule, the ‘black zero’: no new debt. That was it. This stricter rule was not anchored in the constitution, but it was popular. As a direct result, German debt to GDP dropped more than 20 percentage points, and below the 60% debt-to-GDP level in the Maastricht Treaty, during the 2010s.
There exists an exit clause to the debt brake. During ‘natural catastrophes and other exceptional emergency situations’ It could be suspended by an absolute majority of the Bundestag, or lower house. This happened during the Covid pandemic.
The problem with the debt brake
So far so good. What led to the court case was the government’s decision to transfer 60 billion euros borrowed, but not spent, during Covid to a fund for climate and transformation that was to be spent in later years. The opposition Christian Democrats took this to the German Constitutional Court, which ruled that the transfer of the funds to another purpose in the budget, and the transfer across years, were unconstitutional. It also specified the terms under which the debt brake can be suspended. The shock to the budget, the Court ruled, must indeed affect the budget. It is not enough for the Bundestag to simply declare an emergency.
The narrative thus far has been of German navel-gazing. But there are implications for German competitiveness.
The new climate and transformation fund can be seen as a direct response to developments in key competitors abroad, namely in China and in the US. Chinese electric vehicles are beating their German equivalents. Subsidies throughout the economy for new technologies are rife. Similarly, Biden’s Inflation Reduction Act as well as the CHIPS Act provides hundreds of billions of dollars for American companies.
While some of the German fund will come from other sources, the loss of 60 billion euros is a big deal. Moreover, there are a series of measures the German government has taken outside of the climate and transformation fund, including subsidies to lower energy prices, that are also responses to this international competition. Energy prices are cheaper for many manufacturers based outside of Germany. These, too, may at least in part be unconstitutional under the court’s ruling.
The question now is how the government will move forward. It already suspended the debt brake for 2023, which was necessary because most of this year’s budget has already been spent. While some legal questions remain open, the Free Democratic Finance Minister, Christian Lindner, seems intent on enforcing the debt brake in 2024 and not asking the Bundestag for yet another suspension.
Some argue that this situation provides an opportunity to revise all these subsidies, which distort markets and keep the ‘old’ export model of the German economy sputtering along. One could even argue that this type of discipline that comes from the debt brake is a welcome dimension to this fiscal rule – it brings the market back to Germany.
What this line of reasoning ignores is the international dimension. The discipline is only at the national level. The market for the most important technologies today is world-wide. Not only do China and US dominate them, but they subsidise them. They also have scale at the domestic level, which is important for technologies that are capital intensive. Few tech companies in Europe are truly European wide.
This all begs the question: how can Germany move away from the old export model to a new one built on the latest technology under the existing fiscal rule? There is so far almost no discussion about how German companies will be able to compete without existing public subsidies. No matter how market-distorting such subsidies are, they do keep some companies from moving abroad. They also enable the beginning of a green transition. And if Germany is not able to compete with China and the US, who else will in Europe?
So, the court decision has far-reaching implications. But this is what happens when fiscal rules designed for a particular context to address a particular crisis are anchored in a constitution.