German budget disarray sends out powerful ripples beyond Berlin

Olaf Scholz, encountering Liz Truss moment, could face early elections

Widening discord in Germany’s three-party governing coalition over the country’s constitutional court challenge to budgetary policy will spread economic and political effects well beyond Germany.

Robert Habeck, the Greens economics minister and vice chancellor under Social Democrat (SPD) Olaf Scholz, hinted at further setbacks on 20 November, saying a further multi-year public ‘economic stabilisation’ fund may be under threat. This follows the suspension of payments from the government’s keynote climate transformation fund, where on 15 November, the Karlsruhe court ruled as illegal a €60bn allocation to the fund under the 2021 supplementary budget.

The episode extends the long-running dismantlement of Germany’s hard-won international reputation for economic and budgetary orthodoxy. Habeck has since underlined the unpleasant effects of contradictions in Berlin’s economic policies. Higher energy prices and lower social spending might ensue, he warned.

The country’s defects in economic strategy are now being exposed through politically inspired court action in a similar way to the financial markets’ derailing of unbalanced UK budgetary policies under then-Prime Minister Liz Truss in September-October 2022.

More comprehensively than in the UK case, the ripples from German budgetary missteps will have continent-wide repercussions, reflecting the country’s status as Europe’s biggest economy and creditor as well as its pivotal place in economic and monetary union.

Germany’s moral and political authority in EMU weakens further

The setback – and the likelihood that more public spending may come under legal scrutiny by German’s supreme court – weakens further Germany’s moral and political authority in EMU. This mishap represents the strongest blow to Germany’s standing since Chancellor Helmut Kohl’s administration battled unsuccessfully with the Bundesbank in 1997, in a much-derided bid to revalue gold reserves as a last-minute means to meet credentials for joining the single currency in 1999.

More than two decades later, euro area members are struggling with ways of redefining budgetary rules scheduled to re-enter force in 2024 as a way of strengthening the currency’s economic underpinning.

Christian Lindner – leader of the liberal Free Democrats and junior partner to the SPD and Greens in the Scholz coalition – has been advocating a strict reformulation of European Union budgetary rules. Now that he has been recast as presiding over an illegally promulgated budget, Lindner will find his sway over fellow finance ministers painfully diminished.

Successive governments – led by the Christian Democrats’ (CDU) Angela Merkel up to the September 2021 elections, and since December 2021 by Scholz – have resorted to off-budgetary funding vehicles to try to balance increasingly incompatible financial and economic objectives. A total of 29 of these special fund are listed by the German court of public auditors.

Ruling impairs climate fund, throwing doubt on €170bn in three-year spending

The judgment on the climate fund came in a case initiated by the now opposition CDU and its sister Christian Social party CSU. Karlsruhe ruled against reassigning unspent funds borrowed under emergency legislation during the Covid-19 pandemic. The ruling severely impairs the fund, which had planned to spend more than €170bn over the next three years on industrial modernisation and sustainable energy transition, in projects ranging from semiconductor plants to rail refurbishment.

The government’s budgetary woes are largely self-inflicted. They stem from the 2009 enshrinement into Germany’s constitution of tough annual limits on government borrowing, through the ‘debt brake’ – meant to be binding in all circumstances outside economic crisis. The brake, limiting extra government borrowing to 0.35% of gross domestic product, was suspended under an emergency due to the pandemic, but is set to return in 2024.

Fault lines in coalition and across Germany

The judgment lays bare fissures in the three-party line-up formed in 2021. At the time, it appeared that the industry-orientated SPD, the free-market FDP and the ecological Greens might bury their ideological differences.

For a while after Russia’s invasion of Ukraine, the Greens’ decarbonisation intentions and long-time anti-Russian sentiment appeared to combine positively with the FDP’s regard for solid finances without tax rises and the SPD’s traditional industry growth policies.

Over time, common objectives have receded. Bickering over many social and economic issues has exposed fault lines in objectives and priorities – not just in the coalition but also across the country.

The legal action underlines how Karlsruhe has been influencing key areas of government policy. In another landmark judgment in March 2021, the court ruled that government climate action efforts placed an unconstitutionally heavy burden on younger voters. It forced Berlin to intensify 2030 carbon emission cuts and reach carbon neutrality by 2045, rather than the previous target date of 2050.

Effect on monetary policies and on coalition politics

Fresh doubts over Berlin’s budgetary policies are bound to influence the European Central Bank’s monetary policy as well. Hints of budgetary loosening could delay sought-after interest rate cuts in 2024, as hawkishly inclined members of the ECB governing council have made clear. The ruling will increase further the appeal of the anti-establishment Alternative for Germany (AfD) in German politics. This is important especially in view of three influential elections in eastern Germany next year.

It may also bring closer the likelihood of a break-up of the coalition before the next parliamentary election scheduled for 2025. Many leading business representatives predict growing pressure on the Greens or the FDP to leave the Scholz government prematurely.

Like the FDP, the Greens are being gravely weakened by association with the SPD. If the FDP were to depart, depriving the SPD of a parliamentary majority, Lindner would team up with Friedrich Merz, the CDU leader, to force early elections.

Merz, facing an internal party challenge from Hendrik Wüst, the younger prime minster of North Rhine Westphalia, would relish the chance of running against Scholz in autumn 2024 rather than the year later. In German policies, and across the continent, Germany’s budget missteps have opened up a string of scenarios for an action-packed 2024.

David Marsh is Chairman of OMFIF.

Image credit: SPD Schleswig-Holstein

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