Is Germany wise to keep its national debt so low?
While the rest of the world is playing black jack, Germany is staying at home to do its homework.
Dear Reader,
When IMF boss Kristalina Georgieva took to the stage in Washington last week ahead of the fund’s annual meeting, her diagnosis of the health of the global economy held good and bad news for Germany.
Deutschland AG’s economic success over the past two decades has been based on foreign demand for its goods. For a long time, growing markets in the Far East were hungry for German cars and machines.
But Georgieva cautioned that the era of open markets is coming to an end.
“Going forward, trade will not be the same engine of growth as it was before,” she said. “This is the fracturing that I warned of on this stage in 2019 - except that it is worse.”
That Germany is particularly sensitive to such changes in the global weather was affirmed by the IMF this week, when it lowered its growth forecasts for Germany down to zero for this year and 0.8 percent for 2025.
Global demand for Made in Germany is sinking: that is one of the major reasons that the country’s economy is in such a funk.
But a new era of tariffs and protectionism isn’t the only thing keeping Georgieva awake at night.
While she praised the fact that central banks had worked together to bring down inflation while simultaneously staving off a global recession, she added that “the higher price levels we feel in our pockets are here to stay.”
In other words, the era of zero or negative interest rates set by central banks is over. In the future it will be more expensive for consumers - and governments - to borrow money.
Which is bad news at a time when global public debt is at a historic high. Countries like the US, France and Japan all have debt levels that are larger than the size of their national economies. The US and China, in particular, have decided to gun it out over who can offer bigger subsidies to green technologies and chip manufacturers.
“High debt, high interest rates and low growth are coming together,” said Georgieva. “As debt increases, fiscal space contracts.”
Higher interest rates mean that heavily indebted countries are having to spend an ever larger chunk of their budgets on servicing debt. Which means that there is less money to be spent elsewhere.
“Schools or climate, digital connectivity or roads and bridges - this is what it comes down to,” Georgieva said of the decisions that governments are increasingly faced with.
Her remedy is clear. Governments should avoid the voter-friendly path of taking on ever more debt. Instead, they should cut spending while bringing in labour reforms and reducing red tape.
“Governments must work to reduce debt and rebuild buffers for the next shock, which will surely come and may come sooner than we expect,” she warned.
However she has little faith in policy makers to heed her advice.
“Across a wide array of countries, discourse increasingly favours fiscal expansion. Even the traditionally fiscally conservative political parties are developing a taste for borrow-to-spend,” Georgieva observed.
And here we come to the good news for Germany.
Of the world’s major economies, Germany has easily the best debt-to-GDP ratio. While neighbouring France is staring into a “budgetary abyss” thanks to a debt level that has reached 110 percent of GDP, Germany has kept its debt down at 64 percent of GDP despite hefty spending programmes during the pandemic and the energy crisis.
This means that, even in today's tough financial environment, it is much cheaper for Germany to borrow money than countries that have allowed their debt burden to balloon. The UK is currently being punished by the bond markets with interest rates double those of Germany.
What is to thank for this largely ignored strength of the German economy? The much maligned ‘debt brake’, a prohibition on taking out new debt above a level of 0.35 percent of GDP.
Written into the constitution after the financial crisis of 2008, the debt brake forces governments to be transparent about their spending by funding it primarily through taxes rather than burdening future generations with debt.
In the wake of the Euro Zone’s sovereign debt crises, the major German political parties prided themselves on how disciplined they were with the public finances (in contrast to their spendthrift southern neighbours).
The CDU used to call the debt brake their "fetish” and went further by balancing the federal books - a so-called schwarze Null - which allowed them to cut the level of public debt for the first time in decades.
However, as the trauma of sovereign debt crises has slowly been written over by more recent crises, German attitudes on this issue have been transformed.
Journalists, economists and satirists alike now routinely bash the latter half of the Merkel era as a time of missed opportunities, when Germany failed to take advantage of the low costs of borrowing to revamp its public infrastructure.
Typical of the current dissatisfaction with the “debt fetish” is a recent article in Der Spiegel: “The era of negative interest rates... would have been a good time to modernise the country's public infrastructure. Now it is much more expensive due to the rise in interest rates. And the economic damage is immense - the economy has not grown for almost five years.”
What is often forgotten is that, even in the years when Germany prided itself on being the class swat, it only managed to comply with the EU's debt ratio rules on one occasion. EU members are supposed to have a debt to GDP ratio of below 60 percent, something Germany finally achieved in 2019 before blowing that apart with Olaf Scholz' pandemic "bazooka."
Countries like Sweden, Denmark and Poland that have all managed to keep public debt levels well below the agreed threshold are unlikely to see Germany as excessively thrifty.
At the same time, it is undoubtedly true that German debt rules haven’t had the expected effect of encouraging wiser spending. Instead, governments have kicked spending on areas that aren't rewarded by the four-year election cycle into the long grass.
While no government has dared to touch a pension system that currently drains €100 billion out of the federal budget, basic infrastructure like roads, rail tracks and bridges are slowly crumbling. The recent collapse of a major bridge in Dresden and chronic train delays during the European Championships have demonstrated in excruciating detail that thriftiness can easily turn into stinginess.
Another downside: borrowing restrictions are arguably responsible for Germany having one of the highest tax regimes in the developed world - something that is pushing both businesses and skilled workers abroad.
And yet, the accusation that Germany failed to invest in public infrastructure during the era of cheap money isn’t strictly true.
Hundreds of billions of euros were poured into setting up the infrastructure for a renewable-based power grid. In a country where voters consistently tell pollsters that climate change is their number one concern, such investment was more likely to generate a positive headline than repairing an old bridge. But was it money well spent? A much-discussed Norwegian study recently estimated that Germany would have saved €600 billion by simply maintaining its pre-existing nuclear power plants instead of closing them down in favour of wind farms.
Nonetheless, the claim that Germany should be spending the money it has better, rather than simply spending more, is not universally popular.
Inside the government, vice-Chancellor Robert Habeck (Greens) has repeatedly appealed for the leg room to borrow more money, citing the US' trillion dollar spending package on green technologies as an example to follow. Even Olaf Scholz, a fiscal conservative by nature, has described the debt brake in its current form as “out of date”. Only the Free Democrats, who run the finance ministry, are strictly against modifying it.
The CDU, who are likely to take back the chancellery next autumn, also say they are against reforming the Schuldenbremse, a position that just over half of the public still agrees with.
Interestingly, even the IMF’s own staff have concluded that Germany’s strict debt brake rules have been an obstacle to growth in recent years. But Georgieva is reported to have privately patted Scholz on the back for the fact that Germany is swimming against the stream, telling him she “can’t do anything about what her staff write.”
I’m no economist, but I wouldn’t be surprised if many fiscal wonks see the IMF as institutionally conservative.
At the same time, Europe’s sovereign debt crisis is barely a decade old. Given the perilous state of world affairs, it seems to be a touch short sighted when commentators on public television see the way out of the country's economic malaise in following the examples of Spain, France or Italy.