German economists are starting to question the 10-year-old debt brake rule which they warn is hampering urgently needed investment in the country’s crumbling infrastructure.
A non-functional satirical debt brake in front of the finance minister. The real debt brake works too well.
Source: obs/Accor Hotellerie Deutschland GmbH
Germany’s debt constraint amendment, introduced in 2009 and known as the “debt brake”, sets a tight limit on structural deficits and only permits exceptions in natural disasters or severe recessions.
It’s been sacrosanct, with even the powerful International Monetary Fund not daring to question the rule, at least not in public, even though IMF experts regularly exhort the German government to invest more and abandon its strict balanced-budget policy.
But an open debate about its merits has erupted, and it’s been triggered not by Anglo-Saxon economists long critical of German austerity but by German economist Michael Hüther, the head of the industry-friendly IW German Economic Institute.
Hüther told Handelsblatt that the debt brake has turned into an obstacle to tax cuts and investment. “We’ve walled ourselves in,” he said.
The amendment served its purpose and exerted budget discipline on governments, he said. But it’s gone too far, and now bedeviling debt at a time of low interest rates and a huge need for public investment is bad policy.
“Times have changed,” he said. It’s time to “open the windows.”
Other economists agree, such as Jens Südekum of Düsseldorf University. The debt brake contributed to budget consolidation, he said. “But it has over-fulfilled its purpose.” It now stands in the way of much-needed modernization and growth. “That’s why we should get rid of it again.”
The debt brake was agreed in early 2009 by Chancellor Angela Merkel’s first grand coalition with the center-left Social Democrats. The financial crisis was raging, the projected budget deficit was €86 billion ($97.6 billion) and total government debt was rising towards 80 percent of GDP - far above the EU’s limit of 60 percent.
Under the debt brake, the federal government could only borrow up to 0.35 percent of GDP in “normal economic conditions,” while the 16 federal states were allowed no deficits from 2020 onwards. Debts made in times of economic downturns would have to be offset in cyclical upturns.
In recent years, Germany has tightened its belt even more than required under the debt brake — the federal government has had no net new borrowing since 2014.
The brake was always controversial among parts of the SPD and trade unions where many said it was a mistake to start funding government investment from current revenues rather than sticking with the practice of using net new borrowing.
Lars Feld, a member of the country's national council of economic experts, said the doubts now being voiced are warming up the same debate that raged when the debt brake was launched. “It was introduced because from the 1970s until 2008, no one succeeded in sustainably reducing the debt ratio,” he said. In good times there was never enough consolidation and in bad times, borrowing was increased to stimulate the economy.
He denied that the debt brake was an obstacle to investment. “The government can finance investment if it prioritizes correctly,” he said. “Modernization works for all ministry spending if one really wants it. The debt brake is more of a tax cut brake.”
He said it was fulfilling its purpose. “Before, the business federations always demanded tax cuts and social politicians wanted more spending. Now that has to be balanced out because the way out through new borrowing is limited.”
The issue, according to Hüther and other economists, is whether governments are capable of achieving that balance. It’s easier for politicians to delay investment rather than to cut social spending, which explains why Germany has neglected urgently needed investment in its decaying road and rail network.
The IMF has pointed out that in the current low-interest environment, debt-funded investments end up paying for themselves because they increase Germany’s potential growth.
So what should be done? Hüther of the IW proposed having a special budget just for investment. Fratzscher of the DIW said the debt brake should be replaced by a rule that links spending to economic performance.
“In addition, the government should introduce an investment rule that makes sure the state doesn’t squander public assets and instead invests enough in public infrastructure,” he said.
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