Debt-financed infrastructure spending won’t solve Germany’s problems
Published in Newsroom Pro (Wellington), 17 September 2019
As Germany heads towards an economic slowdown, and in fact may already be in recession, calls for deficit spending and fiscal stimulus are getting louder – calls for the federal government to use the opportunity of negative interest rates to borrow and invest in infrastructure.
Siemens’ CEO Joe Kaeser says so. As does Michael Hüther, head of the employer-funded German Economic Institute. As does Dietmar Bartsch, head of the post-communist party Die Linke (‘The Left’) in the German Bundestag. As does Sebastian Dullien, director of the trade-unions affiliated Macroeconomic Policy Institute.
Rarely have there been stranger economic bedfellows.
It must indeed be tempting to binge on infrastructure spending as Berlin can now borrow for 30 years at a negative interest rate of 0.11 percent.
Still, there are reasons to be sceptical about this approach for Germany. First, there is no shortage of tax revenue to finance new infrastructure. Second, there are both economic and constitutional concerns about debt financing. And third, Germany needs microeconomic and supply-side reforms more than any macroeconomic stimulus. Let’s go through these reasons one by one.
On fiscal policy settings, it is not credible to suggest that Germany’s infrastructure is crumbling due to thrifty austerity policy.
Yes, Germany’s infrastructure is indeed in a sorry state. The country’s telecommunications infrastructure lags behind that of other developed countries. Potholes and crumbling bridges show that parts of the transport network need urgent TLC. And if you have recently visited a German school or a university, let’s hope you did not need to use the restrooms.
Germany has not been neglecting its infrastructure because of austerity. Ten years ago, in 2009, Germany’s total tax revenue (all tiers of government) was €524 billion. This year, it is forecast to reach €793 billion. Even adjusted for inflation, this is an increase of 33 percent over a decade.
At the same time, Germany’s budgets benefited massively from falling interest rates. In 2009, the federal finance minister had to budget €42 billion for debt servicing, but only €18 billion this year. Based on its previous trajectory, the federal government saved more than €200 billion over the past decade because of the fall in interest rates.
It is not much of an exaggeration to say that German finance ministers have been swimming in cash for the past decade or so. There was enough money to invest – except the government did not. From 2008 until 2015, federal investment hovered between €25 billion and €30 billion, and it has only now marginally increased to around €35 billion Euro.
So where did the money go?
Instead of investing in Germany’s future, subsequent governments spent on its past and present. Subsidies to the supposedly PAYG pension system were increased substantially to almost €100 billion Euro. Payments to families have increased as well – for example, a subsidy for homebuyers.
It was thus a political choice to neglect infrastructure spending and prioritise consumptive expenditure – this had nothing to do with austerity. If Germany wants to spend more on infrastructure, it could easily do so without debt finance. It just needs to reprioritise its spending policies (as it should).
The second reason Germany should be careful about debt financing is constitutional and economic. After the Global Financial Crisis, the country introduced a preventive ‘debt brake’ and enshrined it in its constitution in 2009. This legal rule limits the ability to debt-finance government spending in ordinary years.
It was a reasonable step to introduce the ‘debt brake’ since Germany’s public debt was more than 80 percent. Berlin had not produced a balanced budget in four decades. To avoid the fates of Italy or Greece, something had to change. Without restrictions, German politicians would have never reined in excessive spending.
It also made economic sense to constitutionally limit expenditure. Since the 1970s, economists have pointed out the phenomenon of political business cycles. They happen when politicians running for re-election increase spending before elections. Fiscal restrictions can limit such politically motivated spending.
Because of burgeoning tax revenues and falling debt servicing costs, the debt brake has been relatively painless since it was introduced. It would be a fatal blow to fiscal credibility to abolish it at the first sign of fiscal trouble.
The third reason a debt-financed infrastructure programme would be wrong is it is not what Germany most urgently needs. Yes, Germany has infrastructure problems, but the real challenges lie elsewhere.
Since Angela Merkel became Chancellor in 2005, she has not introduced any meaningful economic reforms. Whereas her social-democrat predecessor, Gerhard Schröder, had liberalised the labour market and modernised the welfare state, Merkel has done nothing.
Actually, that is not true. She has done plenty but nothing that make sense. Her energy policy switched off nuclear power, is about to phase out coal, and subsidises renewables and electric vehicles while operating within the EU’s emissions trading scheme. It has cost hundreds of billions of Euros without denting emissions much. No wonder the Wall Street Journal called it the “world’s dumbest energy policy”.
Merkel also crippled Germany’s tax system. By not adjusting tax brackets for inflation, taxes have reached exorbitant levels by New Zealand standards. A New Zealand employee on $100,000 takes home 75 percent after tax. In Germany, on the equivalent salary, it would only be 58 percent. German employers must pay social security contributions on top of gross salaries, so the real wedge between gross and net wages is even bigger.
For the past 14 years under various Merkel-led coalition governments, German economic policy has been erratic, short-sighted and counterproductive. Fiscal policy has followed the wrong priorities. What are the chances that a grand debt-financed infrastructure programme would be any different?
Of course, engineering companies like Siemens want to equip infrastructure projects. And employers, trade unions and post-communists always love stimulus programmes. But that does not mean they make sense or would help.
What Germany really needs is proper economic reforms and a re-calibration of fiscal spending priorities. To achieve that, it needs a different Chancellor in a different coalition government.