Zeitenwende — a term signaling a turning point or epochal shift. It was used to describe the change in security policy in Germany. Hopefully the same approach could be used in fiscal policy. As Europe's economic engine, Germany's fiscal decisions reverberate across the continent.
However, recent trends indicate troubling economic stagnation that could undermine not just national, but also European prosperity. Germany must go through a Zeitenwende in its fiscal policy. Especially that Germany and Europe with it faces a sort of impossible triangle. On the one hand, we want to accelerate the green transition and be competitive while doing that, on the other hand, we want to ramp up defense spending. And on top of that, we want to be fiscally prudent. This strategy does not add-up.
The German economy is showing worrying signs of contraction. After a 0.3% GDP fall last year, projections remain bleak, with potential further declines in 2024. This stagnation demands urgent action. Economists and SPD and Green politicians suggest increasing spending on investments and defense as viable solutions to spur growth.
Last year, the deficit was about 2.2% of GDP, and it is projected to decrease to 1.6% this year and to 1.3% in 2025. These figures are not alarming, despite the poor economic output data and one of the lowest public investment-to-GDP rates in Europe, which is about 2%.
Using the German development bank
The German constitution does not allow interference from the central government in the realm of state and local governments — and therefore restricts certain investments, such as those in all education-related fields as well as state and local streets. Considering this, one possible workaround could be the use of the German development bank – KfW. Germany currently has 29 special funds at the federal level, with a total volume of €869 billion.
The country’s strict “debt brake” (Schulden Bremse), which limits annual budget deficits to 0.35% of the GDP, adjusted for the economic cycle, has come under sharp criticism over recent months, including from governing parties SPD and Greens.
The ongoing debates about defense spending illustrate the complexities of fiscal management in times of crisis. Chancellor Olaf Scholz's plans to finance future military expenditures through the general budget, following the depletion of the €100 billion special fund established post-Ukraine invasion, highlight the challenge. This approach, though pragmatic, stirs contentious discussions on prioritizing defense over social welfare, given the existing pressures on the labour and social affairs budget.
Furthermore, the potential doubling of the defense budget presents a stark choice between national security and social welfare. This is a false dichotomy that Germany can ill afford. It risks not only economic stagnation but also social unrest, with the resurgence of right-wing populism as a possible consequence of reduced social spending.
The German government must navigate these fiscal challenges without compromising its commitment to social security and energy transition. This necessitates innovative financial strategies, such as the creation of new special funds or managed increases in debt, explicitly aimed at critical sectors like defense and infrastructure, while safeguarding social expenditures.
If Germany cannot change its constitution and get rid of the Schulden Bremse, then it needs to accept the go-around in order to spend more on defense and green investments.
Using the European common debt
If the Germans are too scared of increasing its debt outside the budget of the state and of the local governments they can always insist on using the common debt in order to increase all-European military expenditures.
In 2020 Germany promoted a bold European response to the corona crisis, involving common EU debt. Social Democrat (SPD) Finance Minister Olaf Scholz, and a young generation of economic policymakers in favour of corona bonds, convinced Angela Merkel to subscribe to common EU debt.
The current FDP-led Minister of Finance, firmly rejected proposals on new European Union joint debt, saying such a move, backed by France and European Council President Charles Michel, was not needed and would send a wrong signal to markets. But in order to increase military spending and boost the economy, Germany needs more spending. Fundamentalism of the FPD-leadership does not help in this matter.
Germany and with it European economic opportunity stands at a crossroads: more debt or creative problem solving. To ensure both economic vitality and social stability, it must craft a fiscal policy that is both forward-thinking and flexible. This involves balancing defense needs with social welfare and energy transition, rethinking the usage of development institutions, and preparing for future issuence of common debt.
We need a strong German economy in order to have a strong European Union. The path Germany chooses will significantly influence not only its future but also the broader European project. As such, German fiscal policy requires a bold reimagining, a Zeitenwende like its approach towards Russia.
