The country’s next chancellor is ready to rip up the rulebook to save the economy Tim Wallace Deputy Economics Editor
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16 November 2024 8:00am GMT
In one casual sentence, Friedrich Merz upended Germany’s economic policy.
Addressing the debt brake, a strict legal limit on borrowing introduced by Angela Merkel in 2009, Merz told a conference last week: “Of course, you can reform it.”
A seemingly permanent feature of Germany’s economy is suddenly up for discussion.
The willingness of Merz – the head of Merkel’s Christian Democratic Union – to consider overhauling Germany’s debt rules marks a major turning point for the country’s economic policy.
Berlin has kept its debt at pre-financial crisis levels, even as most of the rich world has borrowed heavily through the pandemic and its aftermath.
Yet now a country known for its reverence for the “schwarze null” – the black zero, a phrase symbolising Germany’s balanced budgets – looks almost certain to start borrowing heavily in an effort to stimulate its moribund economy.
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Merz is the prime candidate to be the next chancellor, following the collapse of Olaf Scholz’s Social Democratic Party (SDP)-led coalition triggered by a row over the public finances. A snap general election is to take place in February.
“Trump, and the way in which the coalition government broke apart, means this is going to be an election about the economy,” says Claus Vistesen at Pantheon Macroeconomics.
At issue is how to revive Germany’s struggling economy. Increasingly, it looks like a debt-fuelled stimulus could be the way forward.
It is no coincidence that Merz has put forward the idea of abandoning strictly balanced budgets just as Donald Trump is about to move into the White House. The incoming president’s trade policies are a major threat to Germany’s economic model.
The US is Germany’s biggest customer, buying €158bn (£131.8bn) of the country’s exports last year. Trump’s suggestion of imposing tariffs of 10pc, or even 20pc, on everything sold into the US would hammer an already weak German economy.
Germany has performed uniquely awfully among the G7 nations in recent years. Britain’s GDP is about 3pc larger than it was at the end of 2019, just before the pandemic lockdowns. France is 4pc bigger, with Italy up more than 5pc on the OECD’s measure. The US is roaring ahead, growing more than 11pc in under five years.
Over the same time period Germany’s economy has not grown at all.
Much of the problem stems from manufacturing. Once the pride of the German economy, factories have been laid low by a weak Chinese economy and a spike in energy prices following the Russian invasion of Ukraine.
“The economy is not doing well, we know Trump is going to come after them with tariffs: this is going to be a catalyst for more fiscal stimulus in Germany,” says Vistesen.
Merz’s party, which is leading in the polls, previously staunchly defended the debt brake when Scholz tried to loosen the reins to enable more borrowing and spending.
Yet he has changed his tune. Speaking last week Merz suggested that the rules should be reformed to fund investment and stimulate growth.
“The question is why and for what purpose,” he said. “If the result is that we spend even more money on consumption and social policy, then the answer is no. If the result is that it is important for investment, it is important for progress, it is important for the livelihoods of our children, then the answer may be different.”
The constitutionally enshrined debt brake largely limits borrowing to 0.35pc of GDP. Scrapping the rule altogether is difficult – that would require a two-thirds majority in the Bundestag.
However, there is scope for reform and precedent for change: it was suspended in the pandemic.
The debt brake has become bound up with Germany’s national psyche. Yet there are signs that attitudes are shifting.
The Free Democratic Party, which was a staunch supporter of the debt brake and left Scholz’s coalition in a row over borrowing, now risks losing all of its seats in the election, removing a barrier to change.
Holger Schmieding, chief economist at Berenberg Bank, believes a potential Merz-led coalition of the CDU and SPD will loosen the debt brake to allow more borrowing to fund investment. He expects “some pruning of welfare benefits, and a more rational immigration policy focusing on the immigrants Germany wants” to help sell the change politically.
Carsten Brzeski, economist at ING, expects “an additional fiscal stimulus of 1pc-2pc of GDP per year over the next five to 10 years” under a plan he has dubbed “Make the German Economy Great Again”. That would amount to in the region of €40bn to €80bn of investment per year.
Schmieding says the fastest way to get more money spent well would be to give it to municipalities to spend it on projects such as repairing and upgrading roads, bridges and other local infrastructure.
Then there is the issue of defence. Schmieding says that Trump’s election means Germany will also need to find a way to bolster its defence spending over the longer term.
“We have a special €100bn fund for the military, which is a carve-out from the debt brake already, but it is not a permanent solution. Trump in the White House makes it more urgent to come up with a permanent solution,” he says. “Most likely, spending more on defence will require a change to the debt brake.”
Other nations are watching on hopefully, says Leo Barincou at Oxford Economics. A rising tide floats all boats and a resurgent Germany would boost the broader eurozone economy.
“If you had a larger fiscal stimulus – or a stimulus of any kind in Germany – it would be helpful for other countries to have a quicker recovery.”
Across Europe, leaders will be hoping that eradicating the black zero can make the German economy great again.