Germany's absolutism on the debt brake has two overriding effects, one political, one economic. It will kill the coalition. And it will kill investment and growth. It is theoretically true that you can maintain levels of investments while sticking to fiscal targets. This has been the argument of debt brake supporters. In practice, however, politics intrudes. The biggest fiscal red line of the current government is not investment but social transfers. The more political red lines you impose, the more investment will be squeezed.
We have seen a prelude for this year's budget, but the big impact will happen in 2025. Even more difficult is the medium-term financial plan until 2028. The numbers are just not adding up.
FAZ tells us that the additional finance gap for 2025 is around €25bn, citing estimates from coalition sources. This is in addition to the €11bn in cuts for 2024. The original estimate for the austerity measures for this year had been €17bn, but the coalition managed to plunder some reserves. So the total volume of austerity applied to the German economy will be in the order of 1% of GDP. This is an economy in the middle of a cyclical and structural recession. The economic news remains awful. Industrial orders declined by 11% in January, month-on-month. Real incomes should rise this year, and that will be positive for domestic consumption. The recession will probably end in the second half, but the German economic institutes project further weakness ahead.
The fiscal hit will come in the years 2025-2028. The Bundeswehr is currently hitting the Nato defence spending, target but only because of a €100bn fund set aside specifically for repairs and investments. As the fund depletes, the defence budget would have to rise from a current €52bn - which is just over 1.3% of GDP - to around €80bn. This money will have to come out of the ordinary budget.
FAZ notes that 2% is the most that can ever be expected to be spent on defence, given the fiscal constraints. Our observation on this point is that the level of defence spending is ultimately determined by the geopolitical situation, not your fiscal planning. According to the German constitutional court, there exists no legal basis to exempt a long-term increases in defence spending from the debt brake. Its definition of emergencies relates mainly to unexpected natural events like floods, droughts or fires, or sudden military conflicts, but not to foreseeable increases in long-term funding, as is clearly the case here.
Other foreseeable fiscal shocks will be the redemption of the debt from Covid-fund, starting in 2028, and the €100bn Bundeswehr fund, starting in 2031.
The problem with the 2025 budget is that the government will not be able to rely on the usual windfalls, because the economy is so weak. Nor does it have room for manoeuvre on reserves. For as long as the SPD is in power, they will cut social transfers. The FDP will block any tax rises. What's left is non-military investments. Bring back the fax machine.
This is austerity on steroids. It makes no sense for the country or for the coalition. But it makes sense for Christian Lindner. Neither the SPD nor the Greens will dare challenge him. The FDP is the red-line party in German politics. The louder it screams, the more votes it can hope to achieve. The party has recovered a little in the polls, and is back at the 5% minimum representation threshold. This is still too close for comfort. It could still be blown away by a high turnout. But the application of the fiscal wrecking ball is the only chance Lindner has to secure the support from fiscal extremists. This is why this austerity budget will not be stopped. The CDU/CSU is blocking any attempt to reform the debt brake. Friedrich Merz has Olaf Scholz on the ropes. It makes tactical sense for Merz to keep up the pressure until the 2025 budget - but not beyond. If he were to be elected chancellor next year, he would face even tougher problems. Our guess is that the position of the CDU/CSU will change at a propitious moment.
