7th Jul 2022


An economist on 'elephant-in-room' at German election

  • An important climate change ruling by the constitutional court in Karlsruhe will force Germany to confront EU and German fiscal rules, Vallée believes (Photo: Finance Watch)
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In a highly-important move last year, the European Commission suspended its stability and growth pact - to allow member states the fiscal leeway needed to battle Covid-19 and prevent an economic meltdown.

But with economic recovery now well underway, the debate on Europe's fiscal rules is set to re-emerge with a vengeance.

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The financial details of this debate are undoubtedly arcane. But the outcome will shape the everyday lives of European citizens for the foreseeable future, because it determines what member states will be able to spend on, among other things, renewable energy and climate-change mitigation.

However, the two major power-brokers in EU politics have so far remained largely silent on the issue.

To understand the implications of this and Sunday's German election results, EUobserver spoke with the economist Shahin Vallée.

The German debt brake

Vallée has been a distinguished economic policy advisor in Germany and France for a decade.

First, as an economic advisor to the president of the European Council, Herman Van Rompuy, then as an advisor to the French finance minister Michel Sapin. He now heads the German Council for Foreign Affairs.

This has made him privy to the many different intellectual landscapes in which government spending, debt and deficits are debated within the EU.

While a diversity in opinions explains why it can be hard to reach a consensus on the issue, it also puts extra weight on the French and German election outcomes - if Paris and Berlin can reach an agreement, the rest will probably follow.

France, Vallée expects, might use its presidency of the EU Council in the first half of 2022 to take a stand "on this complex issue", which will coincide with the presidential elections.

But the debate will play out most furiously in Germany, which - according to Vallée - will have "overbearing consequences for the rest of Europe."

Although fiscal rules have not played a major role in the German election, the debate will force itself upon German politics, whether they want to or not, Vallée says.

"If the FDP [liberals] and CDU [conservatives] end up in government, the discussion will be postponed, while the Greens are more prone to changing the rules to allow for greater public spending. The SPD has been a bit shy about the matter and avoided the conversation. But regardless of who will form a government, Germany will have to have a difficult conversation on fiscal rules."

Vallée points to an important ruling by the first senate of the German Constitutional Court in Karlsruhe on the Climate Protection Act in April this year.

The judges have tasked the German government to come up with more precise emissions-reduction targets before the end of next year. Otherwise, they might find the climate protection act unconstitutional.

This opens "a potential rift between the climate objectives of the German federal government and the 'Schuldenbremse' [debt brake]".

In 2009 the CDU-led government amended the German constitution that added a debt ceiling of 60 percent compared to GDP into law.

In addition, the German federal states are not allowed to run deficits that exceed 0.35 percent of GDP.

One motivation was to decrease the transfers from the federal government to the states. But more importantly, according to Vallée, it was an effort to reduce the tensions between "rich" western states and "poor" eastern ones within Germany.

"[The debt brake] ultimately reflects the idea that each state could stand on its own feet provided it kept its house in order," Vallee wrote in the Berlin Policy Journal.

But, like their EU counterpart, "these have proven to be unsustainable," Vallée explained to EUobserver.

"Following the migration crisis in 2017, the law had to be updated to allow for money transfers that were needed to help local governments process a million new migrants."

And when the Covid-19 crisis hit in 2020, the law - like its EU counterpart - had to be suspended to allow for the large public investments needed to save the economy from collapse.

In times of crisis, large money transfers are necessary. Without it "the German federation will not survive" Vallée warned during a debate hosted by Dezernat Zukunft, a German think tank. But, he pointed out, what this also shows is that amending Germany's constitution is not as difficult as it seems.

The outgoing grand coalition of CDU/CSU and SPD avoided fundamental reforms. This time around, Germany and Europe cannot avoid reforming the fiscal rules because if they don't, Karlsruhe, the seat of the constitutional court, will precipitate it for them, he wrote in a memo published on the site of the German Council on Foreign Relations.

Climate change = new rules

Although Vallee admits he does not have the definitive answer to what the new rules should be, one of the important outcomes should be that fiscal sustainability in Germany and Europe cannot take precedence over environmental sustainability.

"There is not much sense in having low debt for the future if there is no future on the planet to start with," Vallée wrote recently.

He adds that current rules do not achieve the goal of stability they are designed for, because they have a bias towards 'restrictive' fiscal policy during crises, which in 2010 led to the European debt crisis.

He explains that current EU rules prescribe that indebted economies reduce debt higher than 60 percent of GDP by 1/20th a year.

Italy has a debt to GDP ratio of 160 percent, which in practice means it has to reduce debt by an unattainable five percent a year.

Like the German regional governments, European member states need fiscal space to service their economies, especially during an economic or environmental crisis.

New 'Golden Rule'

That's why, Vallée says, new fiscal rules should not set arbitrary limits but should offer spending guidance. "A golden rule should be that states spend at least a minimum percentage of GDP on the green transition."

Vallée adds that the rules could include exemptions for climate change expenditure. Countries that want to invest more are enticed to increase spending on green technologies.

Although the commission has announced a review of the European economic governance, and the European Parliament will debate its own initiative this week, a pan-European consensus is unlikely without German and French leadership.

Especially in Germany, this will put pressure on coalition talks to produce a mandate for the government to start changing the fiscal rules.

In a policy memo aimed at the German government, Vallée wrote that "the new coalition agreement must avoid language that would undermine Germany's ability to engage and lead."

Because if Germany fails to take up the mantle on fiscal reform, "the [European] union will continue to fail forward with each new crisis."

No clear winner to succeed Merkel in Germany

Both the centre-left and centre-right candidates to replace Angela Merkel as German chancellor have claimed the right to go ahead after an inconclusive election.

Juncker and Schulz in favour of eurobonds

The two lead candidates of the largest EU political families have a common denominator, even if they admit it's a long-term project: eurobonds.

Election means three-party German government likely

The two main rivals both have said they will try to head the next government. But the splintered election result means either will need both the Greens and the liberal Free Democrats to form a majority.


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