Germany Halts Public Spending in Fresh Blow to Europe

22 Nov, 2023

Germany Halts Public Spending in Fresh Blow to Europe

Germany has suspended public spending for the remainder of the year following a court ruling that deemed the government's expenditure plans unconstitutional. This setback hampers Europe's recovery and its initiatives to strengthen defenses and reduce carbon emissions. The court's decision is likely to widen the economic gap between Europe, experiencing a year-long stagnation, and the U.S., which saw a 5% annualized growth in the last quarter, fueled by substantial fiscal stimulus.

The German economy, the largest in Europe, is contracting due to escalating energy prices and trade tensions, casting uncertainty on its export-oriented business model. Chancellor Olaf Scholz's government had anticipated robust spending on green-energy projects and technology to rejuvenate the economy. However, the court's decision to defund the government's 60 billion euro green-transition project has disrupted these plans.

Energy prices are expected to permanently surpass pre-Ukraine war levels, potentially affecting energy-intensive manufacturing. Additionally, an aging population and a shrinking labor force could constrain potential growth. Berlin's freeze on federal spending came after the court ruled against repurposing unspent credits originally designated for addressing the Covid-19 pandemic for environmental and energy projects. The court emphasized Germany's constitutionally mandated fiscal rules limiting budget deficits to 0.35% of GDP in normal times.

The judgment raises questions about using off-budget special funds for public investments, including a €100 billion plan to revamp Germany's underfunded military post-Russia's invasion of Ukraine. While some welcome the ruling for imposing fiscal discipline, others believe it may hinder efforts to retool the economy and maintain competitiveness.

In the short term, Germany must prioritize policy areas, such as boosting collective defenses, supporting Ukraine, or addressing the impact of rising energy prices and inflation. Berlin also needs to review debt-financed expenditures from the past eight years to ensure compliance with the new ruling.

Despite the financial constraints, Germany has assured continued support for a €50 billion EU budget package for Ukraine. However, it has declined an additional €50 billion spending request from the European Commission on migration and other priorities. This belt-tightening occurs amid political fragmentation and crises, impacting Germany's coalition ratings. The far-right Alternative for Germany party is gaining support, opposing military spending in Ukraine and refugee outlays.

Finance Minister Christian Lindner acknowledges the profound effects of the verdict on statecraft. The court ruling, interpreting Germany's fiscal rules strictly, could limit future governments' fiscal flexibility unless more taxes are raised, a challenging prospect given Germany's already high labor taxes. One option under consideration is declaring a state of budgetary emergency for 2023, invoking a clause allowing suspension of spending limits in exceptional circumstances. However, legal difficulties surround this plan, as the court has raised the bar for declaring emergencies.

The court's ruling challenges assumptions that taking on debt to strengthen resilience and transform the economy during geopolitical crises and climate change is necessary. Climate change, unlike war and natural disasters, was deemed a foreseeable crisis that no longer justifies emergency spending, according to the court. Germany's fiscal rules, enshrined under former Chancellor Angela Merkel, are more stringent than the EU's rules and played a role in Germany's limited borrowing, high taxes, and insufficient public investment during years of low interest rates. European finance ministers are expected to agree on new rules next month to tighten spending after years of pandemic-induced expenditure.