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How German fiscal rectitude conquered Europe.
BERLIN, Germany — In recent months, German Chancellor Angela Merkel has been using the urgency posed by the euro zone’s debt crisis to reshape Europe’s economies, largely to conform with a particular quirk of German economists: disdain for government debt.
For now, Merkel appears to be getting her way. Late last month, 25 of 27 EU states obediently signed up to play by her rules when they agreed to pan-European fiscal union. If the pact is ratified by national governments, the entire EU — apart from the British and the Czechs, who opted out — will have to strive to reduce their deficits to close to zero, or face the consequences.
The plan is as controversial as it is bold. For some countries, meeting the debt goals will be a gargantuan task. And there are fears the austerity drive will choke off any hope of growth in many places. Yet it is the price to pay, it seems, to maintain Germany as Europe’s paymaster, providing the bulk of the funds for the euro zone’s bailout packages.
And at the heart of the German-designed fiscal pact is a concept known as a debt brake. Instead of the 3 percent ratio of deficit to GDP that the Maastricht Treaty rules had laid down, most of Europe has agreed to a structural debt strait-jacket of just 0.5 percent of GDP.
The debt brake is almost an alien concept to a continent known for its lavish public sectors. Even Germany has struggled to abide by the Maastricht limits. But Merkel’s Europe-wide initiative is actually an extension of recent German legislation. In 2009 lawmakers incorporated a debt brake into the German constitution, or Basic Law, and it came into effect in January of last year.
The federal government in Berlin has until 2016 to reach a target of 0.35 percent. And the 16 states, which are financial heavyweights in their own right, have until 2020 to reach a zero limit.
This obsession with fiscal rectitude predates the financial crisis. It has its roots in both the prevalent school of economic thought in Germany as well as the troubling experience of high indebtedness that followed reunification, and that was exacerbated by the dot.com bust at the beginning of the previous decade.
Although Germany has spent when it had to, for example implementing stimulus packages when the financial crisis hit, the dominant economic doctrine has long encouraged getting to grips with the public finances. “Balanced budgets have always played a big role in German thinking,” explained Achim Truger, senior economist with Macroeconomic Policy Institute (IMK), a think tank with ties to Germany’s labor unions.
Both current Finance Minister Wolfgang Schaeuble and his predecessor, Peer Steinbrueck of the Social Democrats, have laid heavy emphasis on cutting down the deficit, which had soared since the 1990s due to the more than 1 trillion euro ($1.3 billion) costs of German reunification.
Now that the debt brake is enshrined in law, those efforts have ramped up considerably. The idea behind the brake is that spending, and some increase in debt, should be allowed during weaker periods, but during an upturn increased earnings are to be used for budget consolidation. “When the economy has normal burdens, there should be no increase in debt, and the debts that are incurred during the bad period can be reduced during the strong period,” Frank Zipfel of Deutsche Bank Research explained.
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There are exceptions, for example, for a natural catastrophe or a severe economic crisis. However, any debt incurred must be quickly reduced again. “The decisive new element is that the exceptions are only temporary,” says Thilo Schaefer, economist with the Cologne Institute for Economic Research (IWK). “That means that they have to be reduced within a specific time frame. They only allow for a temporary deviation from the essential rule: no more new debts.”
Schaefer argues that these rules are an important means of ensuring states use money on investment instead of servicing debts. “It’s not that debt itself is fundamentally wrong,” he says. “The problem is when current expenses are financed by debt. That is, of course, not sustainable. A policy of living beyond one’s means in the long term, of always spending more than one takes