More Fiscal Trouble in Germany

Two days ago I reported on France’s rising unemployment  and the potential for a large-scale repetition of the Greek crisis. I concluded that so long as the French economy continues to lose up to one percent of its taxpayers to unemployment every year, the government does not stand a chance at balancing its budget. Any attempts at doing so will one way or the other set a downward macroeconomic spiral in motion that, as Greece has demonstrated, can continue to the next Big Bang.

Unlike its southern neighbor Spain, France still has time to save itself from the Greek tragedy. However, their room to take appropriate action is limited by three factors:

1. The mere size of government as it is today heavily stifles private entrepreneurship. Even if the French government did nothing from hereon to try to balance its budget, the French economy would have a long, slow and frail journey to growth, full employment and rising prosperity. This makes it very difficult to defend continuing EU-imposed budget-balancing measures.

2. The socialist ideology of President Hollande, the prime minister and his cabinet prevents the current French government from thinking clearly about alternatives to big-government intervention whenever there is a problem. Since the only sustainable path out of France’s crisis goes through reforms to reduce the size of government, the people that French voters elected to lead the country are ideologically predisposed to reject such a solution. Even if they tried to develop the right kind of solutions it is highly unlikely that they would get very far before their voters, party grassroots and left-leaning media would cry foul and call them ideological hypocrites. Unfortunately, that alone can be a strong deterrent against the right kind of reforms.

3. A rescue plan to have France evade the Greek dungeon would require that most of the rest of the euro-area economy is in reasonably good shape.

Even if lightning struck twice and the French socialists managed to get their act together, the third condition will stand in their way like a concrete road block. Made in Germany. Behold this report from the EU Observer:

In December 2012, leaders from 25 EU countries all signed up to a pact championed by German Chancellor Angela Merkel. The so-called fiscal compact is supposed to discipline countries into spending within their means and reducing their budget deficits and overall debt. In Germany, the “debt brake” will fully come into force in 2019, when the federal state and the regions (laender) are legally bound to stop making new debt.

This is a charade of royal proportions. The EU has had a ban on member-state debt beyond three percent of GDP since 1992, Effectively, the Stability and Growth Pact, which has been in place over two decades now, has made “excessive” debt illegal. As we all know, that has not prevented EU member states from building excessive debt. But that does not prevent the Eurocracy from making what is already illegal, really illegal.

Back to the EU Observer, which reports some worrying signs from inside the German government conglomerate:

Germany is in a much better position when it comes to deficits and debts than its southern neighbours. But still the federal government currently has a debt running at 75 percent of the gross domestic product – above the 60 percent threshold enshrined in EU rules. But in the multi-layered German state, cities fear it will be they who will ultimately foot the bill for Germany’s exemplary balance sheet.

This is crucial:

Ulrich Maly, the mayor of Nuremberg, told journalists in Berlin on Tueday (1 October) that more and more tasks are being moved from federal and regional to the local level, but without any extra funding. … As head of the association representing 3,400 German towns and cities, Maly tabled a series of requests to the upcoming German government, warning of the unfair burden being placed on townhalls in reducing the country’s budget deficit and debt.

Let’s take this in slow motion. The federal government creates a welfare state, then asks states and local governments to participate in the execution of the welfare state’s entitlement programs. To encourage full participation from lower jurisdictions the federal government sends them money. States and local governments get used to the cash and think nothing more of it. Until the day comes when the federal government has made more spending promises than its taxpayers can afford.

All of a sudden the federal government has to make choice:

a) Do they raise taxes? or

b) Do they reduce spending?

The German government tried alternative (a) but tax-paying voters put an end to that. That is in no way surprising, and incumbent prime minister Angela Merkel is trying hard to avoid tax hikes. But choosing alternative (b) is tougher than one might think. Merkel could just slash spending across the board, but if she did she would be accused of wanting to dismantle the German welfare state. That is a battle she does not want to take, probably because she – like most of today’s European “conservatives” – has embraced the welfare state and wants to keep it.

Merkel avoids a battle over the welfare state if she can come across as not cutting any entitlement programs. But since the entitlement programs are the cost drivers for the German government – just as they are for any welfare-state government – she cannot fend off the deficit wolves without somehow reducing the cost of those same entitlements.

Her solution: pass on more obligations to local governments, so the federal government does not have worry about them. But don’t increase spending – have the cities do more with the same or even less money. That way you look like you are protecting the welfare state while also balancing the federal budget.

Does this seem cynical? Understandable. After all, it is cynical. But this is the way politics works when our elected officials set up policy goals that are entirely incompatible, and where the pursuit of one goal, such as the welfare state, hampers the pursuit of another goal, in this case the balanced budget.

This does not stop Merkel’s political opponents from exploiting the apparent inconsistency in her policies. The EU Observer again:

With social expenditure – such as for the integration of disabled people or kindergardens [sic] – taking up over half of cities’ budgets, the question will be “what kind of country do we want,” the Social Democrat said. “The debt brake will put political choices in the spotlight. It will be a question of what we can still afford if we’re supposed to make no new debt. Do we want inclusion of disabled people – which will cost several billion euros – or do we abandon this human right?”

This would be the perfect point to explain to the German people that not even their economy can carry the welfare state any farther. The addition of new entitlements on the top of already existing ones, while people expect existing entitlements to grow, is a formidably bad idea. It goes to show that to the statist there is no such thing as a government big enough.

But it also goes to show how illiterate the backers of the welfare state actually are when it comes to basic macroeconomics. They choose to believe whatever they need to believe in order to motivate a sustained, even growing, welfare state.

And just to show how desperate the situation is getting in Germany, the EU Observer introduces us to…

Eva Lohse, a member of Merkel’s Christian Democratic Union and mayor of Ludwigshafen, … [Lohse] warned that the townhall has virtually no money left for infrastructure projects. “Reducing deficits and debt actually means that somebody else is doing it, not that the task is gone. So whoever does it also needs to have the proper funding for it. We have bridges crumbling down in the middle of our towns – this is unacceptable,” Lohse said.

In effect, there is a glaring lack of understanding of basic macroeconomics on both sides of the ideological aisle in German politics. This lack of insight will delay or entirely rule out appropriate policy solutions. Both the “conservatives” and the social-democrats in Germany will continue to try and preserve the welfare state while balancing the budget in the midst of zero or negative GDP growth. This is a recipe for decline, putting Germany in the same category of struggling welfare states as France, namely one step behind Spain and two steps behind Greece.

Germany still enjoys a lot of economic strength, but with the country’s fiscal policy makers focused on the unworkable combination of the welfare state and a balanced budget that strength can evaporate quickly. Right now, the case for German economic decline is actually stronger than the case for Germany economic recovery. And with German economic decline other euro-zone countries are in grave danger. Greece and Spain won’t get more bailouts, and France and other less-disaster-stricken economies will not have the same strong support anymore from trade with Germany as they have had historically.

Inevitably, our conclusion from this must be that Europe is continuing its slide into the cold, dark dungeon of industrial poverty.

One comment

  1. Pingback: Free Debate and Prosperity | The Liberty Bullhorn