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17 October 2021

Germany's message to Europe

Be careful what you wish for when you think about Olaf Scholz and his likely German coalition. The hope in Europe is that the new government will be lax on fiscal policy, and support reform of the stability pact. That Germany will champion the completion of the banking union and the capital markets union. That the country will turn green and digital. That it will drop a foreign policy strategy that coddles dictators, and become a champion of European strategic autonomy.

There will be more investment, green and digital, but most will plug gaps that should have been filled long before: the digitalisation of the civil service, road and bridge repairs sacrificed at the altar of austerity, electric charging stations on motorways, high speed rail networks, and optical fibre networks. The Greens are demanding, and will get, a €500bn investment programme, stretched over ten years. At €50bn a year, this would constitute some 1.5% of GDP, but don't think of this number as the size of the fiscal expansion. For starters, the government had already earmarked some funds for these purposes, including money from the EU's recovery fund. Germany has depleted public investments over the last decade, but has not driven them down to zero.

Furthermore, as the economists Lars Feld and Marcel Fratzscher are suggesting, the programme could be counterfinanced by cuts in subsidies, like the anachronistic diesel subsidy. I expect that the next German coalition will continue to respect the letter and the spirit of the debt brake. This means that the net fiscal effect of this investment programme will be counted in decimal point percentages of GDP. And it would not be much different either if Germany ended with any of the other arithmetically feasible coalitions.

The biggest impact from an investment programme would come from an improved quality in public finances. It is better to spend public money on digitalisation than on subsidies for diesel. But even such a qualitative shift will not happen overnight. This will take some time. Moreover, it will be accompanied by legal challenges. I would expect any attempt to introduce more flexibility into the debt brake, whether through a special purpose vehicle or a reserve fund inside the budget, to be challenged in the constitutional court.

What I do not expect to change is Germany's over-reliance on widget exports for its economic growth, which informs all the other stuff that's wrong with German politics in Europe right now: persistent current surpluses; dependence on Russian on gas imports; dependence on China for exports, so much so that the German-Chinese relationship is probably the most strategic geopolitical relationship in the world right now. A future German government will pay lip service to the concept of European strategic autonomy, just as the outgoing government does.

But perhaps most disappointing for the other Europeans will be the sudden realisation that Olaf Scholz is as fiscally conservative as his predecessors, Wolfgang Schäuble and Peer Steinbrück, the social democrat who brought us the debt brake. A plausible finance minister for a traffic light coalition will be Christian Lindner, FDP chairman and fiscal hawk. Lindner is even opposed to the idea of European deposit insurance, a subject that would fall under his portfolio.

Neither Scholz, nor Lindner, nor the Greens will spend their political capital on the reform of the European stability pact. Since they regard the debt brake merely as the national implementation of the EU's stability rules, their decision to observe the debt brake in full would give them little leeway for reform. I expect that they will accept a similar degree of flexibility for the stability pact that they give themselves, but this would be macroeconomic peanuts compared to what the advocates of stability pact reform had hoped for. A traffic light coalition cannot afford to run a tight fiscal policy at home and then allow deficit overshoots elsewhere in the euro area.

This new coalition defines itself as a modernising force for technology, not statecraft. Europe was not a subject in the election campaign. The decade for EU reform would have been the last one, the decade when Europeans deluded themselves into thinking that the European stability mechanism constituted a sufficient response to the euro area's multiple governance problems. That opportunity was missed for reasons I have written about many times.

This decade will be about digitalisation and green investment. By the time the EU agrees on banking union and capital markets union, we may find that crypto-finance will be so developed that the notion of a banking union and even of banks themselves sounds old-fashioned. Technology runs at a faster pace than European reform. I suspect that Germany will see its future as a junior technology partner for China, while pretending to be a loyal ally to the US and a good European at the same time.

One of the many lessons of this sequence is that historic opportunities, like the euro's sovereign debt crisis, cannot be easily kicked down the road. What you miss this decade won't come back the next.

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