Germany, now the world’s worst-performing major economy, grapples with a budget crisis
Chancellor Olaf Scholz vowed recently that his government would work “as fast as possible” to lay out how to solve Germany’s budget crisis, but he offered few details on how he would achieve his goals of promoting clean energy after a court decision struck down billions in funding.
Scholz and his quarrelsome governing coalition must decide what to cut next year after Germany’s high court ruled that $66 billion in funding for renewable energy projects and relief for consumers and businesses from high energy prices caused by Russia’s invasion of Ukraine violated debt limits set out in the constitution.
Cuts that need to be made next year could further slow down what is already the world’s worst-performing major economy.
Germans “need clarity in unsettled times,” Scholz said in a speech to the German Parliament. He promised that the government would not abandon its goals of sharply reducing carbon emissions from fossil fuels and protecting social spending.
Speaking over outbursts of derisive laughter from opposition members, Scholz said it would be “a serious, an unforgivable mistake ... to neglect the modernization of our country.”
In terms of where to reduce spending, he said a cap on consumers’ utility bills is no longer needed because energy prices have fallen, although the government would act if they rose again. “You’ll never walk alone,” Scholz said, quoting the song title in English.
Germany, which long ago decided to phase out non-sustainable energy sources, is shutting down its last three nuclear power plants on Saturday.
The now-banned spending was aimed at some of the long-term problems plaguing growth in Europe’s largest economy, such as the need to invest in new sources of affordable renewable energy like wind, solar and hydrogen and to support battery and computer chip production.
That has led to calls from some to loosen the debt limits because they restrict the government’s response to new challenges.
But Scholz’s coalition of Social Democrats, Greens and pro-business Free Democrats doesn’t have the two-thirds majority to do that without the conservative opposition, the Christian Democrats, who brought the legal challenge in the first place.
Opposition leader Friedrich Merz criticized Scholz as a “know-it-all” who wasn’t willing to change course and who “lacked any idea of how the country should develop in the coming years.” He vowed to uphold the debt limits.
Germany, the second-biggest provider of military and financial support to Ukraine after the United States, pledges further aid worth $1.4 billion.
There was a lack of details from Scholz on what could be cut next year. On top of that, a long-term solution could take years, possibly until after the next national elections scheduled for 2025.
Economists say spending cuts would only add to the challenges facing Europe’s largest economy after Russia cut off the cheap natural gas that fueled its factories, squeezing businesses and raising the cost of living for households.
The constitution limits deficits to 0.35% of economic output, though the government can go beyond that if there’s an emergency it didn’t create, such as the COVID-19 pandemic.
Germany’s constitutional court said the government could not shift unused emergency funding meant for COVID relief to boost wind and solar projects, help with energy bills and encourage investment in computer chip production.
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Some of the banned spending has already happened this year. To comply with the ruling, the government is changing the 2023 budget by declaring an emergency, citing Russia’s natural gas cutoff.
The question now is next year’s budget. The government would have to scramble to cover shortfalls of roughly $33 billion to $44 billion — plus $22 billion to $33 billion for 2025 — compared with earlier plans, according to Holger Schmieding, chief economist at Berenberg bank.
Some spending can be moved to public-private partnerships or taken over by the country’s development bank. But those fudges will only go so far. Ultimately, spending may be reduced by as much as 0.5% of annual economic output for the next two budget years, Schmieding said.
The debt limits were enacted in 2009 after the government piled up debt paying to rebuild former East Germany post-reunification at a time when tax revenue dropped during the 2007-2009 global financial crisis.
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For years afterward, Germany balanced its budget or even ran small surpluses as the economy lived large on cheap Russian natural gas and booming exports of luxury cars and industrial machinery, with rapidly growing China serving as a major market. Economists say the government skimped on investment in infrastructure, renewable energy and digitalization — gaps it is now trying to make up.
The fallout has left Germany projected to be the worst-performing major economy this year, shrinking by 0.5%, according to the International Monetary Fund.
Prospects for next year are only a little better. Industry is struggling with energy prices and a lack of skilled labor, while Chinese automakers are challenging Germany’s Volkswagen, BMW and Mercedes-Benz and have plans to expand sales across Europe.
The budget debate is ironic because Germany has the smallest long-term debt pile of any of the Group of 7 advanced democracies, with debt equaling 66% of gross domestic product. That compares with 102% in Britain, 121% in the U.S., 144% in Italy and 260% in Japan.
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