Putting the Brakes on Economic Modernization

Since 1963, the German Council of Economic Experts has been tasked with providing the Federal Government of Germany — and the public — with assessments and predictions regarding the current state and development of the economy as a whole. The five-person council has advocated a — cautious — reform of the infamous debt brake for some time now. Its most recent report, published on 13 November 2024, primarily focuses on the issue of “overdue modernization efforts”.

But which modernization efforts are overdue, and why? What politicians, parties, and policy mechanisms have stalled them to such an extent that the economy has now fallen into recession for the second year in a row? Achim Truger, an economist and member of the aforementioned council, recently sat down with the Rosa Luxemburg Foundation’s Eva Völpel to discuss what the report means for German politics and policy in the months and years to come.

The German economy will continue to contract in 2024, and important pillars of the German export model, such as Volkswagen, also find themselves mired in crisis. What are the underlying structural causes of the recession?

When faced with an acute crisis, it’s always difficult to say what is the result of broader trends and what is structural. Perhaps it would be better to say “unusual” rather than “structural”.

What is unusual is the ongoing weakness of the industrial sector, which in turn is connected to the fact that German exports are clearly developing more sluggishly than one would expect in relation to the global economy and the economic state of the country’s most important trade partners. This is arguably also connected to a lower competitiveness in terms of price — following the energy price shocks, German companies have been forced to contend with steep increases in both energy and labour costs.

What’s more, exports are also facing additional pressure due to the fact that the Chinese economy is pushing into markets that were previously German strongholds, such as automobile and machinery manufacturing. This would suggest that the German economy has neglected to make its product range competitive. High subsidies for Chinese manufacturers have only exacerbated the problem.

The German Council of Economic Experts recently presented its new report and highlighted a failure to implement modernization measures. When it comes to public investment, Germany has been lagging behind for years — just how significant is the problem compared to other economically robust countries?

When it comes to economic performance — i.e. gross domestic product — public investment is decidedly weaker here in Germany. But it’s also important to note that these kinds of international comparisons only serve as a reference point. It’s obvious that the country’s transport infrastructure is in a state of disrepair. Extensive train delays, collapsing bridges, and the like are all clear indicators of this. These kinds of issues also really stymy productivity and growth.

The fact that even the Council is now advocating reforming the debt brake has certainly attracted a lot of attention. Had the traffic-light coalition adopted such a provision, it may have avoided collapsing over the issue of the debt brake.

At the same time, the education system is also severely under-resourced. Equality of opportunity, though often invoked, does not exist in concrete terms, and German students perform poorly in international comparison tests. There are some serious deficiencies, and a profound need for modernization.

What role has the debt brake played in hamstringing modernization efforts?

In my opinion, the debt brake has played a decisive role here. The doctrine of austerity that led to the introduction of the debt brake and the “black zero” simply did not allow the crucial question of what was actually needed in terms of public investment to be raised, let alone seriously discussed.

Between 2014 and 2019, when the economy was strong, politicians did — depending on the state of the books — make a show of slightly increasing public investment and also helping out local authorities by way of project funds. The actual deficiencies and needs that existed were brushed aside. After years of budget wrangling and the harsh verdict handed down by the Federal Constitutional Court, it’s now clear that modernization efforts cannot succeed without first reforming the debt brake.

How should the debt brake be reformed – and how many billions more in potential debt would this concretely allow to be taken on at present?

A reform would have to achieve two objectives. Firstly, there must be much broader scope for stabilizing the economy in times of economic crisis. According to the Federal Constitutional Court’s ruling, emergency lending can only be offered for one year. In the year immediately following an emergency, the debt brake must immediately be reapplied. However, the concomitant consolidation policy can seriously endanger any recovery.

With that in mind, it would make sense to reintroduce the debt brake gradually in the wake of a crisis, in order to ensure a transitional period in which financial policy can continue to support an emergent recovery. This is exactly what the Council suggested in its joint proposal on reforming the debt brake in January this year.

Secondly, there must be a large-scale and permanent expansion of credit capacity in order to enable increased levels of public investment. As a compromise, the Council has proposed additional capacity of 0.15 percent of GDP to 0.65 percent of GDP, which corresponds to between 6.5 and 30 billion euro per year, although we have not yet determined how exactly to ensure that this additional borrowing actually ends up being used for investment purposes.

In light of the challenges we are facing, I believe these figures are far too low, but it was a compromise — and the fact that even the Council is now advocating reforming the debt brake has certainly attracted a lot of attention. Had the traffic-light coalition adopted such a provision, it may have avoided collapsing over the issue of the debt brake.

The Council also criticizes the fact that policymakers have not made reliable and long-term investments, and makes recommendations concerning transport, education, and defence. With regard to transport, an infrastructure fund has been floated, while in other areas, there’s talk of minimum spending quotas, and in the education sector, talk of increasing funding on a per-student basis. What sorts of figures are we talking about in terms of investment in these areas?

We take the arguments presented by proponents of the debt brake seriously in this regard: if they are worried that, in the absence of a debt brake, politicians will neglect long-term interests and rack up high levels of debt, then we must also assume that politicians are neglecting future-oriented expenditure — an explanation for the neglect that has occurred in the past.

The fact that we are finally recognizing the existence of major expenditure requirements rather than obfuscating things to ensure that no-one thinks to question the sacrosanct doctrine of the debt brake represents an enormous step forward. Of course, it’s impossible to provide a precise figure, but we predict it will amount to hundreds of billions in just a few years.

If a harsh course of austerity were to be implemented, it is unlikely that the economy would be able to recover. Not only would that result in social division, it would also be economically counterproductive.

How would it be ensured that this sort of investment remained a long-term endeavour? What would this look like in concrete terms?

For transport infrastructure, we have proposed an infrastructure fund that regularly receives transport-related revenue (such as tolls, fuel taxes, and vehicle taxes) from the core budget. This would allow predictable, consistent, and reliable expenditure to be budgeted for the maintenance, upkeep, and expansion of train and road networks.

Why has the Council not proposed funds or minimum expenditure quotas for long-term and dependable investment in climate protection? The current debate around the budget makes it clear how contested the climate and transformation fund is.

Yes, that would also have been an option that I personally would have been in favour of. But we haven’t been able to reach consensus on that.

The traffic-light coalition has collapsed. This rupture was knowingly precipitated by Christian Lindner and the Free Democrats (FDP) through their presentation of an 18-page paper on an “economic transition”. What do you make of this paper?

It’s a paper that was written with an election campaign in mind — one that posits a neoliberal “economic transition” as the supposed requirement for economic recovery in a very contrived manner. It would have been much better for the economy if the FDP hadn’t blocked the passing of a budget for the past year and been so focused on cuts, and if the government had actually implemented its planned growth initiatives. Following the forced collapse of the coalition, the economy will now be burdened by the fallout for at least the next six months — reckless.

In a dissenting opinion presented in the Council’s new report, your colleague Veronika Grimm also makes the case — in a manner not dissimilar to that of the FDP — that more investment can only be made when there are concomitant cuts to the welfare state, such as pensions. Business associations take a similar view and, like the FDP and the Christian Democrats (CDU), are also banging the drum for a reduction in corporate tax cuts. Are you worried that the upcoming federal election will result in a rightward economic shift?

I certainly hope not. If a harsh course of austerity were to be implemented, it is unlikely that the economy would be able to recover. Not only would that result in social division, it would also be economically counterproductive.

I also don’t understand the political and social logic behind such an approach. It’s quite clear that we are faced with significant societal challenges at present. War in Ukraine, and the many refugees that it has produced, other geopolitical risks, the energy crisis, transformation — not to mention the ongoing impact of past neglect. And these challenges are supposed to be dealt with by pitting societal goals and groups and groups against one another? Ridiculous. That may make sense for a small clientele party like the FDP, but not for one like the CDU that aspires to be — and to remain — a major party.

What is your view on lowering business taxes?

Business taxes can be a locational factor. When lowering them leads to austerity, due to the lower tax revenue that results, to the detriment of other locational factors such as education and infrastructure, then they are counterproductive. Never mind the fact that it’s debatable whether such reductions actually herald positive growth effects in their own right.

It would definitely be irresponsible to simply scrap the rent control regulations, which is a threat made possible by the collapse of the coalition.

Instead, I would favour fixed-term investment bonuses and increased write-off facilities. Only those who actually invest stand to benefit from such measures, and the public purse would not be permanently impacted by them.

In the US, it was primarily people with low to middle incomes who voted for Trump, as they continue to suffer as a result of the cost-of-living crisis. Economist Isabella Weber has therefore called for an “antifascist economic policy” that would swiftly provide the majority of people with economic relief, for example through a rent cap or restrictions on the price of groceries. If there’s a clear connection between the social situation or downward social mobility and the increase in votes for extreme right-wing parties, what is it that the poor and the lower middle class in this country need?

I think that Isabella Weber’s ideas are useful as forms of crisis intervention. On the whole, what’s required in the medium-term is a significant improvement of public services. Incidentally, this would dovetail wonderfully with bolstering climate protection measures when it comes to housing, energy provision, and transport.

Let’s talk about rents. The Council advocates ramping up construction and simplifying building regulations — but is also in favour of raising the cap on existing rental contracts and advocates lifting the rent brake after 2028. The idea is that this would generate more incentives for construction and for tenants to move house, for example in the case of families whose children have left home and who are living in large apartments that could be inhabited by other people. These proposals are socially explosive and amount to market-liberal wishful thinking. For a much greater number of people, such policies would result in higher rents without actually increasing the amount of housing on offer.

I admit that they can certainly be read that way. As far as I’m concerned, it’s crucial that we increase housing supply, and we have made many recommendations concerning this. I also believe that we are more balanced in our view than ever before, in that we categorize the rent brake in its current form as not being detrimental to the construction of new housing, while simultaneously also recognizing the important function of social housing construction.

However, it would definitely be irresponsible to simply scrap the rent control regulations, which is a threat made possible by the collapse of the coalition. But it’s also true that rent regulation alone will not result in more houses being built.

You are the most progressive of the economists on the five-person Council. The recent dissenting opinion expressed by your colleague Veronika Grimm reflects a belief in the pure doctrine of the market. I imagine your debates must be quite intense — do you often engage in heated discussion when topics such as these are on the table?

Ah, it really depends. I’ve also written dissenting opinions in the past myself. Those who are in the majority never really take kindly to them. But it’s a legally guaranteed right that must be respected. That’s why it’s also important to me that we remain respectful towards one another, even when there’s clear disagreement.

I believe that this also functions better in our current five-person constellation than it did for example back in 2019 or 2020, when the make-up of the council was different and we were quite curt with each other at times. I think it’s quite remarkable that the council’s make-up has essentially been inverted. The paean to the market is no longer being sung by the majority of the choir; now it can only be heard from one solitary dissenting voice. I see that as a giant step forward!

There was also a great deal of disagreement over a new compliance codex, which you as a Council approved — with the exception of Veronika Grimm, who is seeking to overturn the codex in court. There was a dispute concerning her position on the supervisory board at Siemens Energy. Veronika Grimm has no intention of relinquishing either her position on the board or on the Council. Where is the red line when it comes to conflicts of interest?

In view of the ongoing proceedings, I will decline to comment on the matter.

Translated by Ryan Eyers and Louise Pain for Gegensatz Translation Collective.