On Friday, Germany’s upper house of parliament, the Bundesrat, approved a historic amendment to the country's Basic Law, which stands in as Germany’s constitution. The move follows the lower house’s vote in favour earlier this week.
The far-reaching amendment exempts defence spending above 1% of the country’s economic output from tight debt restrictions. It also makes way for a €500 billion fund for infrastructure and climate-related investments. In a win for the Greens, which is exiting government, climate neutrality is now constitutionally binding.
The dramatic overhaul is partly a response to a shaky transatlantic alliance with the US, which has become unpredictable, if not hostile, since Donald Trump returned to the White House. After years of self-imposed austerity, thanks to the so-called debt brake that entered the Basic Law in response to the financial crisis in 2009, the largest and richest member of the European Union will now be able to carry a budget deficit above 0.35% of GDP for defence and infrastructure projects.
Until now, higher levels of debt were permitted only as exceptions to address one-off emergencies, such as the COVID-19 pandemic. A similar defence-related spending allowance, in the amount of €100 billion, was made in 2022, in response to Russia’s full-scale invasion of Ukraine.
The constitutional legwork required some political manoeuvring by Friedrich Merz, Germany’s presumptive next chancellor. Funnelling more money to both defence and infrastructure was part of preliminary coalition negotiations between his Christian Democratic Union (CDU) and the Social Democrats (SPD), which is likely to move from top dog to the CDU’s junior partner in the next government.
To reach the two-thirds majority that a constitutional change requires, both parties needed support from the Greens, which look to be heading to the opposition when the next parliament convenes. Explicit climate commitments were their demand.
The dramatic vote marks the final major work of the outgoing parliament. The CDU and SPD didn’t want to wait for the incoming one, when an emboldened Kremlin-friendly, far-right Alternative for Germany (AfD) and the socialist Left, which opposes military spending, would have had more power to block the legislative process.
Germany’s newly granted spending powers have been widely applauded around the EU. Yet there is plenty that could go wrong. In a Q&A with The Parliament, Marcel Fratzscher, President of the German Institute for Economic Research (DIW Berlin), explains why the move is good news for Germany and Europe more widely — with caveats.
The following interview has been edited for length and clarity.
You have yourself long called for an easing of the debt brake. Are you pleased with this development?
It’s better than doing nothing. It's certainly progress, and I would even say it's a regime shift. It's a major break with Germany's past. It's a major break with Germany's obsession with debt and savings. So in that sense, I think one cannot underestimate the fundamental shift of this decision that comes with it.
It essentially says, ‘Look, we have understood that conducting more public investment in infrastructure and defence is more important than avoiding debt,’ and that's really a major shift in the political thinking of the past 20 years.
Germany has had negative net public investment for the past 25 years, meaning public investment has been less than the depreciation of the capital stock of infrastructure, roads, bridges, public buildings pretty much every year for the past 25 years. So in that sense, it's absolutely crucial for having an economic transformation.
But it's not the ideal solution. It's a workaround. It's essentially the circumvention of the debt break. Yes, on the defence side, that's a true change of a debt brake. But on infrastructure, the creation of a special purpose vehicle — a special fund of €500 billion over 12 years to finance public investment — is not the right solution.
Infrastructure investment and investment in education is not a one-off. It's a permanent task and therefore it should be in the regular budget — not in a special fund — that would require a true additional change to the debt break to distinguish between public investment and public consumption.
What has changed to make the EU's most tight-fisted member into its most fiscally lax?
I'm not sure it is a complete shift to make Germany the most fiscally expansionary country. Having more money is a necessary, but clearly not sufficient condition to actually spend more money. And that's the important thing for the German government.
It needs to understand Germany will not be able to spend much of that money if it doesn't conduct a number of crucial and fundamental reforms to deregulate, reduce bureaucracy, speed up planning permission processes, and give more money to the municipalities rather than at the federal level. The municipalities spend 50% of all public investment. So there are a lot of issues. I'm very doubtful that much of this money will be spent over the next two or three years, and even over the 12-year period.
Could you put €500 billion into a more meaningful context?
Five hundred billion euros over 12 years, so roughly €40 billion per year — that's 1% of German GDP. This is a decent number, but it's not extraordinary. To put it into perspective of Germany's gigantic trade surplus, which has been running on average 5%-to-6% of GDP over the past 20 years.
So you see that kind of net savings, the big current account surplus, it would only mean Germany is using a small part of that in terms of public spending. Hopefully that public investment will also trigger private investment. We actually think that there might be a pretty big multiplier, meaning it might trigger an equal amount of additional private investment in innovation capacities and so on. So the growth effect on the German economy is substantial.
We estimate if Germany was actually able to spend €40-to-€50 billion per year by 2027 or 2028, that might add more than one percentage point of GDP growth. So, substantial effect and with a big positive spillover to the rest of Europe — meaning more German growth means more demand for other European countries.
Around the EU there seems to be plenty of support for what Germany has done, but also some worry. Can you explain that tension?
There's some degree of competition between German companies and other European companies, but extra demand, more German growth, more German investment, will trigger extra demand in the rest of the euro area and the rest of the European Union. So I think that effect clearly is much bigger and dominant.
Take the German car manufacturers. Yes, you could say they're competing with Italian or French or Spanish car producers, but mostly they're in competition with Chinese and American car companies. The positive spillovers clearly dominate the competition effects — that this might actually lower market shares of other European companies.
Based on the “Zeitendwende” experience, which saw €100 billion in off-budget funds to increase military spending, what can you say about how this even bigger round of borrowing will fare?
The €100 billion announced after the start of the Ukraine war was limited in scope. Most of the money has not been spent precisely for the reasons I described — that Germany is lacking the capacities both as a public sector to make the procurement and trigger purchases, and also because of a lack of private-sector capacities. So that has not been a huge success. It was necessary because it created space to give additional money to Ukraine and additional weapons, but it’s a good example that shows the difficulties of actually spending the money.
The new defence plans are different in the sense that they are open-ended and potentially unlimited. It says above 1% of GDP, defence spending can be spent outside of the regular budget. The German government has understood that the US is no longer a reliable partner on defence and [US President Donald] Trump has made that abundantly clear, and that fits well with EU plans to try and replace the US within NATO.
How do Germany's spending plans fit into the EU's parallel relaxation of debt rules?
That's a good question. [European Commission President] Ursula von der Leyen announced on fiscal policy that the European Commission would trigger the escape clause allowing more spending, in particular on defence. And Germany's plans are consistent with that.
On infrastructure spending, I would say, it's not a regular spending in the budget, it makes Germany's debt behaviour more consistent with EU rules. One of the big problems with Germany's debt break still is that it's not really consistent with the European rules. It's a lot stricter. And now this new spending will bring Germany more in line with what other European countries do in terms of fiscal spending.
Could loosening the debt brake have unintended consequences, such as sparking an economic downturn?
Quite the opposite. If you look at financial market reactions, they don't always get it right. But I think in this case, they have done a pretty good estimation. Long-term interest rates went up, not because of fears of less solidity or solvency of the general public sector and its spending, but more because of additional growth in the future.
Our models tell us this will actually improve growth. Not right away: We still expect a year, a year and a half, of economic stagnation or possibly recession in Germany, but more growth in the medium to long term. And there are also more tax revenues. So the public sector debt-to-GDP ratio is probably not going to increase very much over the next ten years.
What else does Germany need to do to make this a win for the EU, not just Germany?
In the European dimension, Germany needs to coordinate — on defence, infrastructure, energy and digitalisation. Germany must change course and not go it alone at a national level as it has done far too often over the past ten years. It needs to coordinate much more closely at the European level. It needs to coordinate, in particular, with France.
That's the lesson of the last 65 years: Without close partnership between France and Germany, Europe will not advance.
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