30/07/2010
Germany: Austerity Package, Debt Brake and Structural Deficit
Christiane Jaecker, BHF Bank, Frankfurt.
This article appeared in the July 2010 issue of Current Economics with permission of the author.
Key Concepts: Austerity Measures | Structural Deficit | Automatic Stabilisers |
Key Economies: Germany |
It was recently reported that Germany expects new borrowing in 2010 to
be €15bn to €20bn less than originally envisaged – not as
a result of stringent saving measures, but solely due to the economic upturn,
falling unemployment and special revenues. It now looks as though the total
deficit ratio of national, regional and local governments and the social
insurance system will be around 4 per cent this year, and not 6 per cent,
as the EU Commission had feared about six months ago. If both the economy
and the labour market remain stable and the austerity measures take effect,
the deficit ratio could even fall below 4 per cent in 2011. It must be borne
in mind, however, that the reduction in new borrowing is not the result
of a savings drive, but of favourable economic conditions. The cyclically
adjusted structural deficit still remains and needs to be reduced through
austerity measures. The debt brake hinges on the structural deficit, and
this is somewhat problematic.
The current developments in the federal budget show how easy consolidation
can be, if the economy plays along. Tax and social security receipts rise
automatically, and government transfer payments for unemployment and short-time
working benefits decline. In Germany, the volume of these so-called automatic
stabilisers tends to be greater than that of the fiscal policy measures,
as the progressive income tax system and the extensive social network are
significantly influenced by the economy. This is underlined by the latest
figures and also, the other way round, by what happened during the crisis.
From today’s perspective, the automatic stabilisers could ease the
burden on public finances next year by an estimated €20bn to €30bn,
compared to the €11bn which will be saved by the new austerity package.
In contrast, during the crisis, the stimulus package implemented in 2009
cost around €13bn, whereas the automatic stabilisers cost a good deal
more – around €40bn.
Borrowing Lower than
Planned
In reply to criticism that the German austerity measures are too drastic, the German Chancellor and her Finance Minister point out that the new so-called “debt brake” clause in the Constitution, which is forcing the government to cut spending, will start to take effect next year. According to the debt brake law, after the transitional period has come to an end in 2016, structural new debt is to be capped at 0.35 per cent of gross domestic product. Additional borrowing will only be possible if the economy is weak. As from 2020, regional governments are no longer allowed to run fiscal deficits. However, the brake mechanism is not as automatic and manipulation-proof as it is made out to be. Firstly, the structural deficit at the core of the debt brake is only an estimated figure, and secondly the envisaged transitional period up until 2016 leaves scope for political restructuring.
Calculating the structural deficit is not an easy task; it is not just a simple sum with only one right answer. The elasticity of government spending and revenues has to be estimated, i.e. how much expenditure and taxes fluctuate in the economic cycle. Moreover, it must be ascertained whether the economy is in an upswing or a downswing. This is done by calculating the difference between actual and potential gross domestic product – both of which are frequently revised.
Chart 3. Consolidation Through the German Austerity
Package and Consolidation Requirements According to Size of Structural Deficit
(in bn euros)
It is therefore not surprising that, within the space of a year, the federal budget structural deficit for 2010 has been adjusted from 1.6 per cent of GDP to 2.8 per cent to 2.2 per cent currently. What is remarkable, given the improvement in the economy, is that the structural deficit is now judged to be bigger rather than smaller. This is significant, as, according to the transitional period regulation in the debt brake clause, the structural deficit in 2010 forms the basis for calculating borrowing and consolidation requirements up until 2016. Here the following rule applies: the higher the initial speed, the harder the brakes must be slammed on; but then a higher speed is allowed for the whole braking distance than if the initial speed had been lower.
A high initial basis is therefore an advantage for the German finance minister: a more pessimistic initial assessment of the structural deficit gives more leeway for the following years, thus making it less likely that targets will not be met. Instead, structural deficits which are below the maximum level permitted can be regarded as consolidation success stories. Furthermore, the higher the initial basis, the higher the extent of consolidation stipulated by the debt brake; this makes it easier to implement austerity packages and refuse expenditure requests or tax cut demands.
Let us assume that the structural deficit of 2.2 per cent of GDP, which the Finance Ministry is currently projecting, is the correct basis. In that case, the austerity package would more or less comply with the debt brake regulations up until 2014; in 2011 and 2013, even more would be saved than necessary. From today’s perspective, a further austerity package would be required for 2015 and 2016. If, however, the original estimate of 1.6 per cent of GDP proves to be correct, the austerity package would far exceed the debt brake minimum requirements in the first few years – the Chancellor and her Finance Minister could score points with this success story. If the economy and the labour market continue to develop favourably, this scenario could well become reality.
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