Germany’s government recently collapsed, over a radical economic rule —the debt brake— which states that, essentially, Germany’s government should, on average, never spend more than it earns. This is extremely unusual. No other major government in the world has limited itself in such a way. In fact, most economists around the world think limiting yourself in such a way is a ridiculously bad idea.
So, then why do most German economists still support the debt-brake? Are they right to think that is protects the country from a disastrous debt crisis? Or did it actually lead to years of underinvestment in crucial infrastructure, ruining the German economy for future generations?
To answer these questions, I’ve immersed myself in the German public debate, both from when the debt brake was introduced, and from right now, when even the chancellor who introduced it, Angela Merkel, has now criticized it for being too strict. Essentially, I found that the main disagreements are about two things. The first is about whether or not Germany’s debt brake is too strict, where remarkably, now most German economists have come to believe that it is too strict, even if that is just by a small margin.
The second disagreement is about whether or not you even need a rule like the debt brake, that limits how much the government can borrow, or whether the democratic process can help control debt.
But, to truly understand these two disagreements, we first need to briefly get into
Why Germany introduced the debt brake in the first place
Officially, the debt-brake story begins in 2009, in the aftermath of the global financial crisis. To save the economy, Germany’s broke banks needed a bailout. This caused German government debt to skyrocket, after it had already risen for years.
The public was afraid of this ever increasing debt. Therefore, chancellor Angela Merkel felt that, to assure the German public government debt would be brought back under control, Germany needed a new rule: the debt brake.
After codifying this rule in the constitution, Germany’s federal government can, on average, only borrow 0.35% of it’s GDP each year. But, given that this is an average, the rule is actually less rigid than it seems for two reasons. First, the rule stipulates that, if the German economy is in a downturn, the government can borrow more to stimulate the economy. However, if it does occur, the debt brake requires that the increased debt incurred needs to repaid later. The second reason that the debt brake is less strict than you might think is that it contains an escape clause for emergencies. This clause, which allows the German parliament to suspend the debt brake if there is a natural disaster or another extraordinary emergency that requires extra spending, can explain why, Germany spent quite a lot more than it earned in 2020, 2021, 2022, and 2023. Not surprisingly, in these years its debt shot up.
After all, the pandemic of 2020 was clearly an extraordinary emergency. After that, the Russian gas crisis was again, clearly, an extraordinary emergency. However, underinvestment in the energy transition and in keeping industry competitive with China, was that an extraordinary emergency? No. At least, not according to the German Federal court which blocked moving pandemic era funds to a so-called ‘climate and transformation fund.’
And while, it ,initially, seemed that the German government found creative ways to make the next government budget work, despite the court ruling. The need to invest in times of sky high energy prices and when all of Germany’s geopolitical rivals are investing heavily in their industries, ultimately was not compatible with the debt-brake rule, causing the German coalition to collapse.
This is where we are now. It is not very controversial to say that Germany’s infrastructure is terrible. Almost everyone agrees that the German economic model needs to be reformed. And, almost everyone agrees that, reforming all of this, is not cheap.
So, then, why is reforming Germany’s debt brake so controversial?
Well, as I see it, there are two fundamental disagreements about Germany’s debt brake. One disagreement is about whether or not Germany’s debt brake is actually too strict. But, before getting to that, we first need to talk about the most fundamental disagreement which is about the question:
Do countries need a rule that limits how much politicians can borrow?
Of course they do, say ultra-conservative economists like Romina Boccia from the libertarian think tank the Cato Institute. In a recent op-ed, she said that:
“The United States illustrates the peril of allowing short-term political priorities to undermine long-term fiscal sustainability. Without a debt brake or similar fiscal rule, US politicians have repeatedly deferred hard choices about tax and spending policy.”
To me, the essence of this argument is that, if left to their own devices, politicians will always get into more and more debt. After all, many politicians only care about the next election in four years. However, on average, government debt only comes due in 10 years. So, of course politicians will borrow to give goodies and benefits to their voters, that the country cannot afford.
I can see the logic in this argument. I can also see that in countries where voters are extremely divided, such a dynamic CAN take hold. For example, in Lebanon and Sri-Lanka, economists had been warning that the debt-build up was unsustainable for a long time. But, in highly divided, imperfect democracies, economic research has indeed shown that, rather than providing good governance, politicians are often more successful just bribing voters, in the case of Lebanon and Sri-Lanka with borrowed money.
On top of that, if we compare the debt trajectory of Germany to other mature democracies like France and the United States, we can indeed see that, after the introduction of the debt brake, Germany’s debt started falling while that of other countries continued to climb.
However, now have a look at this graph which compares Germany’s government debt to some of its northern neighbors that also have a reputation to be conservative about government debt. As you can see, in these countries debt clearly increased and decreased, like in Germany, but without a debt brake.
Similarly, if we take a long historical perspective, we can see that even countries like the US & France have had much higher debt loads than today, and they were also able to bring these down without a debt brake.
So, I think it is pretty clear that advanced democracies do NOT NEED a debt rule to decrease government debt. That being said, given that government spending really did decrease after German politicians committed to it in 2009, I do think the debt-brake worked for Germany in reducing the debt.
However, this could have came at the cost of gross underinvestment. Because, if you reason that getting into debt to buy votes works because the political costs only comes later, you could also reason that cutting government spending on crucial investments like infrastructure works the same. After all, a politician that does this can look really responsible to get votes. But, when the time comes that bridges start collapsing and trains stop driving on time, the politicians that cut funding to infrastructure 10 years ago already left office.
This brings us to the second disagreement, which is about the following question:
Is Germany’s debt brake so strict that it is actually bad for its economy?
But, before going into the arguments in favor and against, to avoid unnecessary comments, I just want to emphasize that almost all economist, from very progressive to pretty conservative agree that
- yes, a government can borrow too much, this is bad for the economy
and
- SOME government borrowing is NEEDED for an economy to thrive.
The two most often heard arguments about why some government debt is good are that. Number 1: government debt plays a crucial role in how our monetary system works. That is, what is debt from the perspective of the government. Is an asset for its citizens. In fact, government debt is the safest investment there is for institutions that need stability such as pension funds, banks, and central banks.
Indeed, what is often misunderstood about government debt is that, especially in a democratic nation, the people essentially own the government and therefore are liable for its debt BUT they also own almost all of this government debt, either directly or via their bank and pension fund.
So, if people say that government debt is a burden on future generations, they forget that if debt remains high, future generation will inherit the burden of the debt, but also come to hold that debt as they inherit it from older generations.
The second crucial argument about why government borrowing is needed, is that to grow an economy, governments continuously need to invest in things such as education and infrastructure. If the economy grows, they can collect more taxes. This means that a government can borrow more and more each year. But, if it borrows to invest in a growing economy, it’s debt load compared to the size of the economy remains the same.
If you look at Germany’s debt brake through this lens, it looks overly harsh. That is, few people would be willing to invest in a firm that tells its investors that it would never spend more than it earns. Similarly, even relatively conservative economist agree that a government should be allowed to borrow as long as it borrows to grow the economy.
This brings us to the concept of a so-called ‘golden rule,’ which state that a government is only allowed to borrow to finance investments that are needed to grow the economy. But, if it wants to redistribute more money, it needs to do so by raising taxes. If the debt-brake was turned into a golden rule, Germany’s government could borrow to repair its crumbling infrastructure. It could borrow to fix its broken energy sector, and it could potentially even borrow to modernize its industry to remain competitive with China and the USA. However, if its politicians wanted to bribe voters by giving them subsidies, then they’d still need to raise taxes to do that.
A golden rule is unlikely to satisfy ultra-conservative economists like Romina Boccia from the Cato institute who write that
“Infrastructure assets are often better managed by the private sector and state and local governments.”
However, there are now clear signs that the political tide in Germany is shifting in favor of reforming the debt brake. Indeed, even Angela Merkel, who’s party is expected to win the upcoming elections has said that, while the idea behind the debt brake remains correct it:
“must be reformed to allow higher debt for future investments.”
And, I absolutely agree with her. In fact, even as an individual, I do borrow money from time to time. Never to buy luxury items, or to go out. Of course. But, I have borrowed in the past to finance my studies, and to buy a house. These investments have helped me grow my income more than the debt burden. These investments were a no brainer. Similarly, whatever your stand on using debt rules, I think it is really a no-brainer that Germany needs to be able to borrow to invest to continue to grow its economy.
But of course, for a massive country that is easier said than done. How much should be borrowed? and What should be invested in to avoid a debt crunch? Answering these questions is beyond the scope of this video.
So, if you want to get into more depth about how countries should best avoid a debt crunch, I highly recommend checking out this article about how Trump, Starmer, and Macro can avoid a debt crunch, from the sponsor of this video, the Economist. Then, I suggest you follow up by this article about how Elon Musk can best cut government expenditures for the US, and then finally, this one about why Germany cannot afford to wait to relax its debt brake.
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