Budget Burden

The Hidden Costs of Not Spending

brake-zach zupancic-CHANGED
Working on the breaks could turn out quite expensive.
  • Why it matters

    Why it matters

    Is Germany’s obsession with limiting public debt a good thing – or is the cap on spending counter-productive?

  • Facts

    Facts

    • Since August 1, 2009, German law has stipulated that the budgets of federal and state governments are to be balanced without reliance on loans.
    • Next year, German plans to take on no new sovereign debt for the first time since 1969.
    • The cap’s implications are part of the ongoing discussions about public investment to meet infrastructure needs.
  • Audio

    Audio

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In Germany, the debt brake has constitutional status. Since August 1, 2009, the law stipulates in Article 109’s third paragraph that budgets of federal and state governments are in principle to be balanced without reliance on loans. For the federal budget, Article 115 states more precisely the requirement is met when borrowing doesn’t exceed 0.35 percent in relation to nominal GDP. Starting in 2020 as a general rule, German states may not take on any more debts. However, in economically hard times, a higher level of borrowing is permitted as long as loans will be paid off in better times. Seven of the 16 German states have incorporated these regulations into their constitutions.

This is the third attempt in Germany to specify a cap on public debt through constitutional law. The 1949 Basic Law, Germany’s constitution, contained the requirement that the state could take on loans only for “exceptional necessity” and those earmarked for “expenditures for promotional purposes.” In 1969, the rule was amended so borrowing was allowed to the level of estimated “expenditures for investments” unless the borrowing was necessary to protect against a disturbance of the overall economic balance.

Ultimately, PPP models or infrastructure funds are shadow budgets, with which strict public debt rules can be circumvented.

The implicit logic behind the current regulations is long-term, sustainable public finances should allow temporary loans for three reasons only: First, for the smoothing of tax rates over a period as a means of optimizing tax policy. Second, for moderating economic fluctuations through the operation of automatic stabilizers within the national budget. And third, for financing discretionary measures to cushion short-term, demand-related economic slumps – under the condition that debts would be paid off in a recovery. A deficit in the federal budget due to an economic slowdown in 2015 would therefore not be considered a breach of the debt cap.

There are good arguments to cut back the debt ratio to increase macroeconomic resilience against external and internal shocks, at least within the allowed level set by European agreements, which specify debt caps of 60 percent in relation to GDP. However, it is questionable whether the upper level of a structural deficit of only 0.35 percent for the federal government and the effective ban on debts for states are wise regulations. Even in an only slow-growing economy with a growth rate of little more than 0.35 percent, this debt cap has the effect of forcing a continuous decline in the debt ratio. As the regulation specifies no target value for debt ratio, a consistent application of the law drives the debt ratio toward zero. In that way, the current regulations constitute a solution of last resort and such solutions are rarely efficient.

Where the debt cap leads can be seen in the current discussion of public investments. Amid a background of cross-party policy failures in the maintenance and development of federal infrastructure, Sigmar Gabriel, the minister for economic affairs, has founded a group of experts to deal with the challenge. Given the debt ban and a politically imposed renunciation of tax increases, this group should seek ways to mobilize the substantial private savings in Germany for public investment. It remains to be seen whether this happens by way of either:

– A PPP model, a public-private partnership funded and operated through government and private sector companies, where private partners take on the construction, operation and financing of bridges, highways, etc.

– Or through an infrastructure fund with money lent by banks and insurance companies. In any case, private investors will be willing to invest only if they get a surcharge of 1 to 2 percentage points on the interest returns of German government bonds for their commitment.

Ultimately, PPP models or infrastructure funds are shadow budgets, with which strict public debt rules can be circumvented. The future financial burden associated with this way of financing is therefore certainly not less than through direct public debt. The costs could even be significantly higher if the state agencies are not up to the task of dealing with their private “partners” effectively in their efforts to implement the PPP model. Such issues are tellingly documented with the current procurement problems in the defense industry.

The upshot: Compliance with Germany’s constitutionally mandated debt cap has a hidden price clearly higher than direct loan financing.

 

The author is the president of the Handelsblatt Research Institute. He can be reached at: ruerup@handelsblatt-research.com

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