The ‘German Way’ of Curbing Public Debt

Abstract

Public debt: relevance for funding of modern states – Keynesian revolution – Consequences of the financial crisis in Germany – Introduction of the debt brake and Fiscal Compact – The constitutional debt brake: structure and exceptions of the balanced budget rule, four deficiencies of the debt brake – The Fiscal Compact: historical background and structure of the balanced budget rule – Sufficient implementation of the balanced budget rule in Germany? – Constitutionality of the Fiscal Compact? – Austerity as the wrong answer for solving the current economic problems

Introducing public debt

Next to taxes, public debt has always been one of the most important funding sources of modern states.¹ Until the beginning of the 19^th century, however, it was mainly used in emergency situations, especially (though not only) for the financing of war. Since then, public borrowing has become more and more a ‘regular’ way of funding state activities and this growing importance can be explained mainly by two developments. First, the number of state-tasks has constantly expanded, and this has automatically led to growing financial demands on the state.² Due to the intentions of the politicians (who want to be re-elected, and therefore spend more money to please the public), as well as the requirements of the social welfare state,³ these demands could not be fully satisfied by taxes only. Accordingly, public debt has risen continuously in practically all states of the western world, including Germany since 1950 (though it sank slightly, for the first time, in 2013). Secondly, since the middle of the 20^th century and due to the works of John Maynard Keynes,⁴ public debt is not only seen as a (second and useful) possibility to finance specific tasks, but also as an important instrument to influence and stabilize the national economy. According to Keynes, public debt can help fight recessions, as it, first, prevents expenditure cuts, so that the automatic stabilisers (especially reduced income taxes and welfare spending) can take effect; and, secondly, stimulates macro-economic demand through additional expenditure by the state. This ‘Keynesian Revolution’⁵ strongly influenced political life in Germany right up to the beginning of the 21^st century and thereby added to a growing public deficit as the second part of Keynes’ ideas – consolidating public budgets in times of economic upswing – was not taken as seriously as it should have been. Though Keynes’ theory has never been undisputed in the economic field, it seems safe to say that it is at least generally accepted (and even more so since the recent financial crisis) that – especially in times of recession – there can be good reasons for a state to revert to public borrowing to make possible or support economic recovery. German politicians, as well as the German public, accepted this view and, as a consequence, public borrowing became a normal (and not particularly disputed) instrument in everyday politics.

However, due to the constantly growing German public deficit, which was also boosted by the immense costs of the unification of Germany,⁶ opinion about public borrowing started to change in Germany at the beginning of the 21^st century. Public debt was increasingly seen as a problem⁷ and those arguing for sustainable finances and financial austerity gained more and more influence – with the help of one of the leading conservative German newspapers⁸ and, as we will see later, even the Bundesverfassungsgericht (Constitutional Court).⁹ The financial crisis that became apparent in 2008 seemed to confirm the negative consequences of excessive public deficits – the fact that the financial crisis was actually caused by too much private debt and that at least Germany’s public deficit could hardly be interpreted as being too high at the time,¹⁰ was practically not taken into account. The ‘dogma’ that public borrowing had to be restricted was therefore soon broadly accepted among almost all German political parties. This consensus finally led to the introduction of the so-called ‘debt brake’ (Schuldenbremse) in 2009.¹¹ The relevant norms generally demand that the German budget should be balanced, that is, financed without public borrowing. Since then, an excessive public deficit appears to be one of the biggest German economic fears (‘German Angst’), next to inflation.¹² From this perspective, it seems almost natural that the ensuing Euro crisis and the anxiety of having to ‘bail-out’ failing Eurozone states led German politicians almost immediately to demand austerity from practically all its Eurozone-partners – even though the crisis of the Euro, except in Greece, was not primarily a problem of excessive public deficits but of structural deficiencies of the Eurozone itself.¹³ This demand was finally specified and made more or less legally binding in the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (the Fiscal Compact), which was signed on 2 March 2012 and laid the foundation for what has been the (rightly criticised)¹⁴ strict German version of austerity in most of Europe ever since.

Both the ‘debt brake’ and the Fiscal Compact therefore are the result of considerable fear of public borrowing amongst the German public and politicians. Against this background, this article takes a closer look at these two ‘German instruments’ for curbing public debt (including the incorporation of the Fiscal Compact into German law). It concludes that, since they both over-emphasise the negative effects of public deficits and do not take sufficient notice of the positive impacts public borrowing can have, Germany should return to the more relaxed view of public borrowing it had before 2009. To paraphrase a speech of Volker Kauder,¹⁵ maybe it is not Europe that needs to speak German, but Germany that needs to work on its language skills. Otherwise, overcoming the recession within the Eurozone may be a lot harder than is necessary.¹⁶

The German constitutional debt brake

Debt rules before the debt brake of 2009

Corresponding to the abovementioned importance of public debt for any modern state, the Grundgesetz (GG; Basic Law), the German Constitution, has contained specific rules that made public borrowing possible ever since coming into force in 1949. The original version of Article 115 GG, however, allowed public borrowing only in the case of an ‘extraordinary need’ (außerordentlicher Bedarf) and generally only for the purpose of financing infrastructure (werbende Zwecke). This – from a formal perspective – restrictive wording did not hinder a growing public deficit, but was the reason for a major reform of Article 115 GG in 1969 that aimed to incorporate the then prevalent economic ideas of the ‘Keynesian Revolution’ into the Basic Law. The new Article 115 GG¹⁷ therefore made public borrowing much easier, as it no longer demanded an ‘extraordinary need’ as long as the deficit did not exceed the amount of public investments (the so-called ‘golden rule’).¹⁸ A higher deficit was, formally, only possible to prevent a disturbance of the overall economic equilibrium (gesamtwirtschaftliches Gleichgewicht) – yet, due to the wide discretion of the relevant political authorities,¹⁹ this specific restriction played practically no role and therefore was not able to stop the constant increase of the public deficit.²⁰ With public opinion becoming more and more sceptical about this development, and even the Bundesverfassungsgericht recommending the introduction of a constitutional reform in 2007,²¹ the ‘Federalism Reform II’²² presented new debt rules in 2009. By introducing a fairly rigid debt brake, inspired by a similar provision in Switzerland,²³ the new rules thereby changed the previous debt-concept more or less completely.²⁴

According to the new Article 109(3) and 115(2) GG, both the federal level authority (the ‘Federation’) and those at state level (the ‘Länder’) in Germany²⁵ are generally obliged to balance their budgets without any revenue from credit. It is evident that the new concept intends to make public borrowing much harder than before, even though the rules provide certain exceptions (infra). The state, one might summarise, is generally supposed to finance itself through taxes and nothing else. Before 2009 public borrowing was the rule and a balanced budget the normative exception. It will be exactly the other way round as soon as the debt brake comes into force.²⁶ And despite the fact that the former constitutional rules were not able to prevent growing debt, the German public generally believes that the debt brake will be able to manage such a system change even in the complex area of public finances. Such a belief may appear strange from a non-German perspective. Indeed, as the current European (and worldwide) debate shows, (constitutional) rules in this particular area are seldom very successful.²⁷ However, especially because of the strong position of the Bundesverfassungsgericht and the thus created constitutionalisation of the whole legal order,²⁸ faith in the general steering capacity of the Constitution (in combination with the political tracts²⁹ of the Bundesverfassungsgericht)³⁰ remains strongly rooted in German society nonetheless.³¹ The constitutionality of any political action taken therefore plays an important role in practically all political debates³² and almost any highly disputed question will sooner or later be brought before the Bundesverfassungsgericht. The question of compliance with the German debt brake will be no exception – indeed possible non-compliance in the future already forms an important part of the current discussions in Germany.

The general structure of the German debt brake

The basic rule of the debt brake is formulated at the beginning of Article 109(3) GG:³³ ‘The budgets of the Federation and the Länder shall in principle be balanced without revenue from credit.’ From a normative perspective, the provision thus makes clear that public borrowing is supposed to be the exception and not the rule. Yet, as a complete ban of any form of credit would not only have been economically completely absurd, but also practically impossible,³⁴ the basic rule allows for three exceptions, which are also contained in Article 109(3) GG.

1. 1) Article 109(3) GG makes clear that the principle of a balanced budget is deemed to be met for the Federation (but not for the Länder!)³⁵ when credit revenues do not exceed 0.35 per cent in relation to the nominal gross domestic product (GDP); this concerns the so called ‘structural deficit’.³⁶ The relevant GDP is that of the year in which the budget is applicable.³⁷ The Federation is allowed to have such a structural deficit in all circumstances, independent of the economic situation.³⁸ Moreover, and in contrast to the previous provision, Article 109(3) GG does not link this amount of borrowing to the amount of public investments – the ‘golden rule’ has therefore been abolished.³⁹ As public investments usually exceed 0.35 per cent of GDP, in practice this should not make much of a difference. At least theoretically, however, the debt brake allows a public deficit for the Federation even if there are no public investments at all.

2. 2) The second exception applies to both the Federation and the Länder. It allows them to depart from the balanced budget rule ‘when economic developments deviate from normal conditions’. This is the so-called ‘economic exception’ or ‘economic component’, which has also been named a ‘breathing limitation’ (atmende Grenze), because Article 109(3) GG provides that ‘the effects on the budget in periods of upswing and downswing must be taken into account symmetrically’.⁴⁰ Even though this exception is supposed to ensure that the Keynesian anti-cyclical policy will generally remain possible, it will probably make this more difficult than before for two reasons. First, the Grundgesetz now emphasises that the Keynesian theory includes the duty to cut deficits ‘symmetrically’⁴¹ in boom-times.⁴² To ensure compliance with this obligation, it will be necessary to adopt a corresponding amortisation plan that enables the credit obtained to be reduced within an adequate period of time. In other words, the political authorities have to think about ways to reduce debt effectively at the moment they take the credit. Secondly, this exception is linked to a ‘deviation from normal conditions’. How far the debt brake will make anti-cyclical policies possible therefore crucially depends on what kind of economic developments will be assumed to be ‘not normal’ in this sense and how much public borrowing will be deemed acceptable in such a situation.⁴³ The wording leaves a lot of room for interpretation⁴⁴ and the law concerning the execution of Article 115⁴⁵ does not make the situation much clearer.⁴⁶ If one goes by the intentions of the drafters of the debt brake, this requirement will have to be interpreted restrictively.⁴⁷ In the end, it will be the Bundesverfassungsgericht that decides – and one can only assume that it will prefer an interpretation where ‘normal’ really means ‘normal’, so that a deviation cannot be assumed in cases of regular ups and downs of the economy, but only in times of a real recession (whatever that means). In any case, the deviation from normal conditions will have to be justified in detail by the political authorities and this reasoning will be fully litigable before the Constitutional Court.

3. 3) Finally, Article 109(3) GG allows an exception from the balanced budget rule in the case of natural disasters or unusual emergency situations beyond governmental control and substantially harmful to the state’s financial capacity. Whereas there are bound to be no great discussions regarding the interpretation of the term ‘natural disasters’,⁴⁸ it is unclear what is to be considered as an ‘unusual emergency situation beyond governmental control.’⁴⁹ The wording was obviously taken from Article 122 TFEU⁵⁰ and it seems safe to say that at least the financial crisis of 2007/2008 would have been such an emergency.⁵¹ The credit-financed bailing-out of systemically relevant banks and the following economic stimulus programmes of the German Government, therefore, would also have been possible under the debt brake. However, the example of the ‘historic’⁵² financial crisis also reveals that this exception will probably be of hardly any practical relevance in the near future.

Structural deficits of the debt brake

The introduction of the debt brake was widely embraced in the German political arena as well as in most legal and economic literature.⁵³ And, indeed, there would be nothing much to say against a debt brake that ensured a sustainable level of debt and did not neglect the economic rationalities that can make public borrowing a sensible measure to be taken in times of economic downfalls. When looking at the German debt brake from this perspective, one notices at least five aspects which present a problem.

First, a debt brake should limit all sorts of public debt that may have negative consequences (‘problematic public debt’) to be effective.⁵⁴ Otherwise even a balanced budget would not give a correct picture of the actual debt situation of the relevant state. In other words, as the political authorities in such a case would have manifold possibilities for taking up problematic debt without violating the debt brake, the state might go bankrupt despite a formally balanced budget – making the debt brake itself more or less useless.⁵⁵

From this perspective, it does not seem to be a problem that the German debt brake covers neither credit taken from public borrowers⁵⁶ nor public guarantees given by the state to companies or – thinking of the crisis of the Euro – to other states.⁵⁷ In the first case, the public debt does not seem problematic, as only credit taken from the private capital market can have the effect of ‘crowding-out’ private investors,⁵⁸ which is the main reason that public debt can be characterised as problematic at all. In the second case, guarantees may indeed have an effect on the budget sometime in the future and thereby may require additional public borrowing (which would then be covered by the debt brake). But if, and to what extent, this might be the case cannot be predicted with sufficient certainty when giving the guarantee. It would thus be necessarily unclear as to what percentage such a guarantee should be presumed to be ‘credit’ in the context of the debt brake. The same is true, therefore, for credit that is not taken but given by the Federation or the Länder.⁵⁹

However, it appears highly problematic that the debt brake, just as the former Article 115 GG, does not cover any form of debt taken up by autonomous public entities founded by the Federation or the Länder.⁶⁰ Thus, for example, the debt brake does not concern itself with the debt of the social insurance carriers,⁶¹ even though in the end it is the Federation or the Länder that stand behind these. That obviously gives the political authorities enormous possibilities of bypassing the debt brake – making it a lot less effective than it could have been.⁶² In actual fact, the German Government tried to finance massive (and unnecessary) tax reductions using such a construction – it was only because of the massive political and public pressure that it refrained from doing so in the end. However, what might happen in ‘emergency situations’ seems more than obvious.⁶³ Besides, the highly indebted German municipalities (Kommunen) are also autonomous entities in this sense.⁶⁴ In other words, about 7 per cent of all public debts are not covered by the debt brake,⁶⁵ although, in the case of bankruptcy, the relevant Land or, depending on the solvency of that Land, even the Federation will have to step in.⁶⁶ All in all, a ‘balanced budget’ in the context of the debt brake can be a lot less balanced than one might assume.

Secondly, a debt brake should indeed limit all problematic debt, but make public borrowing at least possible where it seems economically appropriate, necessary or (more or less) harmless. This argument has two aspects. First of all, from the perspective of sustainability in the long run, it is not the amount of public debt itself that appears problematic, but its size in proportion to the GDP.⁶⁷ As long as this proportion is stable, public borrowing is at least not harmful⁶⁸ when it comes to the question of state-bankruptcy – though it still might lead to the crowding out of private investors (depending on the economic environment).⁶⁹ A debt brake could consider this, for instance, by making public borrowing harder as long as the debt-to-GDP-proportion is above a certain level⁷⁰ and ‘releasing the reins’ as soon as it falls below. Yet, the German debt brake does not take this aspect into consideration at all.⁷¹ The only mention of the GDP refers to the total possible amount of debt that the Federation is allowed to incur (‘structural deficit’, see supra) and has nothing to do with the current debt level. In other words, the debt level itself plays no role at all. Therefore, the debt brake ‘brakes’ just as hard when the debt level stands at 100 per cent of GDP as it does when it stands at 20 per cent, 10 per cent or even 0 per cent. Economically, such a ‘uniform braking speed’ seems more than questionable and can be endorsed only if one believes that public debt is simply evil in all cases – a view which is hardly maintainable.⁷²

Thirdly, according to Keynesian economics, public borrowing should be possible in times of economic downfalls to make use of the automatic stabilisers and to stabilise demand.⁷³ As mentioned before, the German debt brake allows additional credit in such times, yet it appears doubtful whether it will assure the needed flexibility for an effective anti-cyclical financial policy in this sense. As already pointed out, this will depend on the conditions under which the Bundesverfassungsgericht will deem an economic environment to be ‘normal’ in the sense of the debt brake and how much political action (that is, how much debt) it will allow in ‘abnormal’ times. Judging from its former decisions, it seems more than probable that the Court will take a very restrictive perspective here. Some legal scholars have already pointed out that they believe that the economic exception restricts both the Federation and the Länder to a form of ‘passive economic policy’, meaning that they would be allowed only to refrain from expenditure cuts⁷⁴ but not to enact substantial economic stimulus programmes (‘active economic policy’).⁷⁵ The latter would therefore only be possible according to the third exception (that is in the case of natural disasters or unusual emergency situations, so, practically, not at all). Though this view is hardly convincing from a ‘Keynesian perspective’,⁷⁶ it surely gives a realistic impression of the current atmosphere in German scholarship and public opinion – and this will almost certainly have an influence on future decisions of the Constitutional Court .⁷⁷ In addition, the fact that the political authorities have to try to balance the budget ‘symmetrically’ in times of upswings might also have too restrictive an effect on public borrowing. Economically, upswings and downswings are simply not symmetrical in the sense the debt brake implies – a downswing is hardly ever followed by a completely corresponding upswing. In order to comply with this rule nonetheless, political authorities thus might feel obliged to borrow less than necessary in the first place, as they otherwise might not be able to reduce the debt within an adequate period of time, as the rule demands. Moreover, the danger of a cyclical financial policy is also increased through the 0.35 per cent rule for the Federation, as it automatically allows more debt in good times and less debt in bad times.⁷⁸ From an (anti-cyclical) economic perspective, in order to give the necessary support to the ‘economic exception’, it should have been exactly the other way round.

Fourthly, a public debt brake should differentiate between different forms of public debt, as some forms of debt are more problematic than others. This attribution mainly depends on the use made of the revenue from public borrowing. From this perspective, the now abandoned former ‘golden rule’ seemed sensible for several reasons.⁷⁹ First of all, it is economically rational to permit the financing of investments through public borrowing, as it allows stretching the costs over a longer period of time. As the costs would otherwise have to be carried immediately, without the possibility of incurring public debt, a huge number of investments would simply not be possible – this is the reason why private investments are also practically always financed with the use of credit. Secondly, sustainable public investments (at least theoretically) lead to economic growth and thus more tax revenues, which then enable the state to pay the interest rates. Thirdly, credit-financed investments make sure that all the generations that profit from the investment also contribute to the costs of the investment – the ‘payasyouuse-principle’.⁸⁰ Debt-financed public investments therefore ensure greater fairness between the generations than tax-financed public investments, where one generation pays and future generations use the investment. Finally, because the use of public debt may lead to a crowding out of private investments,⁸¹ as long as public debt is used to invest these public investments are able at least partly to compensate for this effect,⁸² so that public debt, in the end, leads to no losses of investment for the economy from an overall perspective. The German debt brake, however, does not take any of these considerations into account and in actual fact even generally allows a certain amount⁸³ of debt for the Federation to be used for whatever is assumed essential (and therefore not necessarily for economically sensible and sustainable) public investments.⁸⁴ In the rare cases, also, where the debt brake allows additional debt – for economic reasons or in cases of natural catastrophes or unusual emergency situations – the public debt is not linked to the necessity to invest in any form. Apart from being economically questionable, the debt brake provides absolutely no incentives for the public authorities to invest at all.⁸⁵

In fact, the consequences are already visible. Despite an obvious and practically not disputed investment backlog in Germany⁸⁶ and the fact that the German economy has at least lost some of its power the German Government did not even consider further investments in 2014. Instead, it (finally successfully) tried everything to be able to present the first balanced budget for 46 years already in 2015 – that is one year before the debt brake actually comes into force – as if such an aim was of any economic value just for itself. Furthermore, the German Chancellor, Angela Merkel, has also refrained from specific tax reforms, again solely to reach a balanced budget as soon as possible. This policy also seems more than problematic from a European perspective, as Germany is currently practically the only Euro-state with financial resources left to invest. Especially France and Italy are currently struggling to reform their economies without having to breach the European debt rules. German public investments could support these efforts and this at least in the long run would surely also be in the interest of Germany. The most surprising fact, however, is the reaction of the public in Germany, which seems to prefer a balanced budget with no public debt and with the risk of downsizing the economy, bad roads and too few investments over any form of public debt – and the debt brake in its current form not only fails to give the right answers to such irrational expectations, but actually supports them.

Fifthly and finally, a German debt brake has to consider the consequences not only for the national financial markets, but also for the European neighbours and in particular the Eurozone, if the biggest European economy should suddenly drastically reduce public debt and thereby the availability of German government bonds. The Eurocrisis has revealed the importance of more or less safe government bonds that private investors can invest in, and German government bonds from this perspective are – next to American bonds – probably the ‘safest’ bonds on the market. It can obviously hardly be in the interest of German policy that not only professional but also private national investors are more and more forced to invest in the riskier bonds of other European States. This would not only result in even fewer private national investments – so to speak a ‘crowding-out’ from the German market through less public debt – and German investors financing the investments of foreign states,⁸⁷ but might also lay the foundation for the next financial crisis. What has to be kept in mind is the fact that professional investors in this sense are not only hedge funds or dubious investment companies, but also pension funds, insurance companies and other institutions⁸⁸ that play a vital and important role in the functioning of the economy and in practically everybody’s daily life. These institutions are already desperately looking for sufficient safe investment possibilities and with fewer German bonds this will become more and more difficult. In the end, this might even affect monetary policy, as commercial banks need safe marketable securities as collateral when contracting with the ECB⁸⁹ – without being able to invest in German government bonds, these might be hard to get. From this perspective, German public debt is thus an important factor for stabilising not only the national but the European economy as a whole. In other words, public debt cannot be judged separately, but has to be seen in a far wider context, taking into account the complex implications of any radical change in this area for other states and for the stability of the Eurozone.

In conclusion, one might say that the German debt brake is too lax and too strict at the same time. On the one hand, it does not include all sorts of problematic debt and can therefore be bypassed by political authorities too easily and thus may fail in trying to provide the necessary financial soundness. On the other, it restricts economically sensible debt too rigorously, risking not only serious harm to the German economy but – in the worst case – the destabilisation of large areas of the Eurozone and its financial markets – and it will, almost certainly, make any form of recovery for the ‘PIIGS-States’⁹⁰ a lot more difficult. To summarise, the introduction of the German debt brake can hardly be called a well-considered reform.⁹¹

The Fiscal Compact

Historical background and structure of the Fiscal Compact

The Treaty on Stability, Coordination and Governance in the Economic and Monetary Union – the Fiscal Compact – was negotiated and signed within just a few months between December 2011 and March 2012 – that is, at a time when the Eurocrisis was approaching its climax.⁹² For the German public, the culprit of this crisis had immediately been easy to name: too much public debt. The member states with problems – starting with Greece, but also Spain, Portugal, Italy, Ireland – had simply spent too much, and were now facing problems that would have been avoidable. This oversimplified view of the Eurocrisis (which is, if at all, true only for Greece) has determined the public debate in Germany ever since. That German politicians would therefore connect any form of financial aid with the demand for ‘structural reforms’ (meaning massive debt reduction) seems hardly surprising. It is surprising, however, that the German Government managed to convince nearly all the member states of the EU so quickly that collective austerity was the only way to go and to implement this idea in a legally binding contract, despite the fact that the concept of austerity is neither specially new nor particularly convincing.⁹³ The member states that would need financial help in the near future might have had no other choice but to sign,⁹⁴ but this is obviously not true for member states such as France, Austria, Belgium, Denmark and many others. In the end, it was only because of the United Kingdom and the Czech Republic⁹⁵ that the Fiscal Compact has not (yet)⁹⁶ been formally included in primary European law⁹⁷ – but this can hardly be seen as a serious setback for the German Government.⁹⁸

According to Article 1, the Fiscal Compact intends to ‘foster budgetary discipline’ and its basic rule in Article 3(1) therefore demands the budgetary position of the general government of a contracting party to be balanced. Similar to the German debt brake, this rule according to Article 3(1)(b) ‘shall be deemed to be respected if the annual structural balance of the general government is at its country-specific medium-term objective, as defined in the revised Stability and Growth Pact, with a lower limit of a structural deficit of 0.5 per cent of the gross domestic product at market prices.’⁹⁹ The contracting parties shall ensure rapid convergence towards this medium-term objective with the European Commission proposing a time-frame for such a convergence. This lower limit doubles to 1 per cent when the ratio of the general government debt to GDP at market prices is significantly below 60 per cent – yet, due to the current ratio of about 80 per cent in Germany, this provision will probably be of no relevance in the near future. The same is true for the ‘exceptional circumstances’¹⁰⁰ that allow the contracting parties to deviate temporarily from their respective medium-term objective or the adjustment path thereto.¹⁰¹ Nevertheless, with a possible structural deficit of 0.5 per cent, the Fiscal Compact seems to allow for a slightly higher structural deficit than does the German debt brake. However, for two reasons this is probably not the case.

First of all, the maximum structural deficit of the Fiscal Compact includes the structural-deficits of the Federation and the Länder. Yet, due to the transition period of the German debt brake, the Länder will be allowed to obtain credit until 2020 according to their existing debt-rules. As the German debt brake allows a structural deficit of 0.35 per cent of GDP for the Federation alone, the combined structural deficit of all the 16 Länder according to the Fiscal Compact is not allowed to exceed 0.15 per cent¹⁰². At least until 2020, Germany might therefore have more problems than expected in fulfilling its obligations under the Fiscal Compact¹⁰³ – especially due to the fact that the European Commission has made clear that Germany will have to fulfil the 0.5 per cent rule, beginning with 2014.¹⁰⁴ These problems are even intensified taking into account that the 0.5 per cent rule of the Fiscal Compact – again different from the German debt brake – also includes the debt of autonomous public entities such as social insurance carriers and local communities. To comply with this balanced budget rule of the Fiscal Compact, the different layers of the German Federation will therefore have to coordinate their financial policies a lot more than before – even after 2020.

According to Article 3(2) of the Fiscal Compact, the balanced budget rule was to be implemented into national law at the latest one year after the entry into force of the Treaty (that is by 1 January 2014), through provisions of binding force and permanent character, preferably constitutional, or otherwise guaranteed to be fully respected and adhered to throughout the national budgetary process. In addition, by this time national law also had to provide for a correction mechanism to be triggered automatically in the event of significant observed deviations from the medium-term objective or the adjustment path towards it, with an independent institution being responsible at national level for monitoring compliance with the balanced budget rule of Article 3(1) of the Fiscal Compact. However, at the same time, the Fiscal Compact states that the correction mechanism ‘shall fully respect the prerogatives of national Parliaments’, obviously to avoid too harsh a restriction of the democratic process within the member states, since the national parliaments are decisively involved in the budgetary process in all of them.¹⁰⁵ Yet, it remains more or less unclear what consequences would follow if a national correction mechanism should therefore generally give the relevant parliament the last word regarding necessary corrections. Such a constellation can hardly be interpreted as a breach of the Fiscal Compact if the Fiscal Compact itself emphasises the parliamentary prerogative in such a way. So despite the fact that, according to Article 8 of the Fiscal Compact, it is possible (or even necessary)¹⁰⁶ to take legal action in the form of a special infringement procedure outside the treaties¹⁰⁷ before the European Court of Justice in the case of a contracting party failing to comply with Article 3(2), such a lawsuit would be bound to be unsuccessful in these cases. Moreover, it should even be possible for a national parliament actually to refuse to comply with the national correction mechanism, expressly referring to its ‘prerogatives’. The disputed question¹⁰⁸ whether the ECJ is actually competent to supervise either the correct implementation of the balanced budget rule and the correction mechanism or whether a contracting party actually complies with the balanced budget rule during a certain fiscal period would thus lose much of its relevance.

The German implementation of Article 3(2) of the Fiscal Compact

It was obvious that the correction mechanism as well as the institutional requirements of Article 3(2) of the Fiscal Compact would have to be formally incorporated into German law. Yet, such an incorporation would not have been necessary for the balanced budget rule itself if the existing German version had been at least as strict as that of the Fiscal Compact. This, however, as we have seen, is not the case,¹⁰⁹ which is the reason that Article 3(2) of the Fiscal Compact needed to be implemented by the German legislature completely. Due to the fact that the budget is passed by the German Parliament in the form of a statute and the Parliament, according to Article 20(2) GG, is bound only by the Constitution when legislating, an implementation of ‘binding force’ ‘guaranteed to be fully respected and adhered to throughout the national budgetary process’, at least for the Federation would generally have been possible only by amending the Constitution (the Grundgesetz) itself.¹¹⁰ The German legislature, however, refrained from doing so, and decided to incorporate the balanced budget rule into the new § 51(2) of the so called ‘Haushaltsgrundsätzegesetz’ (HGrG).¹¹¹ This (parliamentary) statute, which is based on Article 109(4) GG, contains budgetary principles that are meant to be binding for the Federation and the Länder, but still is a ‘normal’ federal statute. Therefore, there is no doubt about its binding force for the Länder ¹¹² but, according to the lex posterior-rule, the Federation is allowed to repeal or amend its own statutes – including the Haushaltsgrundsätzegesetz.¹¹³ From this perspective, Germany at least has not fully complied with the requirements of Article 3(2) TSCG; and this is indeed the conclusion which quite a few German scholars would probably draw. However, due to the fact that the Haushaltsgrundsätzegesetz is intended to be binding also for the Federation some, and maybe even a majority of, scholars have tried to argue that the lex-posterior rule can generally not apply in this case.¹¹⁴ According to this opinion, the Haushaltsgrundsätzegesetz within the hierarchy of norms thus stands below the Constitution, but above ‘normal’ statutes;¹¹⁵ in other words, a Federal budget that violates the Act would have to be declared void. The Constitutional Court has not yet had to decide on this question, but with regard to another statute it has accepted a similar construction.¹¹⁶ Yet, all in all, the issue is more or less open. Against this background, however, it seems more than doubtful whether the ECJ, within Article 8 proceedings, would accept this form of implementation.¹¹⁷ At least with regard to EU directives, it has made clear that the binding force of the incorporating law cannot be subject to doubt within the national legal system¹¹⁸ – and this is hardly the case with respect to the Haushaltsgrundsätzegesetz. From this perspective, the contracting parties may refer the matter to the ECJ under Article 8(2) of the Fiscal Compact, or could even be obliged to do so under Art. 8(1) if the Commission should find Germany to be in breach of its duty to implement¹¹⁹ – whether they would indeed do so, however, is more than questionable, taking the political implications into account.¹²⁰

Apart from this, the new § 51(2) Haushaltsgrundsätzegesetz implements the balanced budget rule with regard to content, as demanded by the Fiscal Compact. It especially states that this specific balanced budget rule covers the structural deficit not only of the Federation but also of the Länder, the municipalities and the social insurance carriers.¹²¹ Yet, as the different budgets addressed by the Fiscal Compact are set up independently in the relevant budget-procedures, § 51(2) will entail increased consulting requirements between the different federal levels. § 51(1) therefore requires the Stability Council (Stabilitätsrat) to coordinate the financial and budgetary planning of the Federation, the Länder and the municipalities. This provision was already introduced before the Fiscal Compact was signed, in order to meet the already existing European debt requirements.¹²² But, with reference to the Fiscal Compact, the Stability Council now also has to take the estimated revenues and expenses of the institutions mentioned in § 52 Haushaltsgrundsätzegesetz ¹²³ into account.

According to Article 109a GG, the Stability Council is an institution that supervises the budgetary management of the Federation and the Länder continuously – it was established in 2009 in order to make the debt brake more effective. The Stabilitätsratsgesetz, the statute for the Stability Council, includes conditions and procedures for ascertaining the threat of a budgetary emergency and the principles for the establishment and the administration of programmes for taking care of budgetary emergencies. From this perspective, it seems logical that the Stability Council is now also the institution that is responsible for the supervision of compliance with the Fiscal Compact balanced budget rule in § 52(2) Haushaltsgrundsätzegesetz (see Article 3(2) of the Fiscal Compact). According to § 6 of the Stabilitätsratsgesetz,¹²⁴ the Stability Council reviews twice a year whether the balanced budget rule will be met in the ongoing year and the next four years. If it should come to the conclusion that this is not the case, it has to advise how it might be possible to comply with the requirements of the Fiscal Compact. This advice has to take into account the recommendations made by the Council of the European Union according to Regulation No. 1466/97 and is communicated to the governments of the Federation and the Länder in order to pass them on to the respective parliaments. These suggestions are not binding for the parliaments – however, as pointed out before, Article 3(2) of the Fiscal Compact explicitly states that the ‘prerogatives of national Parliaments’ have to be respected, so that this non-binding arrangement of the correction mechanism should be in compliance with the requirements of the Fiscal Compact – whether it will be specially efficient is another question.¹²⁵

When analysing compliance with the balanced budget rule the Stability Council is supported by an independent advisory board (see § 7 Stabilitätsratsgesetz), which consists of representatives of the German Central Bank (Bundesbank), the German Council of Economic Experts, academic research institutes and the municipalities. As the Stability Council itself consists of politicians only,¹²⁶ the advisory board is obviously supposed to guarantee a more objective analysis of the financial situation. The advisory board therefore gives its opinion regarding the fulfilment of the balanced budget rule and – just as does the Stability Board – gives advice how to get rid of possible excessive financial requirements. These suggestions are again not binding – neither for the Stability Council nor for any of the involved parliaments, but have to be published, so the public can and will take notice of them.

Constitutionality of the Fiscal Compact?

Though it certainly contains a ‘German spirit’, the balanced budget rule of the Fiscal Compact is not an exact reflection of the German debt brake – which is hardly surprising taking the international consensus-finding process into account. Yet, while the Fiscal Compact in certain parts is even stricter than the German debt brake, this also raises the question of the constitutionality of the Fiscal Compact itself. In other words, is it possible that Germany binds itself to stricter budget rules internationally than in its own constitution? Due to the supremacy of European Law,¹²⁷ this question did not come up before, even though the European Treaties include similar (though not quite as strict) rules, as the European Treaties do not have to comply with all the provisions of the Basic Law but, according to Article 23(1) GG, only with the provisions mentioned in Article 79(3) GG – the so called eternity clause.¹²⁸ Yet, as the Fiscal Compact was not formally inserted into the European Treaties, but presents itself as a ‘normal’ international treaty, it has to be compatible with all existing provisions of the Basic Law – and thus also the existing debt brake. In its decision on the ESM Treaty and the Fiscal Compact, the Bundesverfassungsgericht has already had to deal with this question: it held that the Fiscal Compact raises no constitutional concerns.¹²⁹ Though it appears hardly convincing when the Court, in doing so, states that the Fiscal Compact mainly includes rules that are very similar to those already existing on the European and constitutional level, given that they are still at least partly stricter,¹³⁰ the two other reasons given in this decision seem convincing.¹³¹ First of all, the Fiscal Compact fully respects the prerogatives of the German Parliament and therefore gives the European institutions no possibilities of interfering with the overall responsibility of the Parliament concerning the budget¹³² – though this argument again obviously raises doubts about the efficiency of the Fiscal Compact itself. And secondly, the Fiscal Compact can at least theoretically be cancelled according to the general rules of international law¹³³ and therefore does not constitute an irreversible commitment of the German authorities to a certain form of budgetary policy.¹³⁴

Deficiencies of the Fiscal Compact and concluding remarks

The Fiscal Compact avoids a few of the structural deficiencies of the German debt brake. It includes all sorts of problematic debt, so the national authorities will not be able to circumvent the balanced budget rule as easily as with regard to the German debt brake. It includes aspects of economic sustainability, by adapting the ‘braking-force’ at least partly to the proportion of debt to the GDP (the structural deficit maybe up to 1 per cent if the debt is below 60 per cent). Yet it again fails to give the right incentives for any form of public investment, as it includes no form of the ‘golden rule’ – although, as the Fiscal Compact refers only to the structural deficit, this is not quite as problematic as with regard to the German debt brake. However, the most dangerous aspect of the Fiscal Compact is the fact that it forces practically the whole of Europe to be austere at the same time. As Mark Blyth has pointed out convincingly, it is not only questionable whether the concept of austerity can work at all, but also practically certain that ‘we cannot all cut our way to growth at the same time’.¹³⁵ At least someone has to be there to spend if everyone else is trying to save. Looking around within the Eurozone, this someone can hardly be anyone other than Germany – although it is probably the last state that will be willing to do so under Chancellor Angela Merkel.

The debt brake and the Fiscal Compact thus offer austerity as the answer to the current European problems. This answer is not only too simple, but in combination these two ‘German’ instruments might also effectively hinder the recovery of the European economy.¹³⁶ While the effects on the German economy will probably be limited, there may well be drastic consequences for those of its European neighbours when the biggest economy refrains from investments financed through public debt. With the Fiscal Compact making austerity the way to go also for the rest of Europe, economic recovery seems more or less impossible in the short run. If one wants to stick to the aim of a balanced budget nonetheless, it is at least to be welcomed that even German politicians are now thinking of allowing a little more time for the economic reforms that are without doubt necessary in some of the states of the Eurozone. But, apart from this, the reforming countries themselves should not forget the second way of balancing a budget in times of recession: tax increases.¹³⁷ In its recommendations for the PIIGS-States, the Troika has almost only reverted to expenditure cuts,¹³⁸ despite the fact that a fairly new study by the IMF has found that ‘only a balanced composition of cuts to expenditure and tax increases boosts the chances that the consolidation will successfully (and rapidly) translate into lower debt-to-GDP ratios.’¹³⁹ However, it will be hard (or even impossible) to teach German politicians to speak these foreign economic languages in the near future.