Economic Governance 101: Germany

Foreword

This series of articles aims to provide a summary analysis of some of the key economic governance methodologies in application in the world today. Starting with the world’s largest economy the United States of America – characterised by its free-market orthodoxies. Onto Germany, the beating economic heart of the European Union. Through the hybrid phenomenon that is the contemporary Chinese economy and its direct democratic counterpart in India. The series will finish with an examination of “The Nordic Model” in Sweden and finally the enigma that is Post-USSR Russia.

The Economic Governance 101 series consists of 6 main articles:

1. Economic Governance 101: United States of America

2. Economic Governance 101: Germany

3. Economic Governance 101: China

4. Economic Governance 101: India

5. Economic Governance 101: Sweden

6. Economic Governance 101: Russia

Economic Governance 101: Germany

With a population in excess of 83 million, Germany is the largest of the European Union member states (“Facts and Figures”, European Union, N.D.) and remarkably for a nation of its size, the 4th largest economy in the world (Silver and Rasure, 2021). Known for its excellence in manufacturing and remarkable production efficiency, Germany’s primary economic governance model has commonly been labelled as “Social Capitalism” or the “Social Free Market”. A free-market based economic model with an explicit focus on improved social outcomes and economic responsibility. It has been described as “a practical mid-way point between ‘late-form capitalism’ and ‘socialism’” (Claridge, 2017) , with the stated goal of ensuring “the greatest possible prosperity with the best possible social protection.” (“70 years of”, 2018). Beyond the basic premise of an evenly balanced and prosperous capitalist society, German economic governance is marked as much by its flexibility and openness to change as it is by any one set of ideals. This flexibility can be observed throughout Germany’s rich and diverse economic history, from the disaster of the Weimar Republic era and the epoch that followed, its rebuild under the US-guided Marshall plan (Stern, 2006), the difficulties posed by the reunification of two vastly divergent states in the 1990's and more recently in its remarkable policy adaptation to the economic and social difficulties posed by the Covid-19 Pandemic.

Figure 1: Germany is as much defined by its EU membership as the EU is by it

The Social Free Market

Germany’s status today as an extremely well-rounded and efficient modern economy is all the more remarkable in the context of the nation’s recent history. On top of the utter devastation wrought by its principle involvement in two successive World Wars, Germany has had to deal with internal State division, Allied and Soviet Occupation and ultimately re-unification (Becker, Mergele & Woessmann, 2020). Having previously flirted with other governing methodologies, modern Germany is a western styled democracy that has firmly settled on its “Social Free Market” approach, the origins of which are found in the Freiburg “Ordoliberal” school of economics, most associated with German economist Walter Eucken and his associate Franz Böhm.

Eucken and Böhm’s Ordoliberal framework differs from the free market orthodoxies espoused by the likes of Adam Smith and Milton Friedman and synonymous with US Economic Governance in its more serious endorsement of the role of State and institutions in the facilitation of what at least in theory aspires to be a largely egalitarian capitalist society (Vanberg, 2004). While an orthodox free market can be described as one in which private individuals make decisions based on personal choice with minimal government intervention, the ordoliberal model recognises that “economic orders are subject to human design, and that they can be improved upon by deliberate reform” (Böhm, 1950, as cited in Vanberg, 2004). Rather than being slave to a free market system and the inherent inequalities within, an ordoliberal system of governance can be readily tweaked and re-ordered for the intended betterment of society as a whole. It is important to establish that ordoliberal theory does believe fundamentally in the functioning of the free market, and to paraphrase the afore mentioned Adam Smith, the pursuit of individual interests ultimately leading to superior social outcomes. It simply advocates more strongly for the essentiality of government in the creation of said outcomes. Eucken’s fellow ordoliberal co-founder Franz Böhm is memorably quoted by Vanberg, J. in the following passage “to maintain a well-functioning market economy requires a continuous nursing and gardening, comparable to creating and maintaining a highly cultivated park.” (Böhm 1980: 115; 200, as cited in Vanberg, 2004).

The maintenance of such an economy is achieved through regular audit of the legal framework that establishes the rules of economic governance; “At its core, ordoliberalism endorses the idea that a stable legislative —or constitutional— framework is needed to protect both entrepreneurial competition and economic freedom for all private market actors” (Dold and Krieger 2019, as cited in Dold and Krieger 2021, P. 2). Other notable tenets of the ordoliberal school include a strong anti-monopoly stance, with Freiburg ordoliberals believing “cartel-agreements to be in principle incompatible with a competitive economic constitution” (Vanberg, 2004, P. 11), and the position that “the competitive market order can be, and should be, combined with a system of minimal income guarantees for those who are, temporarily or permanently, unable to earn a living by providing saleable services in the market” (Vanberg, 2004, P. 2). (Dullien and Guérot, 2012).

Figure 2: The fall of the Berlin Wall in 1989 was followed by the formal re-unification of East and West Germany in 1990

Social Capitalism in Practical Application

As is the case in a majority of developed economies Germany employs a progressive income tax system, meaning individuals pay a continuously higher percentage rate of tax on their earnings as they increase. The standard income tax rate in Germany runs between 14 and 42 percent, with a maximum marginal tax rate of 45 percent for individual earnings in excess of €274,612 per year (“Germany”, PWC, 2022). A progressive income tax system serves the purpose of redistributing income from those better off in society to those in more immediate need, with the explicit aim of producing a more equal society. These rates are approximately on par with other western European nations and the previous subject of this series, the USA.

In keeping with the central ordoliberal tenet that government should ensure protection for those left worse off by the machinations of a market-based system, Germany employs a host of state insurances which create a strong social safety net for its citizens. These include free public healthcare, unemployment insurance and a mandatory state pension scheme (“Strong Welfare State”, 2018). In fact German public social spending for the most recent year available of 2019 was recorded at 25.9 percent of overall German GDP, a figure in excess of those recorded by other well-known “social democracies” such as Sweden, Norway and the United Kingdom for the same period (“Social Spending”, OECD, 2022). Beyond basic social insurances, Germany is also known for investing heavily in public education through to university level (“Germany, Funding”, European Commission, 2022). It has also enshrined extremely detailed antitrust law into the German constitution in order to ensure the prevention of Monopolies or Cartels forming and to ensure the competitiveness of markets (“Act against Restraints”, Federal Office of Justice, 2021).

What Makes German Economy so Strong?

Germany enjoys an excellent global reputation for the manufacture of high quality goods. German engineering is itself world renowned, while other high value industrial sectors include automotive, electrical and chemical goods (“Why is the German”, 2018). Given its prominence in manufacturing, exports are of vital importance to the German economy accounting for more than 30 percent of German GDP. This makes Germany both the third largest exporting nation on the planet and the largest exporter amongst the European Union member states (Szmigiera, 2022). The EU itself accounts for more than half of Germany’s total trade, while the US and China remain Germany’s two second most prominent export destinations, accounting for 10 and 7 percent of total German exports respectively (Wolff, 2021).

Figure 3: Heavy Industry forms the backbone of the modern German Economy

In this context, Germany is extremely reliant on its continued presence in, and the continued existence of the European Union and wider European Economic Area (EEA). Firstly, for access to the EEA's common market, which allows for the uninhibited “free movement of goods, services, persons and capital — throughout the 30 EEA States” (Hoff and Lúthersson, 2022 )and notably includes Iceland, Liechtenstein and Norway on top of the 27 member states that make up the EU itself. Secondly, because Germany’s EU membership also allows it access to the vast array of International Trade Agreements which the EU has ratified and which grant trade access to a host of lucrative export markets such as China, Australia, Japan and more (European Commission, 2022).

Complex Relations

As a dominant exporting nation Germany relies on the smooth functioning of diplomatic relations globally, and between major trade partners in particular. Of pressing concern then will be the host of political crises on the immediate horizon. The ongoing trade war between Germany’s second and third largest trade partners in the US and China has no doubt been closely monitored by EU and German officials alike. A worst case scenario from a German and wider EU perspective would be tensions rising to such a degree that future relations amount to a straight choice between either nation as a continued trade partner. The entire planet is reliant on Chinese manufacturing and distribution for a majority of everyday goods, not least those related to renewable energy production. China is also as of last year now the largest importer of EU goods overall. The US, meanwhile, remains in the words of the European Commission “the EU’s largest trade and investment partner by far” (European Commission, United States, 2022), and an essential political and military ally. Retaining positive relations with both nations is absolutely essential to continued German and wider European economic success. Achieving this however may test the absolute limits of German and EU diplomatic abilities.

Of more immediate concern is the ongoing degradation of European Russian relations. Germany faces an increasingly urgent dilemma in how to address its heavy dependence on Russian energy imports – specifically oil and gas. These commodities are essential not just in keeping homes and transportation running, but also in the functioning of Germany’s indispensable heavy industry sector. Germany has already succeeded in reducing its Russian gas dependence by 15 percent to now 40 percent of its total gas usage for the year to date. Russian oil imports have also been successfully reduced from 35 to 25 percent of total German oil usage over the same timeframe. These measures however have not been without controversy or opposition with German industry leaders particularly vocal in their dissent against German policy makers attempts to stem Russian energy usage. (Eddy, 2022). In many ways Germany’s internal discord with regard to the handling of its present Russian energy dependence mirrors that experienced by the EU leadership and the union as a whole. In both instances, a compromise appears the most likely scenario, certainly for now (“Russian oil: EU”, 2022).

Figure 4: Germany's continued reliance on Russian energy remains a hugely controversial topic

Contemporary German Economic Policy

Germany have traditionally placed enormous emphasis on ensuring economic stability. This is most plainly evident in what many have labelled the “German obsession” with a balanced budget (Truger, 2020). This obsession is perhaps best evidenced by Germany’s pronounced role in the EU and the (ECB) European Central Bank’s handling of the 2009 financial crisis. Germany were notably one of the leading voices in what came to be known as the “austerity era” in Europe. A period in the direct aftermath of the 2009 global financial crisis marked by heavily reduced public spending and brutal debt mandates which many lesser well off European nations such as Greece are still struggling with to this day (Papadimas, 2022). The formal introduction of a “Debt Brake” into the German legislature at this time was a direct response to the perceived financial excesses of the pre-2009 era. The Debt break is a specific legal clause inserted into the German constitution in 2009 that directly limited the German Federal Government’s structural net borrowing level to a total of 0.35 percent of German GDP, ensuring that the German government would be legally forbidden from running a significant public spending deficit. (Rietzler and Truger, 2019).

The Debt Brake mechanism has been a source of controversy within Germany as well as without. Many have argued that the German economy’s success in the aftermath of 2009 serves as a justification of this policy, and as evidence that “budget consolidation and growth can go hand in hand” (Rietzler and Truger, 2019, P. 13). This view is further compounded by the prolonged economic difficulties faced by other – in particular – European nations (Associated Press, 2012). There is compelling evidence however that German economic success was achieved in spite, rather than because of the introduction of the “Debt Brake” mechanism, and the era of European economic austerity that it heralded. With interest rates running at a sustained low in Europe even prior to the onset of the Covid-19 pandemic, an economy as powerful as Germany’s could have easily sustained a structural national debt rate far in excess of the 0.35 percent mandated by the Debt Break mechanism. Bearing this in mind, and particularly in light of future events, Germany’s self-imposed austerity era if anything has to feel like a missed opportunity.

Given the excellence of Germany’s credit rating, their dominance in the European economic sphere, and their pivotal role within the Governorship of the EU itself, Germany could easily have used this time to borrow cheap, and invest in key areas to benefit future generations (“Why German politicians”, 2021). One of the most obvious missed opportunities in this sense would have been an increased investment in renewable energy, which would in turn have alleviated Germany’s overwhelming dependence on Russian energy imports. In light of Russia’s ongoing military invasion of Ukraine and the immense pressure and division this has created within the EU as it attempts to reduce the Bloc’s almost total Russian energy dependence (Rankin, 2022), this missed opportunity has become all the more poignant.

Figure 5: Germany has had to make significant amendments to its economic operating policy in order to effectively handle the fallout from Covid-19

Covid Responses and Revised Economic Policymaking

The onset of the Covid-19 pandemic in 2020 and the historic changes in German economic policymaking that accompanied it, have added further credence to the idea that the German economy could have benefitted from a much different economic approach throughout the 2010’s. The initial “Debt Brake” ruling formally written into the German constitution in 2009 contained within it a specific escape clause allowing for the existing structural budget deficit limitation to be temporarily overruled in the event of a “severe economic downturn of the euro area or the EU as a whole” (Federal Ministry of Finance, 2022). This escape clause was activated in 2020 (“The end of the”, 2021) in order to allow the ruling German government to attempt to better manage the extreme economic challenges brought about by the global spread of the Covid-19 virus and the wide range of containment measures put in place to deal with it.

For the year of 2020 alone, Germany recorded a public deficit of €189.2 billion, as compared to a surplus of €45.2 billion for the previous year 2019 (Connor, 2021). This remarkable reversal of German fiscal policy has continued through to 2022. Though the current parliamentary budget draft for the year sees a downgrade in the expected federal budget deficit from 7.25 percent of GDP in 2021, to an expected 3.25 percent in 2022 (Federal Ministry of Finance, 2022), these estimates are shrouded in a host of uncertainties, and what can be termed "fiscal unknowns". Amongst them, the aforementioned rising price of oil and gas in Europe, the immediate need of fresh energy suppliers as a result of the ongoing Russian military conflict in Ukraine, and the host of global Supply disruptions manifest by China’s ongoing Zero-Covid Policy (Kinkartz, 2022).

Bearing these difficulties in mind, revised budget projections accounting for a higher debt-GDP ratio for the year, and a further departure from traditional German fiscal policy appear extremely likely. Of particular interest in the proposed German draft budget for 2022 is the setting aside of €100 billion for Military spending and €200billion “to support the transition towards a carbon neutral economy and the digital transition” (Sievert, Zimmerman & Barisone, 2022, P. 1). Of added significance is these specific funds’ exemption from ongoing debt brake regulations, indicating a keen awareness among the German establishment of the enduring significance of current events. While the German government have stated directly their intention to return to what they have phrased “the regular borrowing limit under the debt rule in 2023” (Federal Ministry of Finance, 2022), achieving this directive amidst such rapidly evolving wider political and economic circumstance is likely to prove much easier said than done.

Figure 6: The German Government is under increasing pressure to marry its economy's heavy industry requirements to sustainable carbon emissions standards

Sustainability through Adaptability

While German economic governance has long prioritised stability and sustainability over unimpeded economic growth, it has also repeatedly shown itself open to change under exceptional circumstances. This principle is plainly evident throughout Germany’s economic history, from the initial fall of the Weimar Republic to the implementation of the Marshall plan in the aftermath of World War Two (Stern, 2006), its management of the re-unification of East and West Germany post-Soviet Occupation in the early 1990’s, and more recently in the significant policy adjustments it has made in its handling of the Covid-19 pandemic when Germany's government saw fit to throw the existing economic rule book out the window in direct response to previously unimagined circumstance. German economic Governance as a whole can perhaps best be summed up by the analogy of the “Debt Brake” ruling that first formally entered the German constitution in 2009, and more specifically by the “escape clause” within it which allows for a break from existing protocol when wider economic conditions dictate it necessary. Germany may prioritise stability and responsible economic governance in keeping with the Ordoliberal framework which guides the modern German economy, but it will always remaining open to change under extraordinary circumstances.

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