Difficulties in sustaining a government in Germany and France

Political machinations in Europe continue to cast a shadow. In Germany, the leadership coalition dissolved recently when the SPD Chancellor fired the Free Democrat Finance Minister. The other Free Democrat ministers subsequently left the government as they agree Germany must cut its budget deficit to live within the constitutional debt controls. Meanwhile, the SPD and Greens remaining lack the votes to govern.

A Confidence motion is anticipated, likely followed by a General election in February. The CDU is not offering to join the present government in a reprise of the old Grand coalition, sensing their time has come to do better at the polls.

German opinion surveys show the CDU/CSU with a good lead, on around 32%. The AFD is in second place on around 18% and the SPD are third, on 16%. On this basis the CDU could form a government after the election with the AFD but would refuse to do so. They would therefore need to enter coalition with a much-reduced SPD. It could therefore take time to sort out a governing coalition again after the election, unless CDU/CSU popularity rises further.

Meanwhile, in Paris the minority government formed by the Republicans and Ensemble tabled a budget in the National Assembly, only to see the left-wing parties amend it substantially with a large set of tax rises. These are unacceptable to the government. It is reintroducing the Bill in the Senate and even talking about using Article 49 of the French Constitution to put the budget through without a vote of endorsement by Parliament. If that happens then the Opposition parties can demand a motion of no confidence and could vote the government down.

The government will be hoping Parliament becomes more willing to compromise with its views of an acceptable budget. As France has recently held elections and ended up with an impasse between three large blocs of MPs, there is no easy way forward to create a stable coalition or single party government. The Opposition parties might allow the government budget to go through, with substantial and unpopular cuts to spending and tax rises.

The underlying problem is budgets deficit, spending and borrowing

In Germany, the sluggish performance of the economy has hit revenue growth whilst the government has been keen to increase expenditures. The resulting deficit has been greater than the permitted level under the debt control rules.

The government sought to use special funds outside the calculations, only to lose a court case on how far they could go. It has pledged a large increase in defence spending to get above the 2% NATO target and to assist with its generous programme of support for Ukraine. There have been delays in getting up to target levels. Germany also wishes to increase its climate change spending and had a special fund to cover that boost.

Whilst German finances with a planned deficit of a little over 2% and state debt at 63% of GDP look under good control compared to many EU countries, the debt rule of deficits being limited to 0.35% has been reintroduced. It was imposed by Mrs Merkel to try to arrest the steady climb in spending and in taxation. The Leader of the CDI/CSU has not ruled out the possibility of relaxing the budget rule should he do well in the election, though only for investment expenditure, not for current spending.

In Paris, the minority government proposes €40 billion of spending cuts and €20 billion of tax rises. French finances are far more extended than German, with Prime Minister Barnier battling to get the deficit back down to the EU’s maximum of 3% by 2029. This proposed budget estimates a deficit of 5% next year after 6% this year. Consequently, France has been put into the excessive debt procedure by the EU.

A series of measures to address the situation have been taken. Inflation adjustments for pensions will be delayed until July, health spending cuts are promised, as well as reductions in teacher numbers, with other cutbacks to come. The richest will pay more income tax. Large companies face a corporation tax surcharge of 20%, plus there’s a tax on airline tickets and a rise in the electricity tax. The overall package of cuts and tax rises amounts to almost 2% of GDP and will reinforce the pressures slowing the economy.

Economic problems lead to political upheavals

Both France and Germany experienced the western inflation problem in the aftermath of the Covid pandemic and went into slowdown or recession. This led to more disappointment with the governments of Olaf Scholz and Emmanuel Macron. The rise in public sector costs, the squeeze on private sector living standards and consumption and the slowdown in tax revenue growth all conspired to worsen the economic outturn and tempt more people to support parties not in government.

In both countries the issue of migration is mixed in with economic ills, with many people in both countries wishing to see a reduction in the numbers of people entering their communities. This has fed the rise of the AFD in Germany and the National Rally in France, parties that campaign for stricter controls on both legal and illegal migration.

In France, the disillusion with the governing centre has helped boost the left-wing parties as well as National Rally on the right. This has led to a bigger divide with the government over levels of spending and taxes, with the left favouring both being considerably higher. In Germany, the main centre right alliance the CDU/CSU has benefitted There is also a new anti-migrant left party in Germany gaining some traction. In both countries the mainstream parties are unwilling to enter coalitions with anti-migrant parties, complicating the coalition arithmetic when either country goes to the polls.

Conclusions

France and Germany are both in difficult situations, with poor economic performance creating considerable political instability which in turn complicates achieving a recovery in economic confidence. Both countries have allowed spending and tax levels to rise considerably. France has a major debt and deficit issue well outside current EU rules. Germany has a home-produced deficit problem, with many Germans wanting the debt brake to remain to provide some limit on government spending and borrowing.

Both countries need a mixture of monetary and fiscal stimulus to promote growth, but both are restrained by deficit rules and by high levels of pubic spending they already sustain. Neither country can create a stable government. The French budget will need many more compromises in the Parliament, or it will need to be passed despite the Parliament. The European Central Bank should provide some relief to the overall situation as it continues its current policy of lowering interest rates.