The German government runs out of money

The multi-party system, often allied to proportional representation in many European Union countries, creates difficulties after elections. Talks to form a stable coalition government can be fraught.

| 9 min read

The new Polish government is likely to last less than a fortnight before it tries to create a coalition of minority parties to replace it. Spain has managed to form a tortured coalition by welcoming back the rebel Catalan nationalists. The Dutch parties are still shocked that Geert Wilders’ Party for Freedom won the most seats in parliament and are in long talks with their rivals. Meanwhile, the crucial German three-party coalition – formed after an inconclusive election in 2021 – is under new strains, unable to agree next year’s budget.

German Court ruling sparks budget headache

The 2021 election was a narrow defeat of the CDU/CSU coalition, with 197 seats won compared to the SPD’s 206. A three-party coalition was ultimately formed by Olaf Scholz of the SPD with the Greens and Free Democrats.

This was always going to be a difficult grouping. The Free Democratic Party wants lower spending and reduced borrowing, with the introduction of more free-enterprise policies. Contrastingly, the Greens want a big expansion of the state to tackle climate change. The SPD itself wants more social spending to deal with inequalities.

As a result of the Covid-19 pandemic, the current coalition decided to suspend the deficit brake in 2021 and 2022, a rule which limited borrowing. For 2023, it decided to transfer €60bn of spending from unallocated money earmarked for the pandemic response which was held in a special fund outside the debt control to pay for investment in green technologies and infrastructure. The three-party coalition rested on this €60bn transfer taking place.

Christian Wolfgang Lindner, the Free Democratic finance minister, wanted this for apparent fiscal prudence. as he thought the transfer would allow compliance with the debt-brake rule. The Greens desire for more money to fund the climate-change transition was accommodated out of the transfer of special funds money, which also does not count against the deficit/debt brake. The spending requirement of the Greens was therefore also met. This left enough firepower in the budget for the SPD to have extra spending to allocate to welfare payments.

This use of special funds was challenged in the German constitutional court, which found that the spending was illegal.

This use of special funds was challenged in the German constitutional court, which found that the spending was illegal. It said such funds could only be used for a specific and one-off emergency. The court decision, however, does not just create a hole in the current year. It also raises questions around the large special funds earmarked for energy subsidies and for climate change matters that the government is also using.

These funds are crucial to subsidising German industry’s energy costs and providing subsidy firepower against US President Joe Biden’s 2022 Inflation Reduction Act, which put some green subsidies into law. The court said that special funds outside borrowing controls are only allowed for one-offs, such as dealing with a flood or other major emergency, where the money can only be spent on remedying a specific issue. It cannot be an ongoing programme of spending over several years for something such as the ‘net-zero’ transition, which it did not defined as a one-off emergency.

The ruling coalition has now decided to suspend the debt brake in 20213 for a third consecutive year but are divided over what to do for the 2024 budget. As a result, this has now been delayed.

What are the German government’s options?

  • Get constitutional change to the debt brake. This requires the support of two-thirds of German MPs, and the CDU is unlikely to support such a move, so it is short of votes.
  • Cut other spending to allow sufficient energy subsidy and climate change spending – a move unpopular with the leaders of the coalition who want to protect social budgets.
  • Raise taxes, which could include carbon taxes. This is unpopular with the industrial lobby.
  • Suspend the emergency brake for another year, but this just postpones the budget crunch and is against the spirit of the Constitutional Court judgement.
  • Change the coalition and try to get the CDU into government with the SPD, so a budget can be agreed.

Whatever happens, it is likely to mean some fiscal tightening. New commitments to spend have been stopped for the time being by the finance minister. Meanwhile, the governing parties have lost support in opinion polls. The SPD has fallen from 25.7% to 15% and the Free Democratic Party from 11.5% to 5%, although support for the Greens is up one percentage point to 13%. The main winner is the anti-migrant AFD, with support up from 10% to 21-26%. CDU support has risen by six percentage points.

Poor polling by some coalition members is likely to persuade the three parties to become more vocal about their differences as they struggle to push policy in the direction they want. The Greens and SPD would like to spend and borrow more, with the SPD more concerned about debt rules than the Greens. The Free Democratic Party has, so, far supported the controls.

What else has been happening in EU economics?

1. The Netherlands’ shock election result

Talks to form a stable Dutch government are now likely to be protracted. Mr Wilders, with 37 seats, and New Social Contract, with 20 seats, may be able to govern with the centre right VVD refusing to enter government – but tolerating them and agreeing not voting to bring them down. The BBB, a farmers protest party, might also be persuaded to support. A government needs 76 seats to form a majority.

It would also be possible for a group of parties – including two or three of the largest – to form a coalition to keep Mr Wilders’ party out, but its programme would need to reflect some of the Wilders’ approach to migration and the EU to avoid a heavy electoral backlash against such a new government.

2. Spain and its separatists

In July 2023, Prime Minister Pedro Sanchez of the Spanish Socialist Workers' Party lost the election to his centre-right rival. Neither leading party had enough seats to govern. After protracted negotiations, Mr Sanchez created a coalition with the hard-left party Sumar and the Catalan nationalists. He had to grant pardons to the Catalans that had promoted the illegal Catalan independence referendum, which has alienated the right and led to protests. Many in Spain want to keep the country united and stress that it is the national government alone that can enact a legal referendum – and they have no wish to hold one. The government plans to ride out the backlash.

3. A new coalition likely in Poland

On 1 December the elected president of Poland swore in a new government from the largest minority party in parliament, his own Law and Justice party. It has 194 seats compared to Donald Tusk’s Civic Coalition Party’s 157 seats, with 231 needed to have a majority. The new government has younger ministers than the outgoing cohort, with some technocrats to give it a new look. They will exercise ministerial powers and patronage until a vote of confidence on 11 December, which they are expected to lose.

Mr Tusk needs to secure a coalition agreement with both the New Left Party and the Third Way Party to take over. This now looks likely. The Confederation, a nationalist party of the right, will certainly not assist and has also been unwilling so far to support its Law and Justice rivals. It is expected that a left-of-centre coalition will form and will move Poland closer to the EU mainstream.

The implications for the ECB

With Poland likely to become more compliant with EU requirements and Germany struggling to reduce its special funds borrowings, the EU is likely to see less fiscal stimulus next year than in 2023. Whilst there is slow progress agreeing new borrowing controls to reimpose on member states, there is a wish to provide some fiscal restraint after the period of Covid-19 and war-based budget expansion. This strengthens the case for the European Central Bank to relax its monetary policy next year, as the economies remain sluggish against the background of recent tightening.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

The German government runs out of money

Read this next

How can you reduce your self-assessment tax bill?

See more Insights

More insights

US sanctions and Russia's foreign policy battle it out
By Charles Stanley
26 Feb 2024 | 9 min read
UK recession already over?
By Garry White
Chief Investment Commentator
22 Feb 2024 | 7 min read
Changes of government can affect investment strategy
By Charles Stanley
22 Feb 2024 | 7 min read
Has the luxury-goods industry turned a corner?
By Garry White
Chief Investment Commentator
21 Feb 2024 | 6 min read