The economic backdrop to the German election

Good morning from New Economy Brief. 

On Sunday, Germans will go to the polls to elect the 630 members of the Bundestag and decide who will run the next government. The snap election comes after Olaf Scholz’s government was dissolved in December and has brought some uncomfortable dynamics in German politics to the surface. 

Migration and the rise of the far right have dominated media coverage, but as always there is an economic context to all this. This week, we explore the economic backdrop to the German election and the economic policies of the many political parties contesting Sunday’s vote. 

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Shifting allegiances

The upcoming election represents a dramatic reset in German politics. According to YouGov, two in five Germans plan to vote for a different party to the one they supported in 2021. The coalition that took power four years ago – Scholz’s centre-left Social Democrats (SPD), the Greens and the liberal FDP – now faces a dramatic downfall. With the ‘Union’ (a coalition of the centre-right parties CDU and CSU) predicted to win the most seats and CDU leader Friedrich Merz in line to become the new Chancellor, some polls indicate that the SPD may come third behind the hard-right Alternative for Germany (AfD) 

At the same time, left-wing party Die Linke has had a tumultuous few years. It suffered a breakaway in the form of the Sahra Wagenknecht Alliance (BSW), which combines left economics with social conservatism. Until recently, Die Linke appeared at risk of falling out of Parliament entirely, though it has seen a recent surge in support. Nonetheless, the far right will probably be the big winner, with the AfD predicted to take a fifth of the vote and 23% of seats. 

The likeliest outcome is that the centre-right Union will have to form a coalition with the SPD and/or the Greens. This could mean more of the kind of inter-party disagreements over fundamental policy questions that characterised – and eventually brought down – the outgoing three-party coalition government. Another potential source of instability is if a minority ‘blocking coalition’ manages to get over a third of seats (two thirds are needed for any major constitutional reforms). A few politicians have warned that the AfD and BSW could do this, but it now looks unlikely that their combined vote share will get anywhere near a third. 

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‍The economic backdrop

Dramatic shifts in the political landscape often accompany a bleak economic backdrop, and Germany is no different. Not long ago, it was held up as Europe’s  economic success story. But now, the country has been in a technical recession for two years and, since the start of the Covid-19 pandemic, has lost almost a quarter of a million manufacturing jobs. German industry has proved vulnerable to global economic shocks, particularly to the energy crisis sparked by Russia’s invasion of Ukraine. This industrial decline has been a central topic of the election, with CDU leader Merz warning that Germany faces ‘deindustrialisation’, with manufacturing investment moving abroad. 

‍Cost of living. Thanks in large part to the war in Ukraine and falling real wages, Germans have seen living standards fall over recent years – the most severe drop since the Second World War, according to economist Isabella Weber.  She argues that while the AfD’s rise has many causes, it is “impossible to ignore how this unprecedented slump in German living went hand-in-hand with the rising popularity of the far right”. Weber and Tom Krebs have also noted that the slowness of the German government slowness to implement energy price controls in 2022 coincided with growing approval for the AfD. 

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Proposals

‍Investment and fiscal policy. It is estimated that Germany has an investment gap of at least €600 billion over ten years to provide the public infrastructure that’s needed and to hit energy transition targets. In the face of ongoing recession, increasing investment might also seem the obvious growth-boosting choice. However, the constitution has constrained effective public policy. Under Chancellor Angela Merkel, a constitutional ‘debt brake’ was introduced in 2009, forbidding the federal states that make up Germany from taking on new public debt and limiting federal government debt to 0.35% of GDP. 

The current economic and social pressures are leading to calls to reform the fiscal rules. In particular, pressure to increase defence spending is making the idea of reforming the debt brake more palatable even to the centre right, who are likely to win the most votes on Sunday. Options for reform include replacing a hard limit on budget deficits with more general guidelines and exempting public investment from borrowing limits. However, as the debt brake is constitutional, changing it would need the backing of two thirds of the Bundestag. 

‍Tax. With the debt brake so dominant in the election debate, calls for tax reform have taken a back seat. Nevertheless, left-wing party Die Linke has said that billionaire wealth must be tackled and has proposed a sliding scale wealth tax, with a 1% levy on fortunes worth over €1 million, 5% on those higher than €50 million, and 12% above €1 billion. The party has also called for higher inheritance tax and reforms to capital gains tax. (It’s worth noting that Germany did have a wealth tax until it was ruled unlawful in 1995). On the other hand, the CDU is promising large scale tax cuts, which critics say mainly benefit the top 10%.

‍Climate. Climate has been another divisive topic in German politics in recent years: as part of the outgoing ruling coalition, the FDP has consistently pushed for less ambitious green targets. So what will happen to climate policy post election? On the surface, there are reasons to be optimistic. Current poll-leader the CDU has committed to Paris Agreement goals in its manifesto – as have its possible coalition partners the SPD and Greens. 

• But… it all comes back to the debt brake. Despite manifesto commitments, recent history doesn’t suggest that green investment will be high on Friedrich Merz’s to-do list if he becomes Chancellor. In 2023, Germany’s highest court ruled that the government’s green spending plans were unlawful because they were incompatible with the debt brake, following a lawsuit filed by the then-opposition CDU/CSU Union. Though the latter seems increasingly open to debt brake reform, climate is a long way from the top of its list of priorities.
• What about the others? Smaller parties vary in their approach. The Greens have disappointed their younger members by not going far enough with climate policies. The Left has outflanked the Greens by committing to reach net zero by 2040, compared to their current 2045 target.
• The threat from the far right. The climate-sceptic AfD says the country is in the grip of an “eco-dictatorship” and rejects any environmental policies. If the party has a good showing on Sunday its aggressive climate stance will become more prominent in German debates and may become harder to rebuff.

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An uncertain future

Germany’s story feels all too familiar. Industrial decline, falling living standards and hostility towards immigration is a sequence that keeps being repeated across Europe and beyond. Failure to provide adequate support with the rising cost of living has contributed to a rightward shift in Germany just as it did in the US. The complexities of the German electoral system make many election outcomes possible. What is already clear, though, is that the growing frailty of Germany’s economic model and the AfD’s rise in recent years have had a hugely destabilising effect on German politics. Whatever the result on Sunday, this instability looks set to continue. 

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