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Germany’s New Green Stimulus Plan Won’t Fix the Economy

Recently, there has been a debate in Germany on the constitutionality of additional government borrowing of €60 billion. The borrowing is debated because Germany has a constitutional debt brake. The debt brake limits the possibility of the government to indebt itself and pushes it toward a balanced budget in normal times. In times of emergency, however, the debt brake allows for exceptions and higher deficits to fight the emergency. Unsurprisingly, huge amounts of debts were issued to cope with the corona crisis.

The German government plans to present a bill that transfers an unused borrowing authorization of €60 billion covid funds from last fiscal year to a special fund called the “Energy and Climate Fund,” even though climate spending by itself would not be excepted from the debt brake. The reasoning to justify the constitutionality of the plan is purely Keynesian. The proponents argue that the state must invest or provide corresponding subsidies to activate private investment in the wake of the corona crisis. The spending shall stimulate the economy. In this way, incomes and jobs are to be saved or secured. And if there must be a Keynesian stimulus plan to overcome the corona crisis, why not spend the tax money on “green projects”? So it is green spending to cope with an emergency.

Government Investment to Cope with the Corona Crisis

Let us discuss the Keynesian justification to circumvent the German debt brake. In the case of the present bill, additional government spending is financed by higher debt of €60 billion. The European Central Bank and the European banking system will in all probability monetize this debt (i.e., the money supply will increase). The new purchasing power will allow the German government to benefit from factors of production and to use them for climate projects. These factors of production absorbed by the government will thus no longer available for alternative projects. In other words, a purchasing power of €60 billion will be withdrawn from civil society and will no longer be available for private-sector projects.

The €60 billion in additional spending drives up the prices of factors of production. The factors of production will become more expensive than they would have been without the additional government spending. This will increase costs for private companies, which will have to pay higher wages, energy prices, and other costs. Projects that would have been profitable with lower costs for energy, wages, and other input factors no longer will be, thanks to the €60 billion in additional government spending.

Consequently, there are more government-desired projects and fewer private-sector projects. The direct beneficiaries are the companies favored by the government subsidy. The losers are those entrepreneurs who can no longer realize their projects due to higher costs and their would-be customers. The visible projects supported by the subsidy are offset by prevented, nonvisible projects. The subsidized climate projects will be visible; the prevented projects will remain unknown.

Most importantly, the additional government spending will not help companies struggling in the corona crisis. Imagine a restaurant owner who has lost sales because of covid passports and other restrictions. It does him no good at all that some climate project has been subsidized. What he needs is the abolition of corona restrictions. Or imagine a company that has supply chain problems. Microchips do not arrive because they are not loaded onto containers in Chinese ports. This struggling company doesn’t benefit from subsidizing green projects either. It does not bring any of the needed microchips. On the contrary, when these new green projects get off the ground, they are also likely to demand the very same factors of production that the struggling company needs, such as microchips. The bottleneck increases, as well as the price of the factors of production the struggling company needs.

From an economic perspective, there is no connection between additional government spending and overcoming the economic consequences of the corona emergency. Far from activating sustainable private investment, public investment and subsidies discourage it by raising costs for businesses. Instead of being used in private projects desired by consumers, resources are increasingly used in projects desired and protected by the state. To achieve the self-imposed goal of the bill and quickly put Germany on a sustainable growth path, it would be more appropriate to reduce government spending and taxes. This would make resources available to the private sector that are currently being hijacked by the state.

In addition, comprehensive liberalization would be helpful. Far-reaching deregulation would make projects possible that are currently prevented by restrictions and would provide a strong upswing. Just ending corona restrictions would help kick-start growth entirely without emergency debts.

Government Resource Management and Consumer Preferences

Now, one could argue that it is important for the state to decide which projects are undertaken with the available factors of production, and which industries thrive and which do not. This implies that consumers can no longer decide on the use of resources (amounting to €60 billion), as would happen in a market economy. In a market economy, entrepreneurs try to anticipate consumers’ most pressing needs and allocate their resources accordingly. Entrepreneurs compete with their rivals to best deploy resources to meet consumer needs, to produce better and better products at lower and lower prices. If they succeed, they are rewarded with profits. If they fail, they suffer losses.

The central planning model, on the contrary, involves politicians and bureaucrats deciding how resources are to be used and which projects are worth implementing. This leads to incentive and information problems. Politicians and bureaucrats lack incentives to act efficiently in the interest of consumers. Bureaucrats do not risk their own capital to make profits and avoid losses, but use taxpayers’ money. Politicians have the next election in mind. They are insulated from the market competition that compels market actors to innovate and economize.

In addition to the incentive problem, the knowledge or calculation problem weighs even more heavily. Of the infinite number of conceivable projects that could be undertaken with available resources, those that are most pressing or important to citizens should be selected. Competition is a discovery process that dynamically produces this knowledge of what is most pressing using market prices. In contrast, politicians decide the question of the most important projects (“green projects” in this case) according to their preferences, arbitrarily. According to Friedrich A. von Hayek the belief that the state knows best where to invest can be described as a fatal conceit.

Implications for the Sovereign Debt Crisis and the Euro

It is true that all EU member states—many to a greater extent than Germany—issue new debt, which is purchased and monetized by the European Central Bank. Since in the intra-European monetary redistribution process, the state that incurs less debt than the other member states is at a disadvantage, one might think that it is now Germany’s turn to incur debt.

However, it is Germany’s responsibility to set a good example. In the eurozone, Germany’s aversion to inflation and deficits has put the brakes on other states’ fiscal policies. Admittedly, the German brake has been sometimes more successful, sometimes less. But it has always been there. If the German brake on eurozone government deficits is removed, if Germany itself uses tricks to circumvent fiscal policy rules, actively engages in a debt race and loses its authority, there is a risk that there will be no stopping government spending, government deficits, and inflation in the eurozone.

The German exit option from the euro—if not explicit, then at least implicit—has disciplined the southern member states, keeping them within certain limits, and thus—paradoxically—enabled the cohesion of the euro area. For this modest discipline to continue, an exit option for Germany from the euro area must remain credible. But a German exit from the euro area can only remain realistic and be defended politically if Germany can demonstrate that it has adhered to fiscal policy rules and minimized deficits, while the other states have not done exactly that. Germany could then justify leaving the euro with the desire to have a more stable currency than is possible within the euro area. If, on the other hand, Germany goes the way of the bill creating €60 billion of new debt and the debt race, then this reasoning no longer works and the door closes.

Conclusion

The increase in German government spending does not alleviate the economic consequences of the corona crisis as Keynesian economists claim. On the contrary, it reduces the resources available for genuine private initiatives. Furthermore, it contributes to the debt race in the eurozone, putting in jeopardy the future of the common currency. Instead of engaging in stimulus plans and debts, the government should reduce taxes and spending and abolish restrictions to foster economic growth.