BackGermany Freezes Public Spending in New Setback for Europe
The move, which follows a constitutional court ruling, complicates Europe’s recovery and rearmament plans as the region battles climate change and geopolitical threats.
PremiumBERLIN—Germany froze public spending for the rest of the year after a court declared the government’s spending plans unconstitutional, dealing a blow to Europe’s recovery and efforts to beef up its defenses and reduce carbon emissions.
The court decision is likely to widen the economic speed gap between Europe, whose economy has stagnated for over a year, and the U.S., which grew at an annualized 5% in the three months through September, turbocharged by massive fiscal stimulus.
Germany’s economy, Europe’s largest, is contracting as surging energy prices and trade tensions cast doubt on its export-oriented business model. Chancellor Olaf Scholz’s government had been counting on bold spending on green-energy projects and technology—from chips to batteries—to revive the model.
Energy prices are expected to remain permanently above pre-Ukraine war levels, which may squeeze out energy-intensive manufacturing, while an aging population and a labor force that is projected to shrink will likely constrain potential growth.
Berlin’s decision to freeze all federal spending for the rest of the year came after the court defunded the government’s 60 billion euro—the equivalent of more than $65 billion—green-transition project. The court said Berlin couldn’t repurpose unspent credits originally earmarked to tackle the Covid-19 pandemic to fund environmental and energy projects. It said Berlin was bound by the country’s constitutionally enshrined fiscal rules that limit budget deficits to 0.35% of gross domestic product in normal times.
Berlin now faces a choice of finding equivalent budget cuts or raising taxes—or both—if it wants to go ahead with the plan, which includes, among other items, multibillion-euro subsidies to build chip-making plants.
The judgment raises questions about the use of off-budget special funds to finance public investments, including a €100 billion plan to revamp Germany’s underfunded military that was announced after Russia’s invasion of Ukraine.
While some German economists welcomed the ruling, which they said would impose much-needed fiscal discipline at a time of high interest rates, others think it could prevent Scholz and his successors from retooling an economy that has been losing competitiveness.
In the short term, the government must decide which policy areas—from boosting Europe’s collective defenses to supporting Ukraine or cushioning the impact of surging energy prices and inflation on businesses and households—it should give priority to. Berlin must also review all debt-financed expenditures in the last eight years to ensure it was compliant with the new ruling.
German officials in Brussels told European Union counterparts Friday that they would continue supporting a €50 billion four-year EU budget package for Ukraine, which is supposed to take effect next year, according to two people briefed on discussions. However, Berlin made it clear it wouldn’t back an additional €50 billion spending request from the European Commission on migration and other Brussels priorities. Germany pays for around a quarter of EU spending.
The emergency belt-tightening comes amid growing political fragmentation and accumulated crises that have eroded the ratings of Germany’s three-party coalition. The antiestablishment opposition party Alternative for Germany, or AfD, is now polling at 22%, making it the first far-right group to obtain such support since the 1930s. The party opposes German military spending in Ukraine and generous outlays on refugees.
“The verdict will have profound effects on the practice of statecraft," Finance Minister Christian Lindner said.
Following Russia’s full-scale invasion of Ukraine last year, Germany embarked on a spending spree to support Kyiv, fortify its own defenses and cut its dependence on Russian natural gas and oil. It also pledged to fund a shift to a zero-emissions economy by supporting consumers and businesses at home and in the EU, and it expanded Germany’s already generous welfare state to keep voters on board.
All these projects are now at stake.
Lawyers and government officials said Germany’s Constitutional Court ruling last week offered the strictest legal interpretation to date of the country’s fiscal rules—themselves among the toughest in Europe. They said it could severely constraint any future government’s fiscal margin of maneuver unless it can raise more taxes—an unlikely prospect given that Germany already has the second-highest taxes on labor among Organization for Economic Cooperation and Development countries.
Senior government officials said one option under consideration would be to retroactively declare a state of budgetary emergency for 2023, invoking a clause in the fiscal rules that allows for a suspension of the spending limits in exceptional circumstances. Previous governments invoked the exception during the pandemic.
The plan is fraught with legal difficulties, in part because the constitutional court raised the bar for declaring such emergencies, according to Prof. Lars Feld, an economist who advises the government.
Strengthening resilience and transforming the economy amid geopolitical crises and climate change was seen as a necessity that required taking on debt, but the court ruling has challenged those assumptions, Feld wrote in the Frankfurter Allgemeine newspaper.
Unlike war and natural disasters, climate change was a “foreseeable" crisis that had been long in the making and could no longer justify emergency spending, the court said.
Germany’s fiscal rules were enshrined in the constitution under former Chancellor Angela Merkel. They affect both the federal and state governments and are more constraining than the EU’s own fiscal rules.
The cap was one reason Germany didn’t raise borrowing, kept taxes high and faced a shortfall in public investment in transport, education, defense and other critical areas during the years of low interest rates.
European finance ministers are expected to agree next month on new rules to tighten their purse strings after years of heavy spending during the pandemic.
Tom Fairless and Laurence Norman contributed to this article.
Write to Bojan Pancevski at bojan.pancevski@wsj.com
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