Global Economics

Germany Back in the Black


The German government is set to record a rare budget surplus, which is expected to grow unless politicians get spend-happy

One tenth of 1 percent may sound like a tiny amount. But the figure, calculated by officials at Germany's Finance Ministry, signifies a big step for their boss, Finance Minister Peer Steinbrück, and for the entire country. It means that the federal government, the federal states, municipalities and the social insurance system will achieve a surplus this year amounting to 0.1 percent of Germany's gross domestic product (GDP).

Put simply, in terms of annual economic output, the amount of money the nation takes in this year will exceed the amount of money it spends by 0.1 percent, or about €2.5 billion ($3.6 billion).

This hasn't happened in a long time. Aside from a brief surplus in the former West Germany back in 1989, for the past four decades Germany's federal and state finance ministers have consistently borrowed funds to balance their budgets. The country has built up a mountain of debt that has reached the enormous sum of €1.5 trillion.

That process has now come to a halt. And Steinbrück's experts expect the surplus to continue growing: to 0.2 percent in 2008, 0.5 percent in 2009, 1 percent in 2010 and 1.5 percent in 2011. This, at least, is what emerges from the preliminary work on Germany's annual stability program -- a sort of accountability report for the federal government on the condition of government finances -- which Steinbrück will be required to submit to the European Commission in Brussels in December.

For the finance minister, these results come a welcome three years early, as he had not expected to balance the total state budget until 2010. But now Steinbrück has presented a clean bill of health for government finances in record time. By comparison, only two years ago, German was bumping up against the upper debt limit of 3 percent stipulated under the EU's Stability and Growth Pact, a measure intended to promote fiscal discipline among member states.

But thanks to a strong economy -- not to mention the biggest tax increase in postwar German history, which came into effect at the beginning of the year -- the country has made a strong comeback out of the red. The question remains as to whether the process of cleaning up the government's finances will last, or if it is merely a brief positive blip on the radar screen.

The favorable figures are not consistent across the board. The finances of the various regional authorities and social insurance systems are recovering at varying rates. The federal government's finances are still in the worst shape, relatively speaking.

Officially, Steinbrück plans to take on another €14.4 billion in new federal debt before the end of the year. But because the economy is doing better than the federal government had expected, he will likely get by with about €2 billion less than anticipated.

The federal budget deficit is offset by surpluses -- some of them large -- in the states, municipalities and social insurance system. For the second year in a row, German cities and municipalities will report a surplus in 2007. According to estimates by Alfred Boss, a financial expert at the prestigious Kiel Institute for the World Economy (IfW), that surplus will amount to about €5 billion in 2007.

For the states, revenues will exceed expenditures by a total of €3 billion, even though not all states have cleaned up their finances. According to Boss, five out of Germany's 16 federal states are still in the red, while the remainder have either balanced their budgets or accumulated surpluses. Bavaria is at the top of the list, with a surplus of more than €2 billion, followed by Baden-Württemberg with its budget surplus of about €1.3 billion.

The social insurance system will register a surplus of about €7 billion, principally the result of billions in excess funds in the coffers of the Federal Employment Agency. A key reason for the flood of cash into the public treasury is the economy. Continuing economic growth has enabled Steinbrück, his state counterparts and municipal administrations to collect additional billions in tax revenues.

In addition to boosting corporate profits, the boom has created many new jobs. This has led to just under a million new workers paying taxes and social security contributions into the treasuries of national, state and local governments, as well as the social insurance system.

On the flip side, the costs of unemployment to the Federal Employment Agency and the federal government are lower than they were a few years ago. Both developments -- higher tax revenues and lower unemployment expenses -- are fueling the surpluses.

This has economists wondering whether the sudden flood of cash could disappear in the next downturn as quickly as it appeared. While this is a distinct possibility, it is not inevitable. In fact, the government's permanent income base has improved considerably. "This is a result of the increase in the rate of value-added tax at the beginning of the year, as well as significant steps toward reducing government subsidies," says IfW expert Boss. The latter effort includes, for example, a reduction in subsidies for commuters and homeowners.

According to the European Commission, Germany's elimination of its deficit is mainly structural, which means that it is more likely to be permanent. Seen in this light, the strong economy only contributed half a percentage point to reducing the deficit in both 2006 and 2007. The deficit was reduced overall by 1.5 percent in both years.

This leads to the conclusion that the strong economy contributed one percentage point of GDP to offsetting the government budget deficit. Germany originally had only committed itself to improving its structural deficit by half a percentage point each year.

Needless to say, the German figures are welcome news for the European Commission. Unofficially, European Commissioner for Economic and Monetary Affairs Joaquín Almunia and his Eurocrat colleagues in Brussels have had nothing but praise for Germany's performance. For notorious debtor countries like Portugal and France, Germany is now being held up as a model of how determination and a bit of luck can quickly put a budget back on track.

But economic uncertainty is not the only potential threat to this unexpected surplus. There is also a significant risk that politicians of a different stripe will redistribute the financial windfall to the people. This is how former Finance Minister Franz Josef Strauß, who, in the 1960s, was the last finance minister to accumulate a significant surplus, described his experiences with other politicians' inability to establish government reserves: "You'd be more likely to see a dog establish a sausage reserve."

He could be right. Politicians, both Christian Democrats and Social Democrats alike, are already dreaming up ways to spend all the extra cash. Topping the list of priorities in both parties within the ruling coalition government is an extension of the amount of time the unemployed are entitled to full benefits. Opponents fear that the measure could cost up to €3 billion.

Politicians are also eyeing other expenditures. For example, the federal government wants to determine whether the current rates of welfare payments for the long-term unemployed are sufficient. And after years of holding back, public servants will likely manage to negotiate a substantial wage hike next year.

The Scandinavian countries have demonstrated that it is indeed possible to resist such temptations and produce surpluses for an extended period of time. Sweden has been running a surplus of at least 2 percent of its GDP for the past three years. Denmark has been even more successful, achieving surpluses of over 3 percent for many years now. The Scandinavians have apparently managed to control their urge to spend money.

Translated from the German by Christopher Sultan


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