Another Grand Coalition is Best Bet to Ameliorate Germany’s Globally Disruptive Economic Policies

WASHINGTON — Germany’s federal elections are intrinsically important but generally boring, and an early look suggests the upcoming September 2017 contest will conform to this pattern. That’s a shame, because a lot is at stake.

As the summer wears on, Chancellor Angela Merkel’s Christian Democrats (CDU) and the Social Democrats (SPD) will heartily criticize one another within the context of a broad defense of the policies the two parties have pursued together in “Grand Coalitions” for 8 of the past 12 years. There are four smaller parties currently hovering between 5 and 10 percent in the polls but only one — the market-oriented Free Democrats (FDP) — currently seems to have a shot at helping form the next government.

The CDU/CSU heads toward summer with a double digit lead on the SPD. Combined with the strong revival of the FDP, this reopens the possibility of renewing the coalition that dominated German politics for most of the 1980s and 1990s, and avoiding another Grand Coalition, quite possibly the only other two-party coalition available in September.

What do these coalitions mean for the European economy?

The last time a CDU-FDP coalition came to power, it helped spark an unmitigated disaster for the European economy. While in early 2009, the SPD Finance Minister had calmed market anxiety over Greece, the government elected in September 2009 shifted its position and signaled that Greece was on its own with its debt. When markets turned sharply against Athens, Berlin reiterated its position until events in late March 2010 finally prompted Berlin to signal the possibility of external assistance. Ultimately, the standoff over roughly $50 billion in Greek debt morphed into a contagion that threatened public finances in several other eurozone member states and helped relegate much of the continent to a decade of economic underperformance.

In opposition between 2009 and 2013, the SPD accommodated the rightward shift in German politics. Though sometimes critical of the shortsightedness of government policy, the party gave its assent to all of the major eurozone reforms. Because opposition support is necessary for a wide range of government policy in Germany — and certainly for major revisions of the EU’s architecture — Germany functions as a kind of permanent “Grand Coalition State,” to use the term of German political scientist Manfred Schmidt. Upon returning to a formal Grand Coalition after 2013, SPD policy became even more supportive of locating the source of most of the eurozone’s problems in the “deficit states” of the South.

Most important, the SPD helped accommodate the pernicious fiction that the primary source of Germany’s large export surplus is the high quality of German products. When U.S. President Donald Trump’s trade advisor Peter Navarro complained about Germany “exploiting” the euro, German Foreign Minister and longtime SPD leader Sigmar Gabriel shot back that maybe the United States should “make better cars.” In fact, neither quality nor exchange rates matter much for the huge surpluses Germany racked up with Southern and Eastern Europe and more recently with the United States.

German engineering has always been good, so a constant feature like this cannot adequately explain the sharp surge in the German current account surplus to above 8 percent in recent years (and above 5 percent for 15 years). Meanwhile, that surplus has been huge whether the euro is at $1.60 or $1.06. The real story is that Germany has become an export-dominant economy in the classic way: by gradually shifting national income out of consumption and into savings. As the labor share of income in Germany has fallen — not least, due to a number of policy reforms — two forms of savings have surged: corporate profits are up 50 percent since 2004, and German governments at all levels are running surpluses. Even Berlin’s chronically indebted districts are now mostly running in the black.

This surge in German savings has not been matched by investment increases — in fact, German public investment has been among the very lowest in the OECD. Savings not invested at home are sent abroad. And the necessary complement of a country saving more than it invests is a country selling more than it buys. The result is a trade surplus. Many of Germany’s European partners have long complained in vain about these dynamics, which German officials have largely ignored or pushed off with earnest explanations about the aging German population’s need to save. The result? A stalemate. Germany’s position does not change. The surpluses (and the resentments) grow.

All this makes the German election very consequential for Europe. If a CDU-FDP coalition moves to even more hardline policies, Germany’s role in blowing up the bubbles will be elided once again, and the burden of adjustment will add pressure to the fragile politics of the South. However, if the two big German parties begin to see the real roots of Germany’s chronic current account surplus — and the role of policy choices in creating this export dependence — there is a chance for positive change. Fortunately, there are signs that Germany’s hardliners are beginning to see that these imbalances cannot be sustained forever.

Given the logic of German politics noted above, carrying out such a major shift would arguably require another Grand Coalition. This would be true politically, as the two large parties would need reassurance that a policy shift would not be instrumentalized by their main opponent. But is also true institutionally, as any major policy changes in tax and investment regimes require both major parties to be on board. The risks of Grand Coalitions are many and should not be dismissed lightly. But together with the election of Emmanuel Macron in France, a Grand Coalition consensus to change Germany’s overreliance on exports could give a new economic dynamism to the larger eurozone and ease the toxic relationship with the United States.

Read Wade’s policy paper Surplus Germany.