MNI INTERVIEW: Germany Heads For Debt Downgrade-Watchdog Chief

Germany’s budget deficit will hit 5% of gross domestic product next year, putting Europe’s biggest economy on a fiscally unsustainable course towards losing its triple-A credit rating, the head of the country’s official fiscal watchdog told MNI.

“There will come a point when fiscal sustainability is an issue, and I fear it might come faster than anyone has recognised. At the moment we still have a triple-A rating, but I see a significant risk, if the current policy continues, that sooner rather than later this triple-A rating will be lost,” Thiess  Buettner, who chairs the Independent Advisory Board of the Stability Council and is a member of the Advisory Board to the Federal Ministry of Finance, said in an interview.

Buettner’s outlook compared with European Commission forecasts for deficits of 3.7% of GDP this year and 4.1% in 2027. The government’s EUR600 billion defence and infrastructure investment special funds are “not so much a solution to poor economic performance, but rather reflective of the unwillingness of German policymakers to meet the challenges of a changed landscape,” he said.

“That government spending in other areas will have to be reduced is therefore inevitable. The social security system alone could kill the federal budget if the current dynamic is allowed to continue, in addition to record deficits at the municipal level.”

MIS-SPENDING

While Germany’s armed forces require modernisation and expansion, as does the country’s creaking infrastructure, most of the money handed to the states for investment has so far been used to fill holes in local budgets, Buettner said, with only a marginal impact on growth. 

Other measures touted as benefitting from the new cash were planned before the special funds existed, he said, “so funds are simply shifted from the core part of the Budget to the newly created special funds. This is merely window-dressing.”

Bad management, with responsibility often split between Federal and local authorities, is a recurrent problem, he said, citing schools and railways as prominent examples, hence “just pouring money into these arrangements is unlikely to solve the problems in a sustainable way.”

The longer-term growth effect produced by extra defence spending may also be weaker than hoped for due to a substantial proportion of new military purchases taking place abroad, because Germany cannot keep pace with technological developments.

“The core strength of the German economy is perhaps less so in high-tech, but rather in mid-tech industrial production, and only part of this defence spending is really initiating anything in this area. Plus, the Ministry of Defence has a very weak track record when it comes to public procurement. Another issue is that a lot of the defence spending is going into staffing.”

While more astute parts of German manufacturing industry know they are losing to China and have begun to reinvent themselves, policymakers are yet to address failures to translate research and development into local production, Buettner said.

DRAGHI REPORT

Flexible labour markets, deeper, more supportive capital markets, tax reforms and less bureaucracy are all necessary, he said, pointing to the recommendations contained in the report for Europe as a whole by former European Central Bank chief and Italian prime minister Mario Draghi.

Regulatory reform would allow German companies to address the challenge of new competition, and to search for new niches where their own products can proliferate, Buettner said. "This may include importing cheap products from China and making them a part of their own production strategy, in order to generate a competitive advantage."

But protectionism and industrial policies are likely to be self-defeating, he said.

“I fear that if you bring the government in, it will aim at protecting local markets, and the German economy would end up being under the control of lobby groups trying to preserve a structure that is inherited from the past but increasingly less relevant, and so do more harm than good.” (See MNI: EU Action On China Would Cut Off Key Supplies - Advisor)