It is perhaps a coincidence of timing that the British and German governments are both pondering higher national insurance contributions for certain groups – companies in the UK, higher earners in Germany. Timing aside, there is an uncanny similarity in how they both respond to fiscal pressure. Rachel Reeves spoke recently about a black hole which she needed to fill. Austerity is back en vogue in Europe, especially on the left.
We should remember that austerity was a serial killer of European governments in the last decade. Nicolas Sarkozy and Francois Hollande each lasted only one term. I count six Italian and five Greek prime ministers in that decade – all victims of austerity. Olaf Scholz could be the next leader to be sacrificed at its altar.
The one-term government is austerity’s single biggest trophy. The UK and Germany are both used to long political cycles. It is too early to predict the next UK election. But the German election is only one year away. On current polling it looks like Scholz may end up as one-term chancellor, something Germany has not had since the 1960s. His rise and fall should serve as a cautionary tale to other parties of the left.
The tragedy about the fiscal rules is that the left invented them. When Labour came to office in 1997, Gordon Brown introduced two rules: the golden rule to balance the budget over the economic cycle, and the sustainable investment rule, which forced the government to keep public sector net debt at 40 per cent of GDP. The SPD was the co-inventor of the constitutional debt brake, which limits Germany’s public deficit to 0.35 per cent of its GDP, in 2009 – it is one of the least flexible budget rules on the planet.
There is a brutalist strand in the economic policy DNA of the parts of the European left. My theory is that they picked this up in the 1970s when the financial establishment mocked them over their supposed fiscal profligacy. The Labour party and SPD were both in power in that decade. Ever since, both have been trying to atone. But in their eagerness to please the conservative financial establishment, they have been left with a disaster of their own making: the rules are now so tight that they can no longer fulfil the promises on which they were elected in the first place.
It is worth recalling the spectacular change of fortunes of Scholz and his government. Scholz won in 2021 because people wanted a change after the long reign of Angela Merkel. He and his coalition partners campaigned on a ticket of modernisation. His government started well – much better than Starmer’s – with a big investment programme and loads of money they diverted from the unused part of a fund that had previously been reserved for Covid-19 recovery.
It was not Scholz who imposed austerity. It was imposed on him. Last November the German constitutional court came down with a thunderous ruling. It decided that the heist from the Covid fund was unconstitutional and ordered the government to find the money elsewhere. The coalition agreed an austerity budget right in time for Christmas. One of the many panicked decisions they took was the overnight abolition of subsidies for electric cars. Unsurprisingly, people stopped buying them.
There is more austerity on the way. This year, the German government slashed the military aid budget for Ukraine beyond what had already been allocated. They are scraping the barrel. Together, the three coalition partners are down by almost 25 points in the polls compared with their election results three years ago. They called themselves the “traffic light coalition”, after the colours of the three parties. The lights have dimmed; the country is gridlocked. It is even possible that Scholz and Christian Lindner, the finance minister, will end their political careers in a year’s time unless a miracle happens.
Much can happen in a year, but I struggle to see how Scholz could pull off an election victory. This is year two of a recession with no end in sight. Scholz is not a great communicator or a natural campaigner. His best claim for re-election would have a solid record in government.
It may be too late for Scholz, but it is not yet too late for Starmer. The lesson from Germany is that the left needs to be more clever about fiscal policy. They need to be sustainable, but it is unnecessary and usually counter-productive if governments try to balance the books year-in, year-out. It is even more counter-productive to talk about black holes, as Reeves did.
Germany applied austerity in a particularly toxic way: through cuts in investment. Investments that do not get made scream less loud than voters who receive lower benefits or pay higher taxes. But less investment today means less growth tomorrow, lower government revenues, higher deficits – and more austerity.
The way out of the fiscal doom loop is to front-load your agenda with strategic economic reforms to raise your productivity, and to focus on this rather than painful measures to be undertaken. The UK’s productivity growth never recovered from the global financial crisis. If you start to reform the economy, you buy leeway on fiscal rules.
This is what Gerhard Schröder, the former German chancellor, did in 2003. He reformed the welfare system, but ended up busting the fiscal rules. I never thought that Schröder’s reforms were the right ones, but he was right to have made that trade-off.
Joe Biden’s inflation reduction act is an example of a policy that does both at the same time – a reform to encourage green investment and pay for it through debt. The idea of a trade-off between reforms and fiscal expansion is sound.
My advice to the centre-left is: less Scrooge, more St Augustine (“Let me be virtuous, but not just yet”). Put that in the budget.
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