_ Prof. Dr. Philipp Bagus, Universidad Rey Juan Carlos. Madrid, 13 January 2022.
Purpose of the bill
As his first official act as Germany’s new finance minister Christian Lindner from the FDP issued a second supplementary budget draft law for 2021, which provides for transferring the unused credit authorization of 60 bln euros to the special fund “Energy and Climate Fund” in order to circumvent the debt brake to deal with the economic consequences of the pandemic. The draft argues that the state must invest or provide appropriate funding to activate private investment. In this way, income and jobs are to be saved or secured. Since the German federal constitutional court has called for climate protection, public start-up investments should be made in this area. This line of reasoning is intended to justify credit authorizations for future financial years.
In the following I would like to answer four questions in connection with this draft law.
- Is the project of 60 bln euros climate investments suitable to meet this self-imposed goal?
- Is this state investment policy in the interest of the citizens?
- To what extent can there be undesirable inflationary side effects?
- To what extent does the venture affect the European sovereign debt crisis and the euro?
Government investments to deal with the pandemic
Is the legislative proposal suitable for putting the German economy on a sustainable growth path and for securing jobs and income? Are there cheaper and better ways to achieve this goal?
The draft law envisages additional government spending of 60 bln euros. In principle, a state can secure a larger share of national economic production by spending more. A state has three options for covering this additional expenditure: additional tax revenue, debt and money creation (with the help of the central bank). In this way, it can use resources that private individuals would otherwise have decided to use.
In the case of the present bill, the additional spending will be financed by higher debts amounting to 60 bln euros. The European Central Bank and the European banking system will most likely monetize this debt, i.e., the money supply will increase. Thanks to the new purchasing power, the German state will be able to enjoy production factors and will want to use them for climate projects.
These production factors are therefore no longer available for alternative projects. In other words, a purchasing power of 60 bln euros is withdrawn from civil society and is therefore missing for private-sector projects. The 60 bln euros additional expenditure drives up the prices of the production factors. The factors of production are becoming more expensive than they would have been without the additional government spending. This increases the costs for private companies, which have to pay higher wages, energy prices and other costs. Projects that would have been profitable with lower costs for energy, wages and other input factors are no longer so due to the 60 bln euros in additional government spending.
There are more government-desired projects and fewer private-sector projects. The direct beneficiaries are the companies benefiting from state subsidies. The losers are those entrepreneurs who can no longer realize their projects due to higher costs, and their customers. The visible projects funded by the subsidies are opposed to prevented, invisible projects. The subsidized climate projects will be visible, the prevented projects will remain unknown. As with any intervention, there is a redistribution, there are winners and losers.
Insofar as the planned expenditure is of a transformative nature, i.e., is intended to develop and promote new branches of industry, jobs cannot be expected to be secured in the short term, since the existing companies, which are struggling with underutilization due to corona restrictions, will not be funded. A classic Keynesian intervention policy would “invest” precisely in the production gaps and not focus on industries that are already working to capacity (for a criticism of Keynesianism, see Rothbard (2009)).[1]
It is also questionable whether short-term effects on the labour market and production can be achieved at all against the background of supply bottlenecks, because these problems cannot be solved on the demand side. Which supply-side measures the government has in mind in connection with the second supplementary budget is not clear and remains open.
Since the government is transferring the mentioned 60 bln euros to a reserve, it is not possible to say when the planned cash outflows will take place. In view of the fact that the government has had difficulties spending the funds made available for investments in the past few years, a slow outflow of funds is to be expected. It is questionable whether the German economy will still be underutilized at all. The federal government is even assuming a speedy recovery. If this were the case, then the planned procedure would also not make sense because the economy can already be expected to be at full capacity again when the so-called impulses set in. In the long term, the venture is not sustainable anyway, since an artificial, state-sponsored demand is created here that is not supported by consumers.
This supplementary budget is therefore not suitable for achieving its stated goal. From an economic point of view, there is no connection between additional government spending and overcoming the corona emergency in Germany. The public investments and subsidies in no way activate sustainable private investments but make them more difficult because the costs for the companies will be increasing. Instead of using the resources for private projects desired by consumers, they are increasingly used in projects desired and sponsored by the state.
In order to achieve the self-imposed goal of the draft law and to bring Germany quickly onto a sustainable growth path, a reduction in government spending and new debt would be required. This would make resources available to the private sector that are currently being hijacked by the state.
Comprehensive liberalization would also be helpful. Far-reaching deregulation would enable projects that are currently prevented by restrictions and ensure a strong recovery. Ending the corona restrictions would also help to stimulate growth without any emergency loans. But there is nothing about that in the draft bill.
Government resource management and consumer desires
Now, one could argue that it is important for the state to decide which projects to undertake with the available factors of production, and which industries will and will not thrive. However, this also means that consumers can no longer decide how resources are used (amounting to 60 billion euros), as would be the case in a market economy. In a market economy, entrepreneurs try to anticipate what consumers’ most pressing needs are and deploy resources accordingly. They compete with their rivals to use resources the most efficient way to meet consumer needs; to make better and better products at lower prices. If they are successful, they are rewarded with profit. If they fail, they suffer losses.
The planned economy model, on the other hand, provides for politics and bureaucracy to decide on the use of resources and the projects worth implementing. This leads to classic incentive and information problems.
Politicians and bureaucracy lack incentives to act efficiently in the interests of consumers (Mises 2013).[2] Bureaucrats do not risk their own capital to make profits and avoid losses but use the taxpayers’ money. Politicians have the next elections in mind. They are shielded from the market competition, which forces market players to innovate and save resources.
In addition to the incentive problem, the knowledge or calculation problem weighs even more heavily (Mises 2007).[3] From the infinite number of imaginable projects that could be undertaken with the available resources, those should be selected which are the most urgent or important for the citizens. Competition is a discovery process that dynamically produces this knowledge. The politician decides the question of the most important projects according to her or his preferences, without being able to dispose of the necessary knowledge. She or he is acting irresponsibly (Huerta de Soto 2013).[4] According to Friedrich A. von Hayek (1996), winner of the Nobel Prize in Economics, the belief that the state knows best where to invest can be described as “the assumption of knowledge”.[5]
In short, compliance with the debt brake is beneficial to German citizens because it limits the political arrogance of knowledge and constrains government spending. This gives more space to private initiative and increased prosperity in the consumer sense. The discussion about the draft law for the second supplementary budget for 2021 shows that the exceptions to the debt brake open up scope for interpretation that can be used by politicians. The debt brake should be reformed in this respect in order to become more effective.
The impact on inflation
Inflation is accelerating in Germany and Europe. The corona restrictions are causing production problems and bottlenecks. Supply chains are disrupted, investments in primary products were not made due to lockdowns and consumers increased their cash holdings due to a lack of consumption options and uncertainty. As soon as consumers reduce their cash holdings again, their increased demand meets a reduced supply. Added to this is the acceleration of the money supply growth, which has been rapid for years anyway.
The corona crisis led to record government deficits in the euro area. The M1 money supply has increased by 23 percent in the euro zone alone since the beginning of the corona crisis. The rate of inflation was 5.2 percent in Germany and 4.9 percent in the euro zone in November 2021. This initial inflation may accelerate as a result of rising inflation expectations; it can spiral out of control when consumers start to anticipate their purchases and wage-price spirals kick in. If the German state takes on 60 billion euros in additional debt in this situation, it will have the effect of pouring oil on the fire. Because these 60 billion euros new debt will be monetized. New money is created, which is detrimental to monetary stability and the interests of savers. It is worth remembering that the value of fiat money rests on trust, which can evaporate.
The implications for the sovereign debt crisis and the euro
It is true that all euro area member states – many to a greater extent than Germany – are issuing new debt which is bought and monetized by the ECB. Since the state that has less debt than the other member states is lagging behind in a process of monetary redistribution within Europe, one might think that it is now Germany’s turn to incur debt.
However, it is Germany’s historical task and responsibility as Europe’s regulatory conscience “to set a good example”. In relation to the climate agenda, it is often argued that Germany’s share of global CO2 emissions is only about 2 percent, countries like China emit much more CO2 and even increased their emissions, but Germany still has to reduce its emissions in order “to set a good example”. This is not the place to go into the climate controversy and the pros and cons of CO2 emissions. Let’s assume for the sake of argument that CO2 emissions are harmful. Then the following applies: As with CO2 emissions, Germany should also set a good example with “debt emissions” and reduce its emissions in an exemplary manner so that other euro countries follow this path. This is all the truer since Germany has no means of exerting pressure on sovereign countries such as China or the USA when it comes to CO2 emissions. With the euro, however, Germany has leverage and can insist on the European treaties to induce other euro states to reduce their debt emissions as well.
In the eurozone, Germany’s aversion to inflation and deficits has slowed other countries’ fiscal policies. If this German brake on government deficits in the euro zone is removed, if Germany actively engages in a debt race, loses its regulatory authority, and even uses tricks to circumvent fiscal policy rules, there is a risk that government spending, government deficits and inflation in the eurozone will become unstoppable. While higher German government spending may be in the interests of German politicians and the sectors they subsidize in the short term, the inflationary scenario would be catastrophic for the vast majority of citizens, especially for the savers.
Last but not least, it should be mentioned that an implicit, if not explicit, option for Germany to exit the euro area must also be credible. The German exit possibility disciplined the southern European member states within certain limits and thus – paradoxically – made the cohesion of the euro area possible. From a strategic point of view, this option should be maintained.
A German exit from the euro area then remains realistic. It can be defended with arguments if the German side can show that it has adhered to the fiscal policy rules and minimized deficits, while the other states have not done exactly that. Germany can then justify leaving the euro because it wants a more stable currency than is possible within the euro area. If, on the other hand, Germany goes the way of the draft law with 60 billion euros in new debt and the debt race, then this argumentation no longer works and the door closes.
Conclusion
From an economic point of view, the economic situation does not justify taking on new government debt to finance energy and climate projects. Because additional public spending is not suitable for alleviating the economic consequences of the corona crisis. On the contrary, taxes and spending should be reduced. I recommend that the German Bundestag not pass this draft budget.
Notes
[1] Rothbard R. N. (2009). Man, Economy, and State with Power and Market. 2nd. Auburn, Ala.: Ludwig von Mises Institute.
[2] Mises L. (2013). Die Bürokratie. Dt. Erstausg., 3. Aufl. Klassiker der Freiheit 3. Sankt Augustin: Acad. Verl.
[3] Mises L. (2007). Die Gemeinwirtschaft: Untersuchungen über den Sozialismus. Unveränd. Nachdr. der 2., Umgearb. Aufl., Jena 1932. Stuttgart: Lucius & Lucius.
[4] Huerta de Soto J. (2013). Sozialismus, Wirtschaftsrechnung und unternehmerische Funktion. Stuttgart: Lucius & Lucius.
[5] Hayek F.A. (1996). Die Anmaßung von Wissen: neue Freiburger Studien. Wirtschaftswissenschaftliche und wirtschaftsrechtliche Untersuchungen 32. Tübingen: Mohr.