The court annulled a decision to repurpose 60 billion euros (USD 64.7 billion) originally meant to cushion the COVID-19 fallout for measures to help combat climate change and modernise the country.

What Does It Mean?

The government-level deal will ensure some breathing space for companies operating in Europe’s largest economy. However, analysts believe that Germany’s long-term financial plans will continue to face uncertainties.

The court ruling forced the Scholz government to suspend a “debt brake” for the 2023 budget. Talking about 2024, the country faces the immediate challenge of plugging a 17-billion-euro hole estimated in the 2024 budget.

Leading up to the deal, Scholz, Vice Chancellor Robert Habeck and Finance Minister Christian Lindner had intense discussions, where the need for reimposing the “debt brake” became a hot topic. The break restricts Germany’s public deficit to 0.35% of its GDP.

The two-year-old coalition government has been known for its infighting, which has resulted in its poll ratings slumping further.

Lindner’s pro-business Free Democrats, on the other hand, have portrayed themselves as guarantors of solid finances, while adhering to Germany’s self-imposed limits on running up debt, and advocating spending cuts.

The lower house of Parliament, the Bundestag, may not be able to manage to finalise the 2024 budget this year, despite the deal’s conclusion, as per the media reports.

From January 1, there will be a provisional management of the budget, with Lindner playing a greater role in this by authorising expenditures.

Knowing The Bigger Picture

Lindner, who earlier estimated Germany facing a funding gap of around 17 billion euros (USD 18.27 billion), has ruled out tax hikes and suggested welfare cuts, with Chancellor Scholz firmly backing his finance minister.

Lindner doesn’t want another suspension of “debt brake” in 2024, going against Scholz and the Greens. A section of the German conservative politicians also wants a reform of the brake.

Talking about the budget gap, the coalition government agreed in December 2021 to make the most of a temporary, pandemic-related suspension of borrowing limits in the constitution.

It also decided that the funds should count in deficit calculation in the year the money was borrowed, giving it more budget leeway in 2023 and 2024. The move would have allowed Europe’s largest economy to conform with the debt limit in 2023. However, the top German court rejected such accounting and argued that spending the funds later would still break the constitutional debt limit.

The whole incident now brings back the memories of the 2018 episode, where the budget for the year was passed on July 5 after extended negotiations among the new coalition partners following the elections in September 2017.

Trouble Ahead

In 2023, Germany faced a recession of 0.5%. In 2024, its GDP will fall by as much as in 2024, as per the predictions of the German Economic Institute (IW).

“For the German economy, 2024 could have been the year of recovery. However, general conditions remain poor as the government’s ongoing budget dispute is leading to investment freezes by the private sector,” IW stated further.

Germany will also be affected by geopolitical uncertainties in 2024. As global trade is expected to grow by 1% in the next few months, Europe’s largest economy will still be in the ‘stagnation’ mode.

In the first 10 months of 2023, German exports already fell by 0.8% to around 1.3 trillion euros, according to the Federal Statistical Office (Destatis).

The country’s construction sector is also undergoing a crisis due to high-interest rates and operational costs. Despite its growing housing shortage, Germany has been mostly behind its construction targets in 2023.

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The official food ration issued by the occupying powers (as Germany got divided into four zones between Britain, France, the United States and the erstwhile Soviet Union) ranged between 1,040 and 1,550 calories per day, and food output per capita was barely 51% of its level in 1938. Moreover, industrial production in 1947 was only a third of what it was in 1938, and a sizable portion of working-age German men were deceased during the war.

However, 20 years later, most of the world was envious of West Germany’s prosperity. At the time, analysts believed that West Germany would have to be the largest beneficiary of the American welfare state. The German economic miracle, or Wirtschaftswunder, became a topic of discussion.

The currency reform and the abolition of price controls, which took place over a few weeks in 1948, highlighted the miracle. In addition, the lower marginal tax rates in 1949 and 1948 also bolstered growth.

Before
By 1948, the German people had endured nine years of rationing and price restrictions. For his government to purchase war supplies at artificially low rates, Adolf Hitler placed domestic price controls in 1936. Later, in 1939, Hermann Goering, one of Hitler’s most important Nazi appointees, enacted rationing.

United States, France, Britain, and the USSR joined to form the Allied Control Authority, which decided to maintain the price controls and rationing instituted by Hitler and Goering. Additionally, they kept up the recruitment of labour and other resources by the Nazis.

A “zone” of German land was under the jurisdiction of each Allied administration. The cost of living index in the American zone in May 1948, calculated at controlled prices, was only 31% higher than in 1938. The total amount of money in the German economy in 1947, including currency and demand deposits, was five times higher than in 1936. There had to be shortages because prices had only slightly increased while money had multiplied.

Food shortages became so severe due to price limitations that some people began producing their food while others made weekend trips to the countryside to barter for food.

Swaps in business-to-business transactions were so common that many companies engaged “compensators,” who were experts in exchanging their company’s output for necessary inputs by engaging in numerous transactions. According to estimates made by American military analysts in September 1947, between one-third and 50% of all commercial transactions in the bilateral area (the US and British zones) took the form of “compensation trade” (also known as barter).

Bartering could have been more efficient than a pure cash purchase of goods and services. But, according to German economist Walter Eucken, the economic model had been “reduced to a primitive condition.” The statistics support him. Bizonal production in March 1948 was just 51% of what it had been in 1936.

The argument
Eucken founded the Soziale Marktwirtschaft, also known as the “social free market,” a school of economic theory with its headquarters at the University of Freiburg in Germany. Members of this school detested authoritarianism and voiced their opinions under Hitler’s rule, sometimes at significant personal risk. The school “represented an intellectual resistance during the Nazi period, requiring great personal courage and the independence of the mind,” according to Henry Wallich.

School members supported free markets, minimal advancement in the income tax system, and antitrust laws to restrain monopolies. Before the war, cartels were explicitly legal in Germany. The Chicago school’s young members, Milton Friedman and George Stigler, shared that it was similar to the Soziale Marktwirtschaft. It supported strong free markets, a small amount of government redistribution through the tax system, and antitrust laws to avoid monopolies.

Wilhelm Röpke and Ludwig Erhard were students at the German school. Röpke promoted price restrictions’ elimination in addition to currency reform to bring the amount of money in circulation in line with the number of products. He reasoned that both were required to put a halt to controlled inflation. The currency reform would put a stop to inflation, and price decontrol would put an end to repression.

Röpke and Ludwig Erhard concurred. During the conflict, Erhard had penned a letter outlining his idea of a market economy. He made it plain in his memo that he wished to stop the Nazis.

On the other hand, the Social Democratic Party (SPD) favoured maintaining governmental dominance. Dr. Kreyssig, the principal proponent of central government control over economic policy for the SPD, stated in June 1948 that decontrolling prices and implementing currency reform would be futile. Labour union leaders, British authorities, most West German manufacturing interests, and some American authorities supported the SPD.

The shift
Ultimately, Ludwig Erhard prevailed. Erhard, whose anti-Nazi sentiments were evident, was chosen as Bavarian minister of finance in 1945 because the Allies wanted non-Nazis in the new German government. In addition, he was a military advisor to U.S. General Lucius D. Clay while serving as the bizonal Office of Economic Opportunity director starting in 1947.

On Sunday, June 20, 1948, Clay and his French and British counterparts implemented a currency reform following the Soviets’ withdrawal from the Allied Control Authority. The basic plan was to replace reichsmarks with a significantly smaller quantity of Deutsche Mark (D.M.), the new legal tender. This would dramatically reduce the money supply, leading to fewer shortages even at the controlled prices—now stated in Deutsche marks.

The currency reform was highly complicated, and many people saw a significant decline in their net worth. In addition, the money supply decreased by around 93% due to the whole situation.

The German Bizonal Economic Council passed a price decontrol ordinance that same Sunday, at Ludwig Erhard’s urging and against the wishes of its Social Democratic members, allowing and encouraging Erhard to do away with price limits.

De-Nazifying the West German economy was Erhard’s summer project. According to the Federal Reserve Bank of New York economist Fred Klopstock, “It followed the directive removing price, allocation, and rationing regulations” from June through August 1948.

Nearly all manufactured items, including fruits, vegetables, and eggs, were exempt from regulations. As a result, many remaining limitations were removed, and ceiling prices on many other things were raised significantly.

Naturally, Erhard was correct in his prognosis. Without a rationing system standing in the way, price decontrol permitted consumers to communicate their wants to sellers, and higher prices encouraged sellers to provide more.

The administration also lowered tax rates, reformed the currency, and released price controls. In a 1949 paper, a young economist named Walter Heller, who was then working for the American Office of Military Government in Germany and subsequently became chairman of President John F. Kennedy’s Council of Economic Advisers, outlined the improvements. According to Heller, Military Government Law No. 64 “cut a wide swath across the German tax system at the time of the currency reform” to “remove the repressive effect of extremely high rates.”

The corporate income tax rate was decreased from its previous range of 35 to 65% to a flat 50%. The top income tax rate for individuals remained at 95%. However, it only applied to income over DM250,000 per year.

In contrast, the Allies had imposed a 95% tax on all income over 60,000 Reichsmarks (about DM6,000) in 1946. With an annual income of just about DM2,400, the marginal tax rate for the average German in 1950 was 18%. If that same person had made the identical amount in Reichsmarks in 1948, he would have paid taxes at an 85% rate.

After
The economic impact on West Germany was tremendous. “The spirit of the nation changed overnight,” wrote Wallich. The drab, starving, lifeless figures pacing the streets in an endless search for sustenance came to life.

On Monday, June 21, stores were brimming with merchandise as individuals understood the money they sold their items for will be worth far more than the previous currency.

Additionally, absenteeism fell. Workers missed an average of 9.5 hours each week in May 1948, partly because their wages were meagre and partly because they were out foraging or haggling for food.

Average weekly absences decreased to 4.2 hours by October. As a result, the bizonal index of industrial production was barely 51% of its 1936 level in June 1948; by December, it had grown to 78%. In other words, there had been a greater than 50% growth in industrial production.

After 1948, the output grew exponentially more each year. By 1958, industrial production had increased more than four times from the six months in 1948, just before currency reform. As a result, industrial output per person tripled. Contrarily, the communist economy of East Germany remained stagnant.

Erhard became Germany’s first minister of economic affairs after Konrad Adenauer, the new Federal Republic of Germany’s first Chancellor, recognized the success of his ideas. He kept that position up until 1963, at which point he became chancellor, which he held until 1966.

Marshall Plan
Through October 1954, overall aid from the Marshall Plan and other aid initiatives was barely $2 billion. Even in 1948 and 1949, when it was at its highest, Marshall Plan funding represented less than 5% of Germany’s GDP. Germany outgrew other nations that received significant Marshall Plan help in growth.

Furthermore, while West Germany was getting aid, it paid far more than $1 billion in reparations and restitution. Last but not least, and most significantly, the Allies levied DM7.2 billion ($2.4 billion) in annual occupation costs against the Germans. Thanks to these occupation expenditures, Germany did not have to pay for its defence. In addition, Belgium recovered from the war the quickest and relied more on free markets than the other war-torn European nations.

Conclusion
What many observers mistakenly believed to be a miracle was not one at all. Ludwig Erhard and other members of the Freiburg school were aware of the harm that can result from inflation when it is combined with price controls and high tax rates, as well as the significant productivity gains unlocked by stopping inflation, eliminating rules, and lowering high marginal tax rates anticipated it. Erhard’s historical success can still be emulated by many struggling economies worldwide.

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The German current account surplus is mainly attributable to trade in goods; in the first half of the year alone, a surplus of €134 billion was achieved here. The main driver was demand from the other countries of the euro area, the other EU countries and from the United States. Also contributing to the surplus were yields from the assets invested outside Germany and earned income by Germans abroad totalling some €20 billion. Transfer payments abroad, for example to international organisations, reduced the surplus by €27 billion.

However, in the current year Germany’s surplus will fall to 7.9 percent of annual economic output, after 8.3 percent in 2016. This is mainly due to energy prices. The prices for imported oil and natural gas are expected to be higher than in the previous year despite the appreciation of the euro, which will increase the nominal import of goods and will reduce the surplus. From 2013 to 2016, in contrast, the opposite effect was observed: a sharp fall in oil prices that increased the current account surplus by 1.4 percentage points during this period. The EU considers a maximum of six percent as sustainable in the long term.

The Chinese current account surplus is also due to goods trade. By June, goods worth €200 billion net were exported. This means that the Chinese goods surplus is significantly higher than that of Germany. However, in the first half of 2017, China was a demander of services from abroad worth €125 billion.

By definition, capital exports are the portion of the savings of a country that is not invested domestically. High net capital exports mean that Germany is building up more financial claims against foreign countries than foreign countries are against Germany. A current account surplus is always accompanied by net capital exports, since the sale of goods or services to foreign countries must be accompanied by higher financial claims against foreign countries. Income from foreign assets also increases the current account surplus, since this increases the payment claims from foreign countries.

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