Will a Scholz-led government bring a change to economic policy?

Against all odds, German coalition talks are moving faster than expected, and the chancellor’s Christmas speech this year could be given by someone other than Germany’s (and the EU’s) longstanding and stoic Mutti. After coordinating between them, the pro-market (if sometimes euro-critical) FDP and the German Greens began discussions with pragmatic social-democrat Olaf Scholz, whose rapid comeback from losing his party’s primary to Merkel’s likely heir would be the subject of television films in the Anglo-Saxon world. Finally, last Friday, the three parties jointly released a 12-page paper to form the basis of negotiations, a pre-agreement of sorts paving the way to a coalition. Thus, in light of the growing possibility Scholz will not only take the reins of the chancellery, but that he will do so earlier than expected, it is worth examining what it would entail to have this former Hamburg mayor as leader of Europe’s largest economy.

Throughout his campaign, Olaf Scholz portrayed himself as the candidate of continuity, claiming Merkel’s mantle with explicit messages like ‘he is ready to be madame chancellor ´(Er kann Kanzlerin). He is also generally perceived as a convinced European, closer to France’s eurozone ambitions than any other top-tier German politician. As finance minister during the pandemic, not only did he captain Germany’s expansive response (known colloquially as the German bazooka), he also nudged his government along the path of greater fiscal integration in Europe that culminated in the Franco-German proposal and then ultimately the Next Generation EU recovery fund. Already in 2019, he and his Chicago (and Goldman Sachs-trained) ally Jörg Kukies, state secretary within his ministry, diverged from the German government’s longstanding ambiguity with ambitious proposals for banking union reform. This included support for a common deposit insurance scheme and introduced the idea of a ‘safe portfolio’ of sovereign debt products. The latter could have laid the groundwork for a structured product of sovereign bonds from the different member states as a synthetic safe asset, a very novel idea at the time (made less relevant by common EU debt issuance to finance Next Generation EU).

Scholz’s economic policy will not only be key to Germany’s recovery, but also that of the entire eurozone. The temporary and exceptional nature of the recovery fund and common European issuance is seen by many as a stepping stone to greater EU fiscal integration, and the next few years may be decisive in this regard. At the same time, a reform of European fiscal norms is on the horizon, before their pandemic-induced suspension ends. A proper debate on the EU’s fiscal structure is long overdue, and Scholz will likely be at the helm of its largest net contributor. On the domestic front, the German economy benefited from a generous fiscal response to the pandemic, but important debates on tax policy, the debt brake and many other core economic issues remain. In this context, it is first important to caution against overoptimism, policy immobility characterises German politics and Scholz (if he succeeds) will preside a coalition (traffic light or otherwise) of fairly diverging views when it comes to economic policy. With this in mind, there are a couple of elements to consider and which might signal a certain departure from the previous era and provide some insight into his future economic policy.

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On the domestic front, and despite hammering down the continuity message, the social democrats campaigned on certain proposals that signal a shift from the Merkel years. In particular, the need to undertake major investments to update German infrastructure has played a central role in the SPD campaign. Germany, in spite of having enjoyed stable if lukewarm growth during the last two decades, has been unable to level-up its infrastructures, to the extent that these are often presented as an obstacle for further growth and development. Indeed, chronic underinvestment is a longstanding German issue that has been highlighted by the Commission in its country-specific recommendations for many years. The social democrats have highlighted this need for investment in their campaign.

The SPD also calls for a 12 euro minimum wage, stable pensions and the construction of 400,000 homes a year. Under the slogan of respect and some back to basics centre-left pledges, Scholz has managed to maintain a delicate balance between the SPD traditional voters and the younger more urbanite supporters they were losing to the greens. The joint paper released last Friday provides some clues in this regard: it calls for a noticeable increase in both public and private investment, looks to modernise the economy and state bureaucracy and a ‘drastic acceleration’ in spending on renewables. The three parties further highlight the need for Europe to exit the current crisis, and praises the proven flexibility of the SGP.

Perhaps more importantly, however, is the position of their future coalition partners. The FDP readily agreed to a traffic light negotiation, even as a Jamaica coalition with the Christian Democrats is a more natural fit for their policy positions, as well as some core SPD and green positions as reflected in their recent joint paper (raising the minimum wage, vastly increasing public investment in renewables, etc.). They will request important concessions in exchange for supporting Scholz. In recent years, Christian Lindner’s party has been critical of a perceived eurozone (and ECB) laxity and they were no great admirers of common European issuance. Their general orthodoxy extends to domestic economic issues, they are firm defenders of the debt brake and would like to cap social spending, reduce corporate taxes and oppose a wealth tax or inheritance tax hikes. Lindner has made no secret of his interest in the finance ministry (and economic ministries more generally) and given as they have conceded to negotiations with a least-preferred partner it is likely they will get it. Lindner as finance minister would be significantly more hostile to expanded EU common issuance or a more permanent recovery fund-like instrument than Scholz (or indeed Merkel). 

That said, his role is not guaranteed, Robert Habeck, co-leader of the greens (who would be the second largest party in the coalition, ahead of the FDP) is also vying for the finance ministry. His chances of success (which appear to be low) depend not only on FDP leverage but also his power within the his own party after co-leader and candidate Annalena Baerbock’s disappointing election performance. Even if the greens lose the finance ministry, they are expected to preside over an enlarged green ministry that may absorb some of the competences traditionally held by other economic ministries. Finally, in the unlikely case that the agreement falls through, a grand coalition with the Christian democrats remains possible (at least more so than a Jamaica government led by the latter). In that case, the finance ministry would probably end up in the hands of the CDU/CSU, but one which is expected to continue shifting to the right following the electoral defeat and thus may not necessarily share Merkel’s stance.

While Scholz may indeed give this years Christmas speech, many options remain for a future SPD-led government, perhaps especially on the economic front. However, despite some innovative proposals, Scholz remains the candidate of continuity, and his surest path to the chancellery relies on the orthodox FDP. Therefore if there is one thing we can count on it is to not expect much to change.

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