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special issue: federations and the economic crisis
Hit hard by crisis, Germany fights back
REUTERS/Johannes Eisele
German Chancellor Angela Merkel poses with executives and employees of German automaker Opel in Ruesselsheim in March 2009. Opel has been scrambling since its parent, General Motors, went bankrupt .
By karen Horn
The global economic crisis has hit Germany earlier and harder than many other countries due to its dependence on foreign trade. To fight the crisis, the German parliament passed its first 30-billion-euro stimulus package in December 2008, which focused on public investment. The second package, voted in January 2009, amounted to 50 billion euros and concentrated on investment, lower taxes and social contributions.
German Chancellor Angela Merkel, heading a grand coalition of her own Christian Democrats with her former opponents, the Social Democrats, surprised everyone with a proposal in January 2009 of giving more aid to the German federal states, or Länder, in the west of the country than to the ones in the former Communist east because the western Länder were hit harder due to their greater dependence on exports. But parliamentarians eliminated Merkel’s preferential treatment of the west from the stimulus laws.
Export-driven industry is stronger in the west, especially in Bavaria, Baden- Wuerttemberg and North Rhine Westphalia. Now that global demand for German exports is down, these western Länder are struggling more than the average.
The crisis didn’t significantly hurt Germany’s yearly economic figures until 2009. In 2008, German exports totalled US $995 billion, or 40 per cent of GDP, which means that Germany could pride itself on being the export champion of the world, ahead even of China, for the sixth year in a row. Germany’s competitive strength resides especially in the automotive industry, machines and other investment goods – but when the global economic climate turns sour, investments dwindle.
German exports shrink
During the first months of 2009, exports were 20 per cent lower than a year before. For industry, the result was that production slowed down by a fifth in February, as compared to the year before.
In total, the German GDP shrank by an estimated three to three-and-a-half per cent during the first quarter of 2009, which is a further deterioration from the last quarter of 2008 consumer spending. During the last quarter of 2008, investment declined by 2.7 per cent.
Economists expect an ongoing decline of German GDP for the rest of 2009. The economy is not expected to reach a positive growth rate again until 2010 or 2011.
Effects of the crisis on the labour market are still moderate right now, given that potentially superfluous staff is being parked in “short labour” schemes, a sort of camouflage for unemployment.
Workers simply work fewer hours and the government reimburses the employers’ share in social contributions. These schemes have recently been extended from 18 to 24 months and, after the sixth month, the federal government now takes over the employee’s share in social contributions as well. Still, there are some repercussions expected this fall.
Germany’s unemployment rate was at 8.3 per cent in June 2009. However, the German Bundesbank’s prediction of a 6.2 per cent drop in German GDP in 2010 means a higher unemployment rate next year, perhaps 10 per cent or higher. Unemployment in the EU is expected to jump to 11.5 per cent.
The “model Land” in trouble
Baden-Wuerttemberg – traditionally Germany’s “model Land” due to the exceptionally entrepreneurial spirit of its people – used to earn every second euro abroad. The sectors suffering most now are automobiles, steel, machinery, chemicals and pharmaceuticals. The crisis in the automobile industry is particularly troublesome, given the international excess capacity – experts estimate it to be around 38 per cent, which means that some producers will inevitably have to cease operations.
A typical case in point is Opel, the German subsidiary of General Motors.
There are four Opel auto plants in Germany: in Hesse, in North-Rhine Westphalia, in Rhineland-Palatinate and in Thuringia. After General Motors filed for bankruptcy protection in the United States, a bidding war broke out over Opel between a consortium led by Magna, the Canadian auto parts maker and Brussels-based equity firm RHJ International. After Fiat entered the competition, GM was considering holding on to the asset.
With federal elections coming up in September, the authorities of both the Länder and the federal government obviously fear a wave of unemployment if this landmark industry were to disappear.
Beyond the provision of financial guarantees, they cannot, however, act individually. A comprehensive strategy is now being negotiated. In Germany, power to pass laws over the economy, agriculture and the environment is for the most part concurrent – that is, shared between the federal government and the Länder.
REUTERS/Christian Charisius
New cars of German automaker Volkswagen await export at the harbour of the Volkswagen plant in April 2009.
Another, perhaps more important and more promising reason may be found in the extremely high degree of specialization, which is indeed
unrivalled in much of the world, and which is a consequence of active regional policy put in place by the new Länder from the former East Germany.
Länder collect few taxes
Germany’s federal structure doesn’t leave the Länder a great deal of leeway for differentiated policy, let alone economic or even fiscal experimentation.
The only fields in which the Länder have a legal prerogative are education and regional policy. The impact that a Land can make here through its spending policy depends entirely on its finances.
The revenues stem from various sources. On the one hand are federal subsidies and equalization payments from other Länder. On the other hand, there are some taxes to which the Länder have an exclusive right, such as the automobile tax and the inheritance tax. The majority, however, are in shares of taxes raised jointly with the federal level, such as value added tax, corporate and personal income tax. A consequence of this is that the automatic stabilizers affect the federal government and the Länder in the same way. The share given to the Länder doesn’t fluctuate. The formula for distributing the taxes among the Länder is fixed. The portion given to the Länder and the federal government is also fixed.
This doesn’t come as a surprise: Germany’s federalism is not a competitive one.
Bavaria runs up deb
The majority of the Länder will need to vote in new budgets – with larger debt. The Land that is suffering the worst from increasing debt is Bavaria, which once was outstanding at maintaining stable finances and balancing its budgets. The budget would be almost balanced now if Bavaria didn’t need to rescue its government-owned Landesbank bank.
As a result, Bavarian citizens are currently weighed down by a deficit of 7.2 billion euros in the first quarter of 2009 alone.
Other banks owned by the Länder are currently deep in trouble, with ratings going down dramatically. For example, Schleswig-Holstein and Hamburg had to inject three billion euros of bailout money and an additional guarantee of 10 billion euros for their jointly-run HSH Nordbank. This is also true for Landesbank Baden-Wuerttemberg, which swallowed Saxony’s Sachsen LB bank earlier and now needs five billion euros of fresh capital.
All of them suffer the same dilemma: excessive leverage passed on mainly from their offshore subsidiaries that have contracted serious exposure in the now distressed sub-prime markets – markets they had no statutory reason to do business with, but that no supervisory board prevented them from engaging in.
Skyrocketing debt is not just a problem of the Länder. Recent forecasts predict the biggest German deficit ever for 2009 and 2010, with 80 to 90 billion euros of new federal debt. This runs counter to former attempts to reach the Maastricht criterion of no deficit larger than three per cent of GDP, let alone balanced budgets as planned by 2010.
Berlin reins in debts
A new debt reduction rule was passed by the cabinet, in agreement with the Länder, in early March 2009. According to this rule, the federal government will have to keep its deficit within the range of 0.35 per cent of GDP every year from 2016 onwards, and the Länder may incur no new debt at all after 2020. As reasonable as this seemed to German legislators, given the already high per capita debt ratios in the Länder (Bremen: 23,000 euros; Berlin: 16,000 euros; Hamburg 12,000 euros; Sachsen-Anhalt 8,000 euros), it will not be an easy task. The fiscal estimate that came out on May 14, 2009, was utterly devastating: over the next three years, a shortfall of 316 billion euros is expected. All levels will be suffering: the federal government, Länder and local municipalities.
The Länder will have to cope with a shortfall of 16.5 billion euros in 2009. The situation is so bad that it has even reopened the debate about merging Germany’s 16 Länder for the sake of efficiency. A formal merger had once been proposed between Brandenburg and Berlin shortly after German reunification, but was rejected in a public referendum.
Stimulus bill targets cities and Länder
The second stimulus package, passed by the federal government in January 2009, was an element in a series of measures that the German government orchestrated as a clear central response to the crisis. It had been preceded by sweeping guarantees and rescue plans, including the creation of a special fund for financial market stabilization.
It also completed the first package, approved in December 2008, which focused on public investment worth 30 billion euros. The second package amounted to 50 billion euros, concentrating on investment, lower taxes and social contributions.
The investment fund amounts to 14 billion euros over two years. Seventy per cent of this money will go directly to local communities while the remainder will be at the immediate disposal of the Länder – as long as they actively use it for “additional investment.”
Each of the 16 Länder has its own measures to complement these stimulus plans. What doesn’t differ is their focus: the money must be spent on either schools or infrastructure according to the federal stimulus package. For example, North-Rhine Westphalia, Germany’s largest Land, added 1.8 billion euros for infrastructure investments; Hesse added 1.7 billion euros of its own, mainly for the refurbishment of schools; Baden-Wuerttemberg 650 million euros; and “poor but sexy” Berlin 50 million euros. However, in terms of the efficient, innovative and knowledge-generating systems competition that federalism is supposed to foster in the public sector, these are quite modest moves.
In this crisis, German federalism has once again revealed its rather toothless character. Regional governments don’t have much leeway left in this country, an insight that comes as no surprise since competition is not fashionable right now. 
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