May 27, 2011

Preventive budget management, corrective arm, European semester and of course the Stability and Growth Pact – these are only a few examples of the terminology used for European-level approaches towards more sustainable coordination of fiscal policy among the EU member states. But what is the situation with coordination and sustainable financial planning in Germany? Before its second reform of federalism in 2009 Germany did not, in principle, have any far-reaching preventive instrument that would have enabled timely corrective action at the federal or Länder level to redress budget imbalances or resultant accumulations of debt. The existing rules – the “old” investment-oriented debt ceiling set out in Article 115 of the Basic Law (Constitution) as well as the Financial Planning Council – had less of an impact than the limits of the EU's Stability and Growth Pact. Things are about to change now given the new “debt brake” and the Stability Council of the Federation and the Länder.

Unlike the debt brake, the Stability Council of the Federation and the Länder has attracted relatively little attention to date – unjustifiably. For the first time, at least at the federal and Länder levels, considerably greater significance will be attached to medium-term budget development and objectives. The body comprises the Länder finance ministers along with the federal finance and economics ministers. Its basic design is very similar to that of the EU Council for Economic and Financial Affairs (ECOFIN). However, unlike in ECOFIN, a “budget offender” does not have the right to vote if affected by the decisions to be taken. Moreover, decisions do not require adoption by qualified majority, but instead by a “simple” 2/3 majority of the Länder votes (plus the Federation, though each Land and the Federation have only one vote apiece). A standing working group does the groundwork for the regular meetings. An evaluation committee is convened separately in times of looming budget emergencies to prepare a potential restructuring programme and subsequently monitor its implementation. At the EU level such tasks are carried out in a similar manner by the Commission and the Economic and Financial Committee.

In October 2010, at its second meeting, the Stability Council conducted its first examination of the stability reports which the Länder are required to submit once per year. At its third meeting, in May 2011, it formally determined the existence of a looming budgetary emergency in four Länder (Berlin, Bremen, Saarland and Schleswig-Holstein) and demanded that these Länder (in collaboration with the evaluation committee) devise programmes to redress the problems before the next session in October 2011. The restructuring programmes will not be formally adopted until then. These programmes are designed to operate for five years. During this period the Länder are to report at six-month intervals on their compliance with the consolidation programme to ascertain whether further measures may be necessary.

Generally, assessments of the budgetary situation focus on four indicators: the structural financial balance per inhabitant, the credit financing ratio (i.e. net borrowing in relation to adjusted total expenditure), the debt level per inhabitant and the ratio of interest expense to tax revenue. The respective Länder averages plus certain top-ups are the benchmark for comparison. Taking the debt level indicator, for example, the related ceilings for the current period are 130% of the Länder average in the case of territorial states and no less than 220% for city-states. Observers review two partial periods that cover seven years altogether. It is when at least three of the indicators breach the ceilings during one of these partial periods that a Land is deemed by definition to be at risk of a budgetary emergency (incidentally, an indicator is considered “excessive” if in a given period at least two readings of these indicators exceed the ceilings).

This very technical and not entirely transparent procedure harbours advantages and disadvantages. One advantage, for instance, is that the procedure is relatively mechanistic and thus the budgetary emergency can be established without recourse to political interpretation. By contrast, it is a disadvantage that the definition more or less creates increased scope for setting individual limits – consider the given example of the debt indicator with its different readings and top-ups for territorial states vis-à-vis city-states. Without becoming involved in a detailed discussion of the suitability of the indicators or their methodology, let us at least look at one further problem as a proxy: the choice of the average value as the benchmark. It raises the problem that the greater the number of Länder budgets in disequilibrium, the easier for an individual Land to stay below the thresholds. Let us take a “European” case for comparison: in 2010, the average debt reading for the eurozone countries was just over 85% of GDP, so the German reading of around 83% would currently not even breach this “flexible” Maastricht limit. Even Spain, which faces intensified market monitoring, would not have reached the forecast average for the eurozone with an estimated reading of just over 70% for 2011.

So is this glass half full or half empty? This remains to be seen. Unlike at the EU level there is ultimately no direct scope for punitive sanctions (let alone an automatic corrective that indeed makes political and economic sense) – so the possibility of “making the grade” may seem at risk, but “failing” can be ruled out. However, a proper, transparent procedure is now in place that can exert influence via public pressure. Incidentally, the increased pressure should also considerably simplify the work of budgetary policymakers at home in the Länder – as the establishment of the Stability Council does extend the number of ways to justify unpopular austerity measures (much as the Maastricht criteria do at the European level). Besides, it has to be borne in mind that the evaluation procedure does not automatically trigger any financial assistance from other Länder or the Federation (however, these do exist indirectly by virtue of the Länder financial equalisation system).

As to the concrete fiscal situation, the formal decision recognising the existence of a budgetary emergency in the Länder Berlin, Bremen, Saarland and Schleswig-Holstein comes as no surprise at all. Nor is it a case of known or perhaps even unknown problems in these Länder coming to a head. At least in the cases of Berlin, Bremen and Saarland, though, it does draw attention to persistent budget imbalances. All four of these Länder (and Saxony-Anhalt to boot) are already the recipients of consolidation aid totalling EUR 800 million p.a. towards lowering their structural debt until final full implementation of the debt brake at Länder level (2020), and therefore they have already had to tolerate stricter monitoring of their budgets. In the event that concrete restructuring plans are disregarded, they run the risk of losing this assistance. Only in October, when the restructuring programmes have been submitted and adopted, will it emerge how ambitious these plans truly are and thus how effective the Stability Council really is. From a current standpoint, at least, there is still some “room to improve” – as was recently noted by the Bundesbank. This suggests that the established structural starting deficits for determining the adjustment roadmap will probably have an excessive bias until the structural deficits are fully dismantled (in 2020). For the starting deficits are not based on updated statistics and this will decrease the consolidation pressure in the short term, allowing additional latitude for debt to develop in subsequent years.

Interactive map for Länder finances

Frank Zipfel (+49) 69 910-31890

 

...more information on Economic and european policy issues

Talking Point - Archive