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Germany’s economy is too strong. What will the new government do?

Workers remove an election poster featuring Chancellor Angela Merkel in Berlin in September. (AP)

German political parties are now negotiating to form a government. Many other countries — both inside and outside the European Union — are watching nervously. The results of these government negotiations will likely affect crucial macroeconomic decisions in Germany that will in turn affect its trading partners.

Building a new German coalition government won’t be easy. Here’s why.

Germany’s economy is strong. Too strong.

Ten years after the economic crisis began, the German economy is booming. Growth has continued increasing (albeit moderately), employment levels are at a record high and German business leaders are highly optimistic. This gives Angela Merkel’s government — which has been following tight fiscal policies and limiting spending — some room to carry out much-needed investments in digital and physical infrastructure. Most economists think that higher spending in Germany would also boost the E.U. economy, and, to a lesser extent, the rest of the world. Germany ran a current account surplus of 8.4 percent of GDP in 2016, which implies by inexorable mathematical logic that other countries are running deficits. Some of those countries owe a lot of money after the financial crisis, but it is hard for them to grow out of their problems as long as Germany and other North European countries prioritize fiscal rigor over spending.

Yes, Germany put a far right party in Parliament. That’s not as alarming as you might think.

Germany’s high and persistent current account surplus means that it has an excess of savings over investments. That in part reflects an aging society, whose members, facing retirement, want to save.

However, German political leaders are more inclined to argue that surpluses are driven by the weakness of the euro, which they say is the result of competitive German goods and the European Central Bank’s policies rather than German politics. Saving less would mean more public and private investment, likely improving productivity in the future. Still, Berlin refuses to take steps to reduce its large savings rate. As was forcefully explained by the political scientist Mark Blyth, achieving a balanced budget (“black zero”) has become the defining indicator of political success for German leaders.

This has implications for Europe

The European Commission has called on Germany to take action against rising current account surpluses. But the German government has not responded, even though the size of its surpluses break E.U. rules. Germany’s emphasis on austerity may have implications for the whole E.U.

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Since the beginning of the European debt crisis, France has sharply criticized Germany’s macroeconomic management, without much influencing Merkel’s policy. Since taking office, the new French president, Emmanuel Macron, has shown impressive diplomatic skill and understanding of Merkel’s domestic political struggles. However, Macron’s vision for the E.U., which he presented publicly two days after elections in Germany, would require a higher German financial commitment, including transferring German taxpayers’ money to an E.U.-level finance ministry. Merkel has not said that she opposes such plans. But both leaders know that nudging Germans to accept a stronger commitment to European integration and European spending will depend on how much political maneuvering space the chancellor will have in her governing coalition.

There is a fight over who will control government finances

The German political system strongly favors government coalitions. Given the election results, Merkel has two options. The first and inferior option for her would be to run a single-party minority government and rely on her former coalition partner, the social democratic SPD and two smaller liberal parties, the FDP and Greens. That would allow all of her political adversaries to hold the chancellor hostage, leading to increased instability. Merkel’s second option is a more formal “Jamaica coalition” (named for the parties’ respective colors, which resemble the Jamaican flag) between her own Christian Democratic CDU, its Bavarian sister party, CSU, and the liberal FDP and Greens. It would be the first coalition of these parties at the federal level in Germany’s history.

This would have significant implications for fiscal expansion and rebalancing in Europe. On one hand, Germany’s long-term finance minister, Wolfgang Schäuble — Europe’s most ardent supporter of austerity — has left office, providing space for more spending. On the other, Merkel’s party had a historically weak share of the vote (33 percent), while the FDP saw a remarkable turnaround (with 10.7 percent). Even before the election results, the FDP called for control of the finance ministry, and it has declared itself to be a strong supporter of a balanced budget, and opponent of plans for E.U. integration that require any further fiscal commitment. The other potential coalition partner, the Greens (8.9 percent) are open to increased public investment, tax relief for lower incomes and further E.U. integration. However, they are likely to be overruled by the other three parties. Hence, the French president spoke for many when he told journalists that he will be “dead” if FDP takes over the finance ministry in the next coalition government.

There is still a chance that government spending will go up

However, no matter how the ministries are allocated, it is possible that spending may go up. Research on parliamentary democracies shows that coalition governments tend to be more spendthrift than single-party governments. This is because they have different spending priorities, meaning that the more of them enter a coalition, the more likely they are to increase government spending.

This might mean that each of the four parties can be expected to target as many spending projects as possible at their supporters, since they all want to be reelected in four years. This makes a diversion from a fully balanced budget more likely. This being said, government spending is ultimately subject to the German debt brake that prohibits extensive new borrowing.

As other research on budget-making in E.U. countries has argued, fiscal discipline works in coalition governments only when the parties agree on spending limits. As well as looking at who gets the finance ministry, people with an interest in German spending policy should look closely at the spending targets laid out in the coalition agreement to be drawn out between now and Christmas.

Laura von Daniels is a research associate at SWP Berlin, where she works on transatlantic economic relations. She has published on the role of budgetary institutions in government stability and on sovereign debt crises in emerging market countries. The text solely reflects the personal opinion of the author.