3 days ago
Can Europe cope with a free-spending Germany?
The market moves were bigger than expected. On March 5th German long-term yields jumped by 0.3 percentage points, the largest single-day rise in almost 30 years, and the euro surged. European stockmarkets, which would normally have suffered owing to higher rates, held on to their recent rises. Germany's bombshell of a fiscal package—currently under negotiation—represents more than just the start of deficit spending on defence. It is the beginning of a new European growth model. The continent will depend more on internal demand, and less on the world.
At almost 3% of GDP, the EU's current-account surplus is hefty, with Germany and the Nordic countries leading the way. Their surpluses are caused not just by their exporting prowess, but by the gap between levels of saving and investment: if a country invests less at home than it saves, the difference becomes a capital export, and the trade balance adjusts to accommodate it. Now that Europe wants to be insulated from global shocks, invest to make its economy greener and rearm quickly in order to repel Russia, saving and investment will have to shift back into balance.
There are good reasons to think this will happen. To deter Russia, defence experts believe that Europe will have to spend 3.5% of GDP a year on its armed forces, which could rise depending on the level of American support. Few politicians want to pay for this with cuts elsewhere. As Johannes Marzian and Christoph Trebesch of the Kiel Institute, a think-tank, note, military build-ups are almost always funded with a mix of debt and higher taxes. Given the low existing debt burdens in northern and central European countries, deficit funding will almost certainly be the preferred option this time round.
Another reason is provided by Europe's shift from being an ageing society to a straightforwardly old one. Ageing societies save for retirement. An old society sells assets to spend. The EU's median age is 45 and more restrictions on immigration will speed the greying process. For the moment, Europeans are keen savers: at 14%, the EU's household savings rate is comparable to that of Japan, which is even older, in the 1990s. By 2015, though, Japan's rate had fallen to zero. Tight labour markets, as people retire, are also likely to lift wages in services and the care industry, and such workers are more likely to spend than save.
The last reason for the shift comes from business investment, which has crept up since the euro crisis of the mid-2010s. New industries are likely to emerge soon, prompting more. Defence and aerospace firms will grow to equip Europe's armed forces. And the EU wants to become a net-zero emitter of greenhouse gases by 2050, which will mean yet more spending on everything from grids to charging stations. Estimates suggest that €500bn ($545bn) in extra annual investment by 2030 will be required, equivalent to 3% of GDP.
Yet Europe's new free-spending impulses will have to overcome constraints. Fiscal expansion will be restricted by high debt levels and deficits in some big countries, notably Italy and France. For its part, despite having space to do so, Spain is reluctant to lavish money on soldiers and kit. Common EU debt to fund such spending, although under discussion, is unlikely to end up happening on a large scale.
Economic growth would make life easier. But ageing will shave between 0.4 percentage points (in France) and 1.1 percentage points (in Italy) off annual growth rates until the end of the 2030s, according to Thomas Cooley of New York University. Although German spending will boost the country's GDP, at least in the short run, it may cause problems elsewhere. When the largest member of a currency union spends big, interest rates must rise to prevent inflation. Higher rates will boost the euro, making exports less competitive.
On top of this, the current Trumpian uncertainty makes businesses nervous about gambling on long-term investments. Policymakers hope that, by boosting local demand, they will also make Europe less vulnerable to trade wars. In order to help the process along, they might consider a dose of deregulation. Linking the continent's capital markets, for instance, would both allow savers to earn higher returns on investments and provide funding for new endeavours. Germany has already done the unthinkable. It would be a shame to waste the opportunity.
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