Is the reduction of Germany's national debt feasible? "In Times of Growth, Economists Often Forget Keynes"

Germany's economy is strong: exports are at record-breaking levels, unemployment is down and billions of euros in additional tax revenues are pouring into state coffers. Given these positive developments, how realistic is a reduction of the national debt? Dr. Friedrich Heinemann gives some answers.

PD Dr. Friedrich Heinemann is the Director of the research department of Corporate Taxation and Public Finance at ZEW. His research focuses on empirical public economics, federalism in Europe, and tax competition. In 2010 he received his venia legendi for economics from the University of Heidelberg. Along with work in several research groups, Heinemann is a board member of the Arbeitskreis Europäische Integration e.V. and a member of the Scientific Board of the Institute for European Politics, in Berlin

During the economic crisis the German government generated growth with a multi-billion-euro stimulus packages. Now that times are good again, why should the state reverse course and save?

The German national economy is currently experiencing the second straight year of extraordinarily high levels of growth. The resulting jump in tax revenues is good news but cannot be simply extrapolated. Besides, many economic risks continue to loom elsewhere in Europe and throughout the world. And because of the safety net mechanism in place for the euro zone, Germany plays an indispensable role in providing stability within the European economic union. The German federal government and the German states must therefore continue to reduce deficits, both as a bulwark against crisis in Europe and as a precaution in case of a renewed domestic slump. Interestingly, Keynesian economists rarely call for comprehensive cost-cutting measures when the economy is strong. Rather it appears economists listen to Keynes’s advice only in times of downturn (“Run deficits!”) and forget his advice for booms (“Pay off debt!”).

How should the additional tax revenues be spent?

Sadly, debt reduction remains a distant prospect. What Germany has to do now is to continue to reduce deficits at the federal and state levels. Noble goals such as boosting education spending or energy security do not justify the creation of new debt during periods of economic upswing. Just as with environmental and education policy, financial policy must take into account the interests of our children and future generations.

The debt crisis persists in some euro zone countries. What burdens can German taxpayers expect to bear should the debt of one or more of these countries need restructuring?

It depends on when it were to happen. The longer an – ultimately unavoidable – debt restructuring is delayed, the higher the cost to all euro zone taxpayers. Every month, Greece, Ireland, and Portugal refinance pre-existing debt with money from the Greece loan package and the euro zone safety net, whose funds are guaranteed by euro member states and their taxpayers. Every month, in other words, risk is shifted from the private sector to the public sector. Consider a scenario in which the euro zone repeatedly purchases new bond issues (as they have with Greece) such that the euro zone becomes the sole guarantor for a state’s national debt. If a so-called haircut were then to become necessary, German taxpayers might face a tab in the upper tens of billions.

How can the Eurozone debt crisis be prevented from jeopardising Germany’s growth and the reduction of its national debt?

At least for Greece, the euro zone must arrange an orderly debt restructuring plan while private creditors still hold significant claims against the country. Banks that become endangered in the process need to be bailed out by the state, as it is significantly cheaper to save some credit institutions than to face a debt remission financed by the taxpayers. The restructuring of Greece’s national debt in order to deal with that country’s over-indebtedness is a precondition for people to regain trust in Europe’s problem-solving abilities. In that sense, the recent decisions by the European Council on the new rescue package are a big step forward even though the implied debt haircut may in the end still be too small.