Conversation with Marcel Fratzscher
It is commonly said in France that the German economic model is being weakened by the ban on Russian gas and by the slowdown in exports to China. Is this a fair assessment of the German situation?
La Grande Conversation
No. The slowdown of exports to China is just one specific point. Germany currently faces many other challenges that explain the short-term weakness in the business cycle. German structural difficulties are much broader than that. China is a significant challenge –China is an important partner for Germany from an economic point of view– but the problems extend far beyond that. China matters because of Germany’s dependence on foreign direct investment there, because of key technologies (consider battery technology, for instance), because of raw materials. China is the elephant in the room. Yet equally challenging is trade with the US –concerning the tariffs Donald Trump is threatening to impose, which would hit Germany particularly hard– as well as energy dependence on Russia and others.
Marcel Fratzscher
When it comes to structural problems, much was said about underinvestment in infrastructure and especially in the digital economy.
La Grande Conversation
Germany has three major economic challenges. First, globalization and global value chains: can it maintain its economic model based on openness? I believe so, but it needs to do this more strategically; diversification is the answer –not reshoring, not friendshoring, not de-risking. Still, it needs de-risking because, to some extent, diversification is de-risking. Thus, Germany’s economic model is the right one, but it needs to become more strategic in terms of diversification. That’s the first challenge.
Second, there is a technological challenge regarding green technologies and digitalization. E-mobility in the auto sector is one example where German companies have been too slow. Another challenge is the development of renewable energy and reducing energy costs. This manifests in many areas, including digitalization. Germany is not alone here; all of Europe lags behind while US/North American and Asian companies increasingly dominate. This creates a challenge not just for new sectors but for industry overall. In the technical and technological sphere, Germany and Europe must become more agile.
Thirdly, there is a social transformation. The biggest impediment we see today in Germany, in my view, is that citizens have not understood that changes in these first two areas are essential to maintain good jobs, competitiveness, innovation, and some degree of autonomy from Asia and North America. These are the three transformations. While all countries share them, some particularly challenge Germany because of its economic model. Reshaping globalization affects Germany more strongly than others. Regarding green technologies and digitalization, this challenge is shared by all Europeans, but it’s likely harder for industry –and Germany, of course, since it has a larger industrial sector. Industries are more important for Germany than for most other European countries. Therefore, while these are common challenges, some are specifically difficult for Germany to tackle.
Marcel Fratzscher
Having to face these challenges means substantial investments. So, there is also the issue of investment and of the debt brake (Schuldenbremse). How is the political debate on this topic?
La Grande Conversation
Germany has a peculiar and unhealthy relationship to savings and debt, as most know. The European Union has its new fiscal rules, and Germany believes we can be tougher. However, in Germany, it’s detrimental to do so. The debt brake has become an important impediment to more public investment and, thereby, to more private investment. This is because companies will not invest without good infrastructure, support for innovation, well-qualified workers, and good financial conditions. The debt brake has not only been the key reason why the last German government collapsed, but it’s also one reason –not the only one, but an important one– why Germany is losing competitiveness. This debt brake needs reform. However, Germany has a peculiar relationship to debt. In the German language, we use the same word (“Schuld”) for “debt” and “guilt.” Therefore, I don’t think Germany is ready to fundamentally reform the debt brake. German citizens support it because they believe debt is inherently negative. It’s very difficult to explain that there is such a thing as “good debt.” For many Germans, this is an oxymoron, a contradiction in terms. I hope that in the future, Germans will be more pragmatic and simply bypass the debt brake. That’s the best hope I see for the next four years.
Marcel Fratzscher
But is there a way to address this at the European level? As you’ve said, we have common challenges: green technologies and digitalization. Does it make sense to think that at the European scale we can invest in new technologies, in new industrial projects, together? Or is this just a French fantasy?
La Grande Conversation
I would say it’s the only way forward for Germany, France, Italy and everyone else. When considering green and digital technologies, these are global challenges, often involving huge economies of scale and requiring significant investment. Artificial Intelligence is just one example. To develop such technologies and to be competitive in global markets requires a large single market, which Germany is not. Germany is a small economy compared to the US and China. The answer must be European, and that requires many elements. In my view, it requires studying the Draghi and Letta reports and implementing their key elements, completing the single market for services, including capital market union.
We need new thinking on European debt. In 2020, Next Generation EU showed that a European approach is possible and, to be frank, the Corona pandemic was economically minor compared to what lies ahead regarding green transformation, digital transformation, and defense. We need these European approaches in terms of single markets, competition policies, joint infrastructure projects, fostering research and development with public funding, and we need some form of fiscal union in Europe. In what I say next, I have most Germans against me, but I must be honest: I don’t see how we can remain economically competitive with the US and China over the next five to ten years without a major push on public and private investment at a European scale. This applies to defense as well. While not an economic issue, it is equally important. I don’t see how we remain competitive without a major European initiative, without being able to defend ourselves and make Europe secure. This is what we need in the next few years.
Marcel Fratzscher
You mentioned the Trump tariffs. There is also concern that European countries, threatened with high tariffs, would negotiate directly with the US to secure exemptions. Do you think Europeans can unite to respond to these new American tariffs? Or is there a real risk of fragmentation with each country negotiating directly with Washington?
La Grande Conversation
Unfortunately, in the past five years, we have too often seen national initiatives. Consider Macron and Scholz going to China individually within weeks of each other two or three years ago, instead of going jointly! It was a significant missed opportunity. China and the US are adept at divide-and-conquer strategies with Europe. As long as France and Germany don’t stand together, don’t maintain a unified position and lead others, we will fail. I don’t see, on either the German or French side, how we will accomplish that over the next two or three years. With the new German government, I saw little commitment in the election debate among democratic parties to reform Europe and transfer competences to the European scale, which is what’s needed. I haven’t heard a single one of the parties address this. The next coalition partners in the federal government have made this a non-priority. I’m typically optimistic, but not in this regard.
Marcel Fratzscher
Do you think all these issues, including structural changes in Germany, were adequately discussed during the legislative campaign?
La Grande Conversation
No. In Germany, the crisis isn’t severe enough, and Germany remains stuck in melancholy –a melancholic view that we can return to ten years ago. Germany would prefer to return to 2018. The 2010s were a very successful decade, though narrow and self-serving for Germany. There was strong growth and high employment growth. Wages increased and there was substantial economic stability. The government had fiscal surpluses and didn’t know how to allocate the money. They spent it primarily on social benefits. The election campaign has shown clearly that parties haven’t understood they must move forward. Transformation means change. Change is painful because some companies will disappear, others will shrink. The industry must shrink. Merely promising we can maintain everything as is, as the democratic parties do, doesn’t help. It’s simply not true. We cannot maintain everything as is. To increase social spending and promise pension increases, knowing Germany faces a significant demographic problem over the next ten years, is unrealistic. It’s not honest.
In short, we see an election debate focused on redistribution. The parties right of center want to redistribute from poor to rich, promising substantial tax cuts, mostly benefiting the top 10% of income earners. The parties left of center promised increases in social spending, particularly on pensions. The Social Democrats and the Left Party did so, making promises nearly as substantial as the tax cuts on the right. Consider the pension package number two, which the traffic light government failed to pass, but the Social Democrats now promise to implement; the next legislation would redistribute the equivalent of 40% of GDP over the next 30 years (not annually, but in total). This means redistribution toward pensioners, toward older people and essentially from young to old. That’s what I mean by redistribution. The right of center approaches it more from poor to rich and the left of center more from young to old, which is also from poor to rich. This occurs without understanding that we need to spend more money. We need to reduce entitlements for older people. That’s where the voters are. This isn’t feasible yet. And as I mentioned, the crisis in Germany likely needs to deepen before that mindset changes.
Marcel Fratzscher
But Germany is already in recession.
La Grande Conversation
Germany is in stagnation, which differs somewhat. Looking at the economic situation, it’s relatively good. Overall, unemployment remains very low. Companies face a shortage of workers rather than unemployment. Over the past ten years, wages have increased substantially. Yes, the lower 20-25% of the income distribution struggle because of high inflation over recent years related to energy and food, and because of rising housing costs. However, for the middle, upper-middle income and wealthy segments, the situation remains relatively good and much better than the mood suggests. The mood shows everyone is depressed, but the economic reality isn’t nearly as bleak as sentiment indicates.
Marcel Fratzscher
By contrast, do you think the crisis in France is severe enough to force change?
La Grande Conversation
I lack detailed knowledge about France to offer a comprehensive perspective. However, France and Germany share many issues. I mentioned social transformation as, in my view, the biggest challenge. Another challenge is the shift of more people to the extreme right to join democratic parties, which France experienced somewhat earlier than Germany, though Germany now moves in the same direction, making transformation very difficult. If you have polarization and infighting rather than solidarity, everyone pulls in different directions. I see similarities. France has different problems with a significant fiscal deficit, perhaps slightly excessive. It needs to reduce spending. But it has performed better in terms of growth and activity in recent years. It has succeeded more in implementing reforms. Consequently, we could learn from each other if we weren’t confined to our narrow national perspectives. France faces different challenges. Some challenges are similar: the social challenge mirrors ours. In other areas, fiscal policy and transformation may differ somewhat. But I wish we Germans looked beyond our national borders more often and tried to learn from others about what we can improve.
Marcel Fratzscher
We share the same redistribution problem you mentioned between young and older people with our pension system. But we mainly face a problem of fiscal discipline. Do you think this weakens the prospect of cooperation with France from a German perspective?
Even if France had a substantial fiscal surplus, convincing the German government –not just the past five administrations but the next two– would remain difficult. As I mentioned, I believe we need a major fiscal initiative, a significant public investment program at the European level in infrastructure, innovation and new technologies, and defense. As long as Germany maintains the view that “we are the paymaster and we provide the money while everyone else spends it on their needs,” we will fail to achieve a joint European initiative. The understanding in Germany that we cannot continue alone isn’t yet present. This is what all parties promise their voters: “We can continue alone. We just need to do the right thing.” Europe barely featured in this election debate.
Marcel Fratzscher
Do you think the energy crisis linked to the Russian invasion of Ukraine is over for Germany?
La Grande Conversation
The most intense phase of the crisis has passed. We shouldn’t forget that in summer 2022, we had serious concerns about winter –whether we would have sufficient gas or need to shut down some energy-intensive industry in Germany. That didn’t occur, marking a success for the previous government. Therefore, it’s not an energy crisis. Germany has higher energy costs than the US, which it always had. Now the difference is somewhat larger, which poses a problem. Germany’s average energy costs within Europe fall somewhere in the middle. For Germany, the challenge lies in accelerating renewable energy development. Germany has performed well under the previous government, particularly succeeding with solar energy and wind power, largely meeting objectives for 85% renewable energy by 2030. In other areas, such as heating or transport, Germany lags behind. I would characterize the previous government’s results as mixed. Energy costs will decrease only if we succeed in accelerating renewable energy development, and nuclear power isn’t an option. I think we should show more tolerance within Europe. France’s use of nuclear power is acceptable, even with substantial subsidies. It helps reduce dependence on fossil fuel imports from Russia and elsewhere. But over the next decade, the priority must focus on renewables across Europe. We need an improved common European approach, especially regarding infrastructure.
Marcel Fratzscher
