Unpacking Germany’s Historic U-Turn on Spending — ft. Carsten Brzeski

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27:58Welcome back. Here's our conversation with Karsten Brzezinski, Global Head of Macro Research and Chief Eurozone Economist for ING, as well as Chief Economist for ING Germany. So, Karsten, we're happy to have you on today to talk about Germany, which we've been discussing a lot recently. Last week, Scott and I discussed this new defence spending package. We've also talked about the German stock market. And we'll get to all of that. But first, I would just like to get a general picture of what's happening in Germany. And I think a good place to start would be politics. Germany held an election last month.

28:36The Conservative Party won, but not by much. Tell us what happened in the German election. Give us the state of play in Germany, the political situation, and what has happened since that election. It was a very important election. As you know, we had a collapsed government before. That was the first time we actually had a three-party coalition in Germany. First time ever. Didn't make it till the end. So with these new elections and snap elections end of February, it was more or less the idea that this would be the last election, the last chance for the established political parties to show that they can really get the economy out of the current slump before maybe extreme parties to both the right and left wing of the political landscape would gain even more votes.

29:29When you look at the results then, what did we get? Yes, we had a winner. There was the Christian Democrat Party led by Friedrich Merz, but they hardly got 30 % of the votes. I think the big surprise, no longer a surprise for Germans, but for international observers was the second place for the alternative for Deutschland. Far-right extreme party coming in with more than 20 % of the votes. And then we had the Social Democrats, the Greens, both in the former government party. They lost. The liberals didn't even make it into parliament. And now we have a new parliament actually since this week, since 25th of March.

30:11in which we do have kind of the right wing, AFD, probably being the largest opposition party. And we have also the left wing extreme, the left party, former Communist Party also being in parliament. So it is not as fragmented as other European parliaments are, but German politics has become more fragmented. Yeah, we hear a lot about the AFD party here in America. You know, obviously Elon has expressed support for this party. You know, it's the far right party in Germany. And then you mentioned the rise of the extreme far left party in Germany. Your thoughts on what this says about the situation in Germany right now?

30:57I think at the elections, there were three elements that were key. One is the economy. The German economy hadn't grown for five years in a row. We had the headlines that also beak industrial companies in Germany. had to lay off people. So it really, you know, I think also all voters understood that there is something structurally at hand in the German economy. So that clearly played a role. People were looking for answers. That is one. Then we have the migration story, where also then over the winter period, we had more attacks by, well, migrants, former refugees. So really how to integrate migrants into society has also been a big topic for these elections and clearly explained why the AFD gained so much support.

31:49And then the third point is more kind of general disappointment with established parties. This idea, the voters thinking, we had given them many chances to show that they are able to manage migration, that they are able to manage the economy in the eyes of many voters than established parties had not succeeded. So why don't we give other parties a chance? So I think this is clearly the stepping away from more centrist parties, established parties, clearly another reason why we had the support for both. And that's interesting, for both the AFD and the left extreme party. You mentioned there's five years of stagnation in Germany.

32:30And of course, last year, it happened again, the German economy shrank. I think GDP fell around 0.2%. Big picture, what has been going wrong in Germany? When you look at the economy, how it's performed compared to America in the past few years, what are the main issues that are causing that stagnation? I always call them cyclical and structural issues. Cyclical issues, pandemic, even more, war in Ukraine, energy crisis. So that clearly pushed down on industry, but also on economic activity in general. Don't forget that Germany had been highly depending on Russian oil and gas before that. So the energy price crisis was a big factor.

33:17Also geopolitical tensions for an economy that is so depending on exports. But that's not all. I always love to look at these international competitiveness rankings. And there, Germany was in the top five 10 years ago, of the most competitive economies in the world. Now, 10 years later, Germany is somewhere between number 20 or rank 20 and 25. And what does this show? This shows underinvestment, underinvestment in infrastructure, in digitalization, in education. So Germany has more or less forgotten to really innovate, to invest in the future. And this is what now all these things came together.

34:01Another important factor, but also only showing it, is the changing role of China. Over the last couple of years, and I think electric vehicles is the best example, but there's more to it, that China is now able to produce the stuff that normally imported from Germany. So China has moved from being a very great flourishing export market for the German industry to a rival. and then the German industry has not been able to face this competition. So as Germany goes, kind of so goes Europe. Largest economy, about 4.6 or 4.7 trillion. I think the next biggest is the UK at about three and a half. If the US can't be counted on in terms of resources for Ukraine, then EU gets to make a decision around how supportive or not supportive they are of Ukraine.

34:53and that's largely i think going to be dictated not entirely but substantively by germany's approach or view on how supportive or not supportive they want to be of ukraine i'm just could you attempt to distill for us the general feeling about the war in ukraine and how how resolute or how firmly behind ukraine germany is or isn't uh given the fact that europe's now I mean, I hate to say this, but more on their own than before in terms of support or lack thereof of Ukraine. The German people clearly stood behind Ukraine and stood behind support for Ukraine. But don't forget that Germany was a split country with different cultural backgrounds, also with different historical backgrounds vis-a-vis Russia.

35:50but this war in ukraine is only a few hundred kilometers away from germany so this is pretty close by um and and you had an interesting well combination of still of fear from russia fear that the whole thing could escalate i think germany was not alone in in 2022 which i think also um made that the German government back then was also maybe too cautious and giving big support for Ukraine, because there was always this fear of any nuclear or technical nuclear reaction by Russia. But the general feeling, Scott, is that really the Germans stand behind support for Ukraine. And if you now really look at what happened over the last couple of weeks, because I think that is even more important than what happened in 2022, 23, and 24, is that Germany and also the German people understood that the role of the U.S.

36:54has completely changed. And this is, well, me not being the economist, but just an ordinary person. I'm born in West Berlin. I'm actually born in the U.S. sector. and I grew up always with this strong belief in the U.S. would support us if push came to shaft. And that is not only me personally, but I think that is something that an entire generation has or has had. And now the problem is, I think many in Germany understand, we can no longer count on this U.S. support, on the U.S. being the last resort. So, which now if you do that, and this is also why we had this big historic fiscal package. And it is not even the new government, because technically speaking, we don't have a new government.

37:48We have possibly an incoming government, but we don't have officially a new government. So, and that is the interesting thing. So, we now had that the probably incoming government, with the probably incoming next chancellor, Friedrich Merz, decided to go for a historic fiscal U-turn, not only on spending more for infrastructure, but to really go for whatever it takes on defense. And I think this is where you're heading to. I think Germany has now understood, and I think most of Europe has understood that Europe needs to step up its game. Yeah, just on the spending package, Carsten, it sounds like this is a turning point in terms of Germany's approach to spending in general, both spending on defense and then also spending on infrastructure, which compared to its peers has historically been very low.

38:44But then there's also the debt side, where Germany has had this basically allergic reaction towards debt and towards borrowing for, I mean, certainly the past many decades. You know, lowest debt to GDP in the G7, one of the lowest borrowing rates. Two questions. One, why do you think Germany has had this approach to borrowing in the past? And two, do you think this is a turning point in terms of debt too? Do you think that we're about to see a country that embraces more fiscal liberalism, I guess I would say, and embraces debt in the same way that perhaps America does? short linguistic journey for you guys um in in german debt means the same as guilt and i think that is not the only language um but but that is an important one yeah um so somehow debt like government debt always had had a negative a negative connotation um let's explain something because the funny thing when you really go back i think until the late 1960s Germany had also been in a kind of, well, this was mainly a fiscal policy framework which allowed deficits only for investments.

40:02We'll call this one of the first golden rules on fiscal policies. Then with the oil crisis and inflation in the 70s, all things changed, and we saw this surge in government debt across the entire G7. Then came the financial crisis. Well, do fast forward, financial crisis 2008-2009, Germany also had to bail out some smaller banks, but with lots of taxpayers' money. And this was the moment when the government back then said, hey, we need to make sure that politicians will not be irresponsibly spending taxpayers' money. So let's go for this constitutional fiscal debt break. Back then, clearly, it made sense, tied politicians' hands.

40:52Then we had the Euro crisis, and in the Euro crisis, 2010, 2012, well, this entire debt break came in handy. Why? Because Germany could lead by example. So Germany was clearly the fiscally frugal country, which could tell the southern European economies to also do austerity. All good. Then I think this is then when the mistakes started to come in, because in the 2010s, after the Euro crisis, Germany was still going on with its fiscal debt break and the fiscal debt break became a political issue because the political issue was this is something one of the very few economic promises all governments led by Angela Merkel were able to fulfill and this was very interesting or very easy to understand for voters.

41:42this was like a normal person, cannot spend more money than it earns. So therefore, why should the government spend more money than it earns? What did not get so much attention in the last decade was the fact that, yes, Germany ran fiscal balance budgets, sometimes surpluses, but it was always because Germany was applying austerity on investments. The government continued to consume and to spend, give out nice electoral gifts, but they forgot to invest. And now, right now, I think we have their research institutions saying that we have an investment gap in Germany of some 600 billion euro. And this is explaining also this loss in international competitiveness.

42:34It's an investment gap mainly in infrastructure, but then infrastructure, conventional and digital infrastructure. And now the interesting thing is it clearly is a political issue. And it also was one of the big topics during the election campaign. Do you want to change the fiscal debt break or don't you want to change the fiscal debt break? Very easy. And now, and that was also the interesting thing because the CDU, Christian Democrats, Friedrich Merz. They always said to you in the election campaign, no, we're not going to change anything. We're going to stick to the debt break. Well, he made this U-turn, this very important U-turn.

43:13And what we're having right now, I think that's also important also for your listeners and viewers here. So what is it that we got in this historic decision? We now have a fiscal package of 500 billion euro to be spent on infrastructure. There are some details of these 500 billion euro, 100 billion euro go into a climate transition fund, 100 billion euro go to the regional state governments, but also to be used for infrastructure investments. And then 300 billion euro remain at the federal government for infrastructure investment. So that is one big package. also means that to be spent over the next 10 to 12 years would make up like 1 % of GDP every single year.

44:05Then we have the other thing, smaller detail, but not completely unimportant. The regional states get more fiscal space. So a bit like what you guys have in the US, until now, the state governments had balanced budget amendments. So they were not allowed to run any single deficit. So now they get a bit more fiscal space, also increasing spending power. And the third point then is clearly defense. And then with the defense story, also technical issue. So what the technicality says is all defense spending in excess of 1 % of GDP will be exempted from the debt break. So simply meaning that Germany could run extreme high annual deficits.

44:53Stay with us.

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47:10We're back with Prof G Markets. When you look at the stock market, I mean, the German DAX hit an all-time high. It's up around, I think, almost 15 % in the past year. But so is the European stock market, which is way outperforming the S &P. I think it's up almost 10 % year to date. Is all of that optimism in Europe, is this all downstream of this U-turn, as you put it, in fiscal spending? Is that what's inspiring this massive surge that is clearly unique to Europe? It's not happening in America. What is that optimism all about? It nicely coincided with this entire debate on Trump session, Trump slump in the US.

47:54So you clearly see that investors got afraid about what's happening in the US. So let's move out of the US. Where can we go to? Then at the same time, we had this big, well, and that is historic, U-turn in German fiscal policy. But we also had at least the announcements that Europe as a whole will spend more on defense. So clearly, clearly positive. We also know the good old saying that Europe very often overpromises and underdelivers. But I think that's also important. Most of these things are relative. So compared to where we were in January, for example, where we were in dynamic growth in Europe, a long-lasting structural stagnation in Germany and very little positive prospects for this year and even the year after, plus the looming tariff threat.

48:52And I think this is the starting point of Europe this year. If you look at the current situation, what has changed? The delta is clearly positive. The delta is German fiscal policy, EU willing to do more on defense, and at least while we speak, we don't have the tariffs yet. Well, come April 2nd, different story. But so therefore, relatively speaking, the European outlook has improved. I'm always, I love Europe, but I'm always warned against too much europhoria. So let's also be clear, because it first really needs to be implemented. it. But from where we were coming from, the outlook has clearly improved.

49:40Each year, Carson, we make a series of predictions. And one of our big markets prediction at the end of 24 was that for the first time in a long time, the rivers of capital would reverse flow. Out of everything, it seemed globally flowing into U.S. growth and back out to international markets, and we specifically called out European value. And right now, it's better to be lucky than good. It appears that is happening. And we've seen a massive uptick in capital inflows to the European market. Do you think this is a kind of a blip, or do you think that Europe has new life, potentially this is the beginning of a multi-year trend?

50:23It's more than a blip. it's somewhere in the middle I'm still cautious enough to say this is not necessarily the start of a multi-year rally let's also be clear but it's more than a blip because I really think we will get more fiscal stimulus which factors, which drivers will now decide on whether this could be a multi-year rally or whether it is more short-lived. This is whether Europe, and I'm now looking again at my home country, Germany, will really be able to also implement structural reforms. I think what I was saying is that spending more money is a good thing. At the current juncture, it is a necessity when it comes to defense.

51:17Don't expect too much economic growth coming out of these defense spendings, at least not this year and next year. So this is a slow burner for Europe because Europe first needs to build up production facilities on military equipment. But infrastructure spending is traditionally positive. But to be very blunt, does 500 billion euro infrastructure spending in Germany now make that the German automotive industry will become more competitive again vis-a-vis China? No, not automatically. And this is why there is more needed than only fiscal spending. And if we get this, what is more needed, and that is topics you all know, this is a bit like in the U.S., reduce bureaucracy, reduce regulation, but also invest in education.

52:11Also really decide and investigate which sectors are actually sources of growth over the next couple of years. in which sectors will Europe be able to compete with China, but also with the U.S.? And I think this discussion has not really gained momentum yet in Europe. If it does, then I would become more optimistic and could even see a longer period of higher growth in Europe. But I'm not overly optimistic yet. There's always a question as an American living in Europe that how come Europe hasn't been able to establish very many tech unicorns? If you look at the number of unicorns that have come on the scene, the proportion of them is actually still fixed in the U.S.

53:02It appears that the rise of China has come at the expense of Europe. And there's a lot of questions about culture. My thesis has always been in Germany because they do a pretty good job of creating on-ramps for, quite frankly, for young men into a decent middle-class life, even without a college degree, that the downside isn't as great so people aren't as risk-aggressive. what what do you see happening in the german tech sector and i'm i've i've met the ceo of a company called salonus and i'm just curious what you think about software and german the german tech environment this is especially relevant right now because sap which is of course the whatever you want to call it the sales force of germany is enterprise sass they just took the crown as the most valuable company in Europe.

53:53They just overtook Nova Nordisk as of this week, now worth$320 billion. So I have the same question as Scott. It looks like maybe German tech is seeing a resurgence, but historically it hasn't been that great. I'm a sell-side economist, so I will not give you any trading recommendations or any individual titles. But Scott, let me just start a bit longer, because you're fully right. This is risk aversion. I think this is one of the more general explanations. And I lived abroad for a long while and then came back to Germany 11 years ago. And then you come to your own country, but with a fresh pair of eyes.

54:39And what I noticed in the very first day, so you go to a grocery store and then you have this kind of elevator music in the background plus some commercials. And these commercials were about what? You know, security stockings and insurances. So, and this was already, you know, somehow telling that, you know, we are not a risk-loving culture. We are risk-averse. And this applies to actually most of Europe. I would argue this is also one of the biggest reasons why we, for example, need a capital markets union, a European capital markets union. which could then also not only change cultural risk behavior but would also allow us that we really have kind of private risk capital.

55:28So when you look to tech companies, to startups in general, it is very hard in Europe to get funding. And this is why they very often then move to the U.S. And we do have many smart people. We do have very good universities at clearly much lower tuition than in the U.S. But when these smart people then develop something, they hardly ever end up in Europe because they are either not supported by the university or the surroundings. They don't find that there is capital, so they move on. So turning to Germany and tech, we had over the last couple of years clearly some very interesting fintechs coming out of Germany.

56:17As I said, sell-side economists, I won't mention any names, but there is clearly something going on. We also had in Berlin, for example, a very good sound startup community. So that is also something that has clearly been happening. regulation, access to capital, is probably the biggest hurdles in Germany and in Europe to make any startup, including the tech companies, really successful. And this is why, Adia, you mentioned one of our champion league players in Germany, and you also know when they were founded. So I think they are more or less my age. So this is no longer a young startup. We are coming from behind now compared with the US, compared with China.

57:17And you're fully right, Scott, that it looks as if China took over the European position. But I think that Europe has understood. So an important milestone was this report by Mario Draghi last fall, an important one. Germany's fiscal U-turn now is another important one. Europe never moves extremely fast, but it moves. And if Europe now really starts to reduce bureaucracy, regulation, provides better access to risk capital, you know i'm i'm still positive that we could see some new unicorns coming out of europe carlston one final question for me we've discussed many of the downside risks and the upside risks for europe um we haven't fully gone into the tariffs uh trump has announced these reciprocal tariffs they're supposed to go into effect on april 2nd we don't really know the details but it should affect Europe.

58:18Just as we wrap up here, give us a sense of what these tariffs will do to Europe, what Europe's reaction has been, and how impactful they might be. They will clearly be impactful. Germany exports, I think, 150 billion euro per year to the US. So if we were to see 20-25 % tariffs, obviously, this is going to hit German and European exporters. To determine the full magnitude is, in my view, impossible, because we simply don't know the price elasticity. I think someone being able to afford a luxury German car in the US will also be able to pay 20 % more on that. But it's going to hurt. And that is, I think, the important one.

59:10It's going to hurt a still hardly growing economy. You know what? To me, even more than only tariffs, the biggest risk for Europe is that if the U.S. administration was also to deliver the tax policies that are in the plans. So if the U.S. administration really manages to make the U.S. economy more attractive, then tariffs are not only about this kind of short-term shock or negative impact on Europe, but they are rather this stick to relocate production out of Europe to the U.S. And I think that is, to me, from a European point of view, the biggest risk for Europe. And the even more interesting thing right now is that we will have, and that is the challenging thing for economists these days, how do you forecast the whole thing?

1:00:11We have two extremely opposing drivers. We have the looming tariffs that are clearly euro negative, and we have the fiscal packages and defense spending that are euro positive. You know, how do you make a reasonable growth forecast right now? Extremely hard. Karsten Brzezinski is the Global Head of Macro Research and Chief Eurozone Economist for ING. He previously worked at the Dutch Ministry of Finance and the European Commission. He is a 2019 JFK Memorial Policy Fellow at Harvard University and member of the Advisory Council on International Affairs for the Dutch Government and Parliament. Karsten, this was very enlightening.

1:00:51Really, really glad you could join us today. Thank you for your time. Thank you, Carson. Thanks for inviting me. This episode was produced by Claire Miller and engineered by Benjamin Spencer. Our associate producer is Alison Weiss. Mia Silverio is our research lead. Isabella Kinsel is our research associate. Drew Burrows is our technical director. And Catherine Dillon is our executive producer. Thank you for listening to Prof G Markets from the Vox Media Podcast Network. If you liked what you heard, give us a follow and join us for a fresh take on markets on Monday.

1:01:27You help me In kind reunion As the world turns And the dark flies In love

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