A different world: issues and challenges from 2006
There are some similarities between 2006 and 2019, including a growing sense that the end of a cycle may be imminent and asset prices are probably overextended. As this review of talking points from the 2006 roundtable shows, however, more has changed than remains the same.
RICHTER While it took some time to get there, the North Rhine-Westphalia budget is now balanced and has been since 2016.
SKOPNIK The länder as a whole have delivered a surplus for several years now, driven of course by the strong länder including Baden-Württemberg and Bavaria. We are pretty comfortable with the budget position of the länder right now – though we will have to see what happens if the economy really declines in the coming years.
Taking all the länder together, the budget surplus happened for the first time in 2014 and this has been the case ever since. This reflects the recovery after the financial crisis.
On a European level, reforms to the Stability and Growth Pact that were devised after the financial and sovereign crises came into effect – including in German law – as early as 2010. The newly established stability council has oversight of the länders’ debt levels and budgets and it strengthens the long-term sustainability of federal and state budgets.
Germany’s federal and state ministers of finance, together with the federal ministers for economic affairs and energy, form a council that meets twice a year to check the länder budget positions and make sure they are on a path to comply with the debt brake that Germany has established.
The debt brake states that the federal government should not create new debt unless it is experiencing a structural economic problem, and the restrictions on länder are even greater.
The länder have used the positive economic situation during the post-crisis period to decrease their overall debt levels. Only two states planned to increase net debt in 2019 and most have already reduced outright debt levels.
VOLK The zero-borrowing rule from 2020 onwards has driven the states to work continually to balance their budgets. At least at the moment they seem to be heading in the right direction to achieve this.
The German constitution is not fully written, so it can loosen the rules if there is a recession. If there is not, the states will achieve balanced budgets. It is a good constitutional rule not to act if there is no recession. On this basis, I would argue that the states are doing fine.
The states have issued more bonds recently due to lower borrowing costs. But total borrowing continues to fall on a long-run basis and the länder may borrow less in 2020.
SKOPNIK Due to the debt brake and the repayment of debt, the supply of bonds from German länder has indeed been decreasing for the last couple of years – and even more so since not all the länder are using their debt allowances in full. In 2018, in aggregate, the states used only 80 per cent of what they were permitted and some states are keeping some capacity in reserve.
VOLK I doubt they will disappear because they have to refinance outstanding debt and I think they will make use of the rule of exemptions from zero-borrowing once there is a recession. The states can undertake countercyclical policies.
SKOPNIK The state equalisation system was a topic of argument in the past because for a long time it was the same states – Baden-Württemberg, Bavaria and Hessen – that had to finance the others. This refers only to the final step of the equalisation process but the one that gets the most media attention. For the whole process, länder like North Rhine-Westphalia were also strong contributors.
Baden-Württemberg, Bavaria and Hessen didn’t want to be paying for the other states all the time, so they filed with the constitutional court several times, protesting the rulings on revenue sharing. These were always adjusted by the government. The last time it did so, it also decided to abolish horizontal equalisation between the länder.
From 2020, there will be only federal grants. In return, the federal government is requiring more competences from the länder.
VOLK One part of the system of revenue equalisation has been abolished and the federal government has supported the states in roughly equal amounts – around €10-11 billion (US$11-12.1 billion) in total. Basically, all the federal states benefit at the expense of the federal government.
RICHTER The background here is that the old scheme – whereby the states shared revenue – was set up in 2005 based on sunset legislation. This meant all involved parties had a call right after 10 years, with a call period of five years. Bavaria and Baden-Württemberg used their call rights.
Given the constitutional target of equal living conditions, state and federal governments had to agree on a new scheme. In autumn 2016, all parties agreed to a scheme that abolished inter-state flows from 2020 and compensated all states with additional payments from the federal government.
LAUTENSCHLÄGER The situation is quite different from how it was in 2006. All the points we touched upon in the first roundtable have been solved for Baden-Württemberg, including the introduction of monthly pension payments on behalf of every civil servant.
This problem no longer exists because the liabilities are not unfunded. The funded component of Baden- Württemberg’s pension schemes is about €8 billion, accumulated over the years. This is significant for the state.
RICHTER A pension fund has been set up in North Rhine-Westphalia to cover the pension liability peaks. The fund now has more than €12 billion (US$13.4 billion) in assets under management. It looks like the challenge of unfunded state pension liabilities is manageable.
SKOPNIK German states have to write to the constitutional court requesting assistance when they are experiencing financial hardship. In Germany, we have something called the solidarity principle, which means the federal government is obliged to help in times of budgetary stress. As part of the same principle, the länder have to help each other and, indeed, help the federal government if it experiences problems.
The states of Saarland and Bremen asked for assistance in the 1990s, which was granted. Berlin did the same in 2002, with the ruling coming in 2006. On this occasion, the court said no – because it believed Berlin could do more for itself. In the same ruling, however, the court confirmed the existence of the solidarity principle and that every German state has the right to ask for assistance.
Berlin sold a lot of its assets, for instance social housing that it owned, and from this improved its situation. Berlin has been performing better economically in recent years and has reduced its overall debt level. Many new companies have moved there and Berlin has become the centre of German start-up culture.
RICHTER Berlin certainly tested the bail-out scheme at that time. The judges made clear that there is no question mark behind the constitutional bail-out. But they also made the point that moral-hazard behaviour will not be tolerated.
Since 2009, the Stability Council has been in place. State and federal ministers have to present their current and expected budget performance – including their efforts to counter potential deficits. The council works with a traffic-light system and everyone is keen to have a green light. German states are now clear of this kind of budget problem.
VOLK This is an ongoing argument. When the system was reformed, I would have loved to see, more potential for competition between the federal states. They should have introduced, as there is in Switzerland, more tax competition between the federal states. But this is not realistic in Germany.
It is not that the government is forced to pay for the federal states as such, but that the system gives the states an incentive to deteriorate over time. Yes, the equalisation system is forcing the government to support the federal states – but it is still only €10-11 billion a year. The total federal budget is €1.6 trillion, so €10 billion is not much.