Ifo Viewpoint No. 52: In the Debt Trap

Hans-Werner Sinn
Munich, 21 May 2004

A dog does not hoard sausage. The German governments did not do so either. When there was money in the till, they spent it. And when there was not enough money, they went into debt. This is how the German state slid into the debt trap in which it is now caught.

The first big leap into debt was taken by the Social-Liberal coalition of the seventies. The debt ratio (the ratio of public debt to gross domestic product) doubled from 20% to just shy of 40%. Helmut Schmidt and Walter Scheel were eager to distribute the gifts of the welfare state, but they did not want to present the bill to the citizens. The second leap occurred under Helmut Kohl. He did not dare tell the citizens the truth about the costs of unification, preferring instead to finance the transfers to east Germany on credit. The debt ratio rose from 40% to more than 60%. It was so high that Theo Waigel, then finance minister, was unable to bring Germany into the currency union in a normal fashion, which would have demanded a debt ratio of less than 60%. Thereafter, even the totally indebted Italians could no longer be denied entry to the currency union.

Gerhard Schröder and Hans Eichel followed in their predecessors’ footsteps. They raised the debt ratio from 61% in 1998 to 64% last year. This year they are pushing the debt ratio above the 66% mark, and next year they will approach 68%. Next year, the public debt will exceed 1.5 trillion euro. This will be more than three times the amount at the time of the fall of the Berlin Wall.

Going into debt is fun at the beginning. The fun stops when one sits atop the debt and must pay the interest. In the past, the topic could be pushed aside by pointing to the wealthy future generations. But this is no longer an option. Firstly, since 1995 Germany is the country with the lowest growth rate anywhere. Where then is the future wealth to come from? Secondly, the future generations are shrinking due to the Germans’ low birth rates. There is probably no country in the world in which the number of births relative to the population is as low as in Germany. The baby-boomers that were born in 1964 are now forty years old. Not many people are coming after them. Even the age cohort of the thirty-year olds is 40% smaller, and the following age cohorts will continue to shrink. No, the idea that future generations will help us out of the mess is ridiculous. We ourselves are the “wealthy future generations” of whom the politicians of the past were speaking. It is us who will have to pay the bill.

Interest on the public debt amounts to more than 68 billion euro this year, although interest rates are as low today as never before. When interest rates normalise again, the interest burden will rise by half and exceed 100 billion euro. Even today, the interest burden is higher than the net borrowing of 65 billion euro permitted by the Stability and Growth Pact.

This is the true reason why the Government is ignoring the Pact and is violating EU law. It also wants to benefit from the debt, like its predecessors, and does not see why it should borrow less than the interest payments due. That is why the budget deficit is to amount to 80 billion euro this year. As always there is not enough money, and instead of tightening its belt, the state once again writes a cheque on the future.

The Government uses the rationale that it does not want to destroy Germany by saving too much. In truth, it not only destroys Germany’s credibility but also the willingness of investors to make longterm commitments in this country. He who leaves his money in Germany must know that some day he will be asked to pay.

With its debt policy Germany has become the laughing stock of Europe. The European Commission has brought suit before the European Court to force Germany to pay the contract penalties. The presidents of the state auditing authorities and the federal auditing office have urgently asked the Government to cut spending, something unheard of in the history of the Federal Republic. All of this reeks of a larger state crisis.

The crisis must be averted. And the German state must learn that one cannot live beyond one’s means for ever. The share of gross domestic product that the state absorbs has risen by 10 percentage points since Willy Brandt’s chancellorship, i.e. from 39% to 49%. The public sector share of national income has risen to 57%. Most of the money went to the welfare state that today amounts to 600 through 700 billion euro, depending on the definition. Companies, too, received many dozens of billions of euro in subsidies. 41% of German adults live on social security, state pensions, unemployment compensation, social assistance, and similar transfers. All of this must change if Germany is to have a future again. That is why most subsides must decline, and why, over the next years, social benefits must only be raised by as much as inflation. Real economic growth must be utilised for a reduction of the public sector share. This is the only way in which Germany will be able to gradually escape the debt trap.

Hans-Werner Sinn
Professor of Economics and Public Finance
President of the Ifo Institute

Published under the title "Schulden sind unsozial", Stern, 19 May 2004, p. 194.