The collapse of Germany’s deeply unloved and dysfunctional three-party coalition offers Europe’s biggest economy an opportunity for political and economic renewal. Two important questions arise: Will Germany put aside political squabbles and grab its golden opportunity. And if so, what can and should it do?
On the first point, I’m not entirely confident. On the second, there’s no shortage of bold and sensible ideas — reforming Germany’s debt brake to fund investment, stemming an exodus of capital and properly funding the country’s military are obvious places to start.
While the leader of the opposition conservatives, Friedrich Merz, is most likely to become Germany’s next chancellor, the CDU/CSU is polling at around 32% and can’t govern alone. The increasing fragmentation of German politics — first via the rise of the far-right Alternative for Germany and more recently the far-left, anti-migrant Alliance Sahra Wagenknecht — makes coalition building especially tricky.
Merz, a business-friendly Atlanticist with a famously short fuse, rightly rules out governing with the AfD; meantime, the business-friendly Free Democrats are polling so badly they might fall below the 5% hurdle required to get seats in parliament. Hence Germany’s next government is likely to be another coalition of uncomfortable bedfellows, with the conservatives ruling either with Social Democrats or the Greens among the possibilities. After the, at times, maddening political ructions of the past three years, I wouldn’t blame voters for fearing we’d then be back to the same tired debates and lack of political consensus.
Merz is clear-eyed about the threats to German prosperity, but I worry much of the electorate still doesn’t fully appreciate the mess the country is in. It’s tempting for them to view Germany’s economical troubles as cyclical, when the reality is they are structural and therefore difficult to fix.
A combination of weak productivity growth, decrepit infrastructure and an aging workforce means economic output risks stagnating for years to come. Meanwhile, the country’s traditional industries — above all its automotive companies — face massive threats to their competitiveness. Even Volkswagen AG, which long prioritized job preservation over making money, is considering closing German factories.
There’s a danger of a vicious cycle. Weak growth and capital flight lead to lower tax receipts, which in turn creates intractable rows about how the economic pie should be divided — as we’ve seen time and again when Germany tries to pass a budget.
In other nations, the solution would be obvious: borrow more to fund investment. But that’s been a non-starter due to the country’s debt brake, which limits new debt to no more than 0.35% of gross domestic product each year (albeit with some limited flexibility to accommodate emergencies and the economic cycle). This is needlessly restrictive given German borrowing is low by international standards. So my first plea to Germany’s next government is simple: For goodness sake, reform the debt brake.
Merz’s conservatives are sticklers for balanced budgets, but recently its leader has sounded ever so slightly more amenable to revising the debt limit (while continuing to insist that Germany also makes more of an effort to control social welfare spending.)
Economy Minister Robert Habeck has proposed establishing a fund to bolster domestic investment by offering companies a 10% subsidy. While Habeck’s idea is worth considering, it will require fiscal firepower. Loosening the debt brake would also make it easier to renew Germany’s military, ensuring it can properly defend itself and support Ukraine. While Berlin will this year meet its North Atlantic Treaty Organization commitment of spending 2% of GDP on its military for the first time in decades, a second Donald Trump presidency adds to the imperative for Germany to fulfil its responsibilities.
If Merz insists on keeping the debt brake, there are other ways to mobilize capital. As I’ve argued before, Germans are sabotaging their own prosperity and the corporate sector by squirrelling away billions of savings in low-yielding bank accounts. While recently deposed Finance Minister Christian Lindner was often a troublesome thorn in the coalition’s side, his ideas to create more of an equity ownership culture and reform the country’s pay-as-you-go pension system were refreshing and shouldn’t be ignored. Happily Merz – a former corporate lawyer and supervisory board chair of BlackRock Asset Management Deutschland AG knows a thing or two about capital markets.
A cull of housing regulations to spur more construction should be on high on the next government’s agenda, as Germany is falling woefully short of the needed 400,000 new homes a year, and around half the population remains locked out of the housing market. And Berlin must redouble its support for startups: Small- and medium-sized companies known as the Mittelstand remain the backbone of German innovation, but the number of new businesses being started is shockingly low.
Finally, a new government should reassess energy policy. In what must be one of the most self-defeating moves of the post-reunification era, the three-party coalition went ahead with the closure of Germany’s last three nuclear power plants in 2023 – even amid a worsening climate crisis and the loss of gas imports caused by Russia’s invasion of Ukraine.
Switching those plants back on again might be technically and politically difficult — but it would signal a recognition by Germany that the time for timidity and false compromises is over.
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